CHAPTER 1 Accounting in Action ASSIGNMENT CLASSIFICATION TABLE Brief Exercises A Problems B Problems 5, 6, 7, 11 1A, 2A 4A 1B, 2B 4B 5, 6, 7, 8 6, 7, 8, 10, 11 1A, 2A, 4A, 5A 1B, 2B, 4B, 5B 9, 10 9, 12, 13, 14, 15, 16 2A, 3A, 4A, 5A 2B, 3B, 4B, 5B Study Objectives Questions Exercises 1. Explain what accounting is. 1, 2, 5 1 2. Identify the users and uses of accounting. 3, 4 2 3. Understand why ethics is a fundamental business concept. 4. Explain generally accepted accounting principles and the cost principle. 6 4 5. Explain the monetary unit assumption and the economic entity assumption. 7, 8, 9, 10 4 6. State the accounting equation, and define assets, liabilities, and owner’s equity. 11, 12, 13 1, 2, 3, 4 7. Analyze the effects of business transactions on the accounting equation. 14, 15, 16, 18 8. Understand the four financial statements and how they are prepared. 17, 19, 20, 21 3 1-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Analyze transactions and compute net income. Moderate 40–50 2A Analyze transactions and prepare income statement, owner’s equity statement, and balance sheet. Moderate 50–60 3A Prepare income statement, owner’s equity statement, and balance sheet. Moderate 50–60 4A Analyze transactions and prepare financial statements. Moderate 40–50 5A Determine financial statement amounts and prepare owner’s equity statement. Moderate 40–50 1B Analyze transactions and compute net income. Moderate 40–50 2B Analyze transactions and prepare income statement, owner’s equity statement, and balance sheet. Moderate 50–60 3B Prepare income statement, owner’s equity statement, and balance sheet. Moderate 50–60 4B Analyze transactions and prepare financial statements. Moderate 40–50 5B Determine financial statement amounts and prepare owner’s equity statement. Moderate 40–50 1-2 Study Objective Knowledge Comprehension Application Analysis Explain what accounting is. Q1-1 Q1-2 Q1-5 E1-1 2. Identify the users and uses of accounting. Q1-3 Q1-4 E1-2 3. Understand why ethics is a fundamental business concept. E1-3 4. Explain generally accepted accounting principles and the cost principle. Q1-6 E1-4 5. Explain the monetary unit assumption and the economic entity assumption. Q1-8 Q1-9 Q1-7 Q1-10 E1-4 6. State the accounting equation, and define assets, liabilities, and owner’s equity. Q1-11 Q1-12 Q1-13 BE1-4 E1-5 E1-6 E1-7 BE1-1 BE1-2 BE1-3 E1-11 P1-1A P1-2A P1-4A P1-1B P1-2B P1-4B 7. Analyze the effects of business transactions on the accounting equation. Q1-14 Q1-15 Q1-16 Q1-18 BE1-5 BE1-6 BE1-7 BE1-8 E1-6 E1-7 E1-8 E1-10 E1-11 P1-1A P1-2A P1-4A P1-5A P1-1B P1-2B P1-4B P1-5B 8. Understand the four financial statements and how they are prepared. Q1-17 Q1-19 BE1-10 Q1-20 Q1-21 BE1-9 E1-9 E1-12 E1-14 E1-15 E1-16 P1-2A E1-13 P1-3A P1-4A P1-5A P1-2B P1-3B P1-4B P1-5B 1-3 1. Broadening Your Perspective Exploring the Web Financial Reporting Comparative Analysis Exploring the Web Synthesis Evaluation All About You Comparative Analysis Decision Making Across the Organization Communication Activity Ethics Case BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. Yes, this is correct. Virtually every organization and person in our society uses accounting information. Businesses, investors, creditors, government agencies, and not-for-profit organizations must use accounting information to operate effectively. 2. Accounting is the process of identifying, recording, and communicating the economic events of an organization to interested users of the information. The first step of the accounting process is therefore to identify economic events that are relevant to a particular business. Once identified and measured, the events are recorded to provide a history of the financial activities of the organization. Recording consists of keeping a chronological diary of these measured events in an orderly and systematic manner. The information is communicated through the preparation and distribution of accounting reports, the most common of which are called financial statements. A vital element in the communication process is the accountant’s ability and responsibility to analyze and interpret the reported information. 3. (a) Internal users are those who plan, organize, and run the business and therefore are officers and other decision makers. (b) To assist management, accounting provides internal reports. Examples include financial comparisons of operating alternatives, projections of income from new sales campaigns, and forecasts of cash needs for the next year. 4. (a) Investors (owners) use accounting information to make decisions to buy, hold, or sell stock. (b) Creditors use accounting information to evaluate the risks of granting credit or lending money. 5. Bookkeeping usually involves only the recording of economic events and therefore is just one part of the entire accounting process. Accounting, on the other hand, involves the entire process of identifying, recording, and communicating economic events. 6. Karen Sommers Travel Agency should report the land at $90,000 on its December 31, 2008 balance sheet. An important concept that accountants follow is the cost principle. The cost principle states that assets should be recorded at their cost. Cost has an important advantage over other valuations: it is reliable. Cost can be objectively measured and can be verified. 7. The monetary unit assumption requires that only transaction data capable of being expressed in terms of money be included in the accounting records. This assumption enables accounting to quantify (measure) economic events. 8. The economic entity assumption requires that the activities of the entity be kept separate and distinct from the activities of its owners and all other economic entities. 9. The three basic forms of business organizations are: (1) proprietorship, (2) partnership, and (3) corporation. 1-4 Questions Chapter 1 (Continued) 10. One of the advantages Maria Gonzalez would enjoy is that ownership of a corporation is represented by transferable shares of stock. This would allow Maria to raise money easily by selling a part of her ownership in the company. Another advantage is that because holders of the shares (stockholders) enjoy limited liability, they are not personally liable for the debts of the corporate entity. Also, because ownership can be transferred without dissolving the corporation, the corporation enjoys an unlimited life. 11. The basic accounting equation is Assets = Liabilities + Owner’s Equity. 12. (a) Assets are resources owned by a business. Liabilities are claims against assets. Put more simply, liabilities are existing debts and obligations. Owner’s equity is the ownership claim on total assets. (b) Owner’s equity is affected by owner’s investments, drawings, revenues, and expenses. 13. The liabilities are: (b) Accounts payable and (g) Salaries payable. 14. Yes, a business can enter into a transaction in which only the left side of the accounting equation is affected. An example would be a transaction where an increase in one asset is offset by a decrease in another asset. An increase in the Equipment account which is offset by a decrease in the Cash account is a specific example. 15. Business transactions are the economic events of the enterprise recorded by accountants because they affect the basic equation. (a) The death of the owner of the company is not a business transaction as it does not affect the basic equation. (b) Supplies purchased on account is a business transaction as it affects the basic equation. (c) An employee being fired is not a business transaction as it does not affect the basic equation. (d) A withdrawal of cash from the business is a business transaction as it affects the basic equation. 16. (a) Decrease assets and decrease owner’s equity. (b) Increase assets and decrease assets. (c) Increase assets and increase owner’s equity. (d) Decrease assets and decrease liabilities. 17. (a) Income statement. (b) Balance sheet. (c) Income statement. 18. No, this treatment is not proper. While the transaction does involve a receipt of cash, it does not represent revenues. Revenues are the gross increase in owner’s equity resulting from business activities entered into for the purpose of earning income. This transaction is simply an additional investment made by the owner in the business. 19. Yes. Net income does appear on the income statement—it is the result of subtracting expenses from revenues. In addition, net income appears in the statement of owner’s equity—it is shown as an addition to the beginning-of-period capital. Indirectly, the net income of a company is also included in the balance sheet. It is included in the capital account which appears in the owner’s equity section of the balance sheet. (d) Balance sheet. (e) Balance sheet and owner’s equity statement. (f) Balance sheet. 1-5 Questions Chapter 1 (Continued) 20. 21. (a) Ending capital balance ..................................................................................................... Beginning capital balance................................................................................................ Net income.......................................................................................................................... $198,000 168,000 $ 30,000 (b) Deduct: Investment .......................................................................................................... Net income.......................................................................................................................... $198,000 168,000 30,000 13,000 $ 17,000 (a) Total revenues ($20,000 + $70,000) ............................................................................. $90,000 (b) Total expenses ($26,000 + $40,000)............................................................................. $66,000 (c) Total revenues ................................................................................................................... Total expenses................................................................................................................... Net income.......................................................................................................................... $90,000 66,000 $24,000 Ending capital balance ..................................................................................................... Beginning capital balance................................................................................................ 1-6 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 1-1 (a) $90,000 – $50,000 = $40,000 (Owner’s Equity). (b) $40,000 + $70,000 = $110,000 (Assets). (c) $94,000 – $60,000 = $34,000 (Liabilities). BRIEF EXERCISE 1-2 (a) $120,000 + $232,000 = $352,000 (Total assets). (b) $190,000 – $80,000 = $110,000 (Total liabilities). (c) $800,000 – 0.5($800,000) = $400,000 (Owner’s equity). BRIEF EXERCISE 1-3 (a) ($800,000 + $150,000) – ($500,000 – $80,000) = $530,000 (Owner’s equity). (b) ($500,000 + $100,000) + ($800,000 – $500,000 – $70,000) = $830,000 (Assets). (c) ($800,000 – $80,000) – ($800,000 – $500,000 + $120,000) = $300,000 (Liabilities). BRIEF EXERCISE 1-4 A L A (a) Accounts receivable (b) Salaries payable (c) Equipment A OE L (d) Office supplies (e) Owner’s investment (f) Notes payable BRIEF EXERCISE 1-5 (a) (b) (c) Assets Liabilities Owner’s Equity + + – + NE NE NE + – 1-7 BRIEF EXERCISE 1-6 Assets + – NE (a) (b) (c) Liabilities NE NE NE Owner’s Equity + – NE BRIEF EXERCISE 1-7 E R E E (a) (b) (c) (d) Advertising expense Commission revenue Insurance expense Salaries expense D R E (e) Bergman, Drawing (f) Rent revenue (g) Utilities expense BRIEF EXERCISE 1-8 R NOE E (a) Received cash for services performed (b) Paid cash to purchase equipment (c) Paid employee salaries BRIEF EXERCISE 1-9 LOPEZ COMPANY Balance Sheet December 31, 2008 Assets Cash ................................................................................................................ Accounts receivable .................................................................................. Total assets.......................................................................................... $ 49,000 72,500 $121,500 Liabilities and Owner’s Equity Liabilities Accounts payable .............................................................................. Owner’s equity Kim Lopez, Capital............................................................................. Total liabilities and owner’s equity ..................................... 1-8 $ 90,000 31,500 $121,500 BRIEF EXERCISE 1-10 BS IS OE, BS BS IS (a) (b) (c) (d) (e) Notes payable Advertising expense Trent Buchanan, Capital Cash Service revenue 1-9 SOLUTIONS TO EXERCISES EXERCISE 1-1 C R C R R C C I R Analyzing and interpreting information. Classifying economic events. Explaining uses, meaning, and limitations of data. Keeping a systematic chronological diary of events. Measuring events in dollars and cents. Preparing accounting reports. Reporting information in a standard format. Selecting economic activities relevant to the company. Summarizing economic events. EXERCISE 1-2 (a) Internal users Marketing manager Production supervisor Store manager Vice-president of finance External users Customers Internal Revenue Service Labor unions Securities and Exchange Commission Suppliers (b) I E I E I I E Can we afford to give our employees a pay raise? Did the company earn a satisfactory income? Do we need to borrow in the near future? How does the company’s profitability compare to other companies? What does it cost us to manufacture each unit produced? Which product should we emphasize? Will the company be able to pay its short-term debts? 1-10 EXERCISE 1-3 Larry Smith, president of Smith Company, instructed Ron Rivera, the head of the accounting department, to report the company’s land in their accounting reports at its market value of $170,000 instead of its cost of $100,000, in an effort to make the company appear to be a better investment. The cost principle requires that assets be recorded and reported at their cost, because cost is reliable and can be objectively measured and verified. The stakeholders include stockholders and creditors of Smith Company, potential stockholders and creditors, other users of Smith’s accounting reports, Larry Smith, and Ron Rivera. All users of Smith’s accounting reports could be harmed by relying on information which violates accounting principles. Larry Smith could benefit if the company is able to attract more investors, but would be harmed if the fraudulent reporting is discovered. Similarly, Ron Rivera could benefit by pleasing his boss, but would be harmed if the fraudulent reporting is discovered. Ron’s alternatives are to report the land at $100,000 or to report it at $170,000. Reporting the land at $170,000 is not appropriate since it would mislead many people who rely on Smith’s accounting reports to make financial decisions. Ron should report the land at its cost of $100,000. He should try to convince Larry Smith that this is the appropriate course of action, but be prepared to resign his position if Smith insists. EXERCISE 1-4 1. Incorrect. The cost principle requires that assets be recorded and reported at their cost. 2. Correct. The monetary unit assumption requires that companies include in the accounting records only transaction data that can be expressed in terms of money. 3. Incorrect. The economic entity assumption requires that the activities of the entity be kept separate and distinct from the activities of its owner and all other economic entities. 1-11 EXERCISE 1-5 Asset Cash Cleaning equipment Cleaning supplies Accounts receivable Liability Accounts payable Notes payable Salaries payable Owner’s Equity Karin Meredith, Capital EXERCISE 1-6 1. 2. 3. 4. 5. 6. 7. 8. 9. Increase in assets and increase in owner’s equity. Decrease in assets and decrease in owner’s equity. Increase in assets and increase in liabilities. Increase in assets and increase in owner’s equity. Decrease in assets and decrease in owner’s equity. Increase in assets and decrease in assets. Increase in liabilities and decrease in owner’s equity. Increase in assets and decrease in assets. Increase in assets and increase in owner’s equity. EXERCISE 1-7 1. 2. 3. 4. (c) (d) (a) (b) 5. 6. 7. 8. (d) (b) (e) (f) EXERCISE 1-8 (a) 1. 2. 3. 4. 5. Owner invested $15,000 cash in the business. Purchased office equipment for $5,000, paying $2,000 in cash and the balance of $3,000 on account. Paid $750 cash for supplies. Earned $8,300 in revenue, receiving $4,600 cash and $3,700 on account. Paid $1,500 cash on accounts payable. 1-12 EXERCISE 1-8 (Continued) 6. 7. 8. 9. 10. Owner withdrew $2,000 cash for personal use. Paid $650 cash for rent. Collected $450 cash from customers on account. Paid salaries of $4,900. Incurred $500 of utilities expense on account. (b) Investment ............................................................................................. Service revenue ................................................................................... Drawings................................................................................................. Rent expense ........................................................................................ Salaries expense.................................................................................. Utilities expense................................................................................... Increase in capital ............................................................................... $15,000 8,300 (2,000) (650) (4,900) (500) $15,250 (c) Service revenue ................................................................................... Rent expense ........................................................................................ Salaries expense.................................................................................. Utilities expense................................................................................... Net income............................................................................................. $8,300 (650) (4,900) (500) $2,250 EXERCISE 1-9 S. MOSES & CO. Income Statement For the Month Ended August 31, 2008 Revenues Service revenue ................................................................... Expenses Salaries expense.................................................................. Rent expense ........................................................................ Utilities expense................................................................... Total expenses ............................................................ Net income...................................................................................... 1-13 $8,300 $4,900 650 500 6,050 $2,250 EXERCISE 1-9 (Continued) S. MOSES & CO. Owner’s Equity Statement For the Month Ended August 31, 2008 S. Moses, Capital, August 1 ................................................ Add: Investments................................................................. Net income................................................................... $ $15,000 2,250 Less: Drawings ...................................................................... S. Moses, Capital, August 31 .............................................. 0 17,250 17,250 2,000 $15,250 S. MOSES & CO. Balance Sheet August 31, 2008 Assets Cash ................................................................................................................ Accounts receivable .................................................................................. Supplies ......................................................................................................... Office equipment......................................................................................... Total assets.......................................................................................... $ 8,250 3,250 750 5,000 $17,250 Liabilities and Owner’s Equity Liabilities Accounts payable .............................................................................. Owner’s equity S. Moses, Capital................................................................................ Total liabilities and owner’s equity ..................................... $ 2,000 15,250 $17,250 EXERCISE 1-10 (a) Owner’s equity—12/31/07 ($400,000 – $250,000)..................... Owner’s equity—1/1/07 .................................................................... Increase in owner’s equity.............................................................. Add: Drawings .................................................................................. Net income for 2007 .......................................................................... 1-14 $150,000 100,000 50,000 15,000 $ 65,000 EXERCISE 1-10 (Continued) (b) Owner’s equity—12/31/08 ($460,000 – $300,000) .................. Owner’s equity—1/1/08—see (a)................................................. Increase in owner’s equity ........................................................... Less: Additional investment....................................................... Net loss for 2008 .............................................................................. $160,000 150,000 10,000 50,000 $ 40,000 (c) Owner’s equity—12/31/09 ($590,000 – $400,000) .................. Owner’s equity—1/1/09—see (b) ................................................ Increase in owner’s equity ........................................................... Less: Additional investment....................................................... $190,000 160,000 30,000 15,000 15,000 30,000 $ 45,000 Add: Drawings ............................................................................... Net income for 2009........................................................................ EXERCISE 1-11 (a) Total assets (beginning of year)................................................. Total liabilities (beginning of year) ............................................ Total owner’s equity (beginning of year)................................. $95,000 85,000 $10,000 (b) Total owner’s equity (end of year) ............................................. Total owner’s equity (beginning of year)................................. Increase in owner’s equity ........................................................... $40,000 10,000 $30,000 Total revenues.................................................................................. Total expenses ................................................................................. Net income......................................................................................... $215,000 175,000 $ 40,000 Increase in owner’s equity .................................. Less: Net income................................................... Add: Drawings ...................................................... Additional investment........................................... $30,000 $(40,000) 24,000) (c) Total assets (beginning of year)................................................. Total owner’s equity (beginning of year)................................. Total liabilities (beginning of year) ............................................ 1-15 (16,000) $14,000 $129,000 80,000 $ 49,000 EXERCISE 1-11 (Continued) (d) Total owner’s equity (end of year).............................................. Total owner’s equity (beginning of year) ................................. Increase in owner’s equity............................................................ $130,000 80,000 $ 50,000 Total revenues .................................................................................. Total expenses.................................................................................. Net income ......................................................................................... $100,000 55,000 $ 45,000 Increase in owner’s equity................................... Less: Net income ................................................... Additional investment .............................. Drawings .................................................................... $50,000 $(45,000) (25,000) (70,000) $20,000 EXERCISE 1-12 LINDA STANLEY CO. Income Statement For the Year Ended December 31, 2008 Revenues Service revenue.............................................................. Expenses Salaries expense ............................................................ Rent expense................................................................... Utilities expense............................................................. Advertising expense ..................................................... Total expenses....................................................... Net income ................................................................................ $62,500 $30,000 10,400 3,100 1,800 45,300 $17,200 LINDA STANLEY CO. Owner’s Equity Statement For the Year Ended December 31, 2008 Linda Stanley, Capital, January 1............................................................ Add: Net income ......................................................................................... Less: Drawings............................................................................................. Linda Stanley, Capital, December 31 ..................................................... 1-16 $48,000 17,200 65,200 6,000 $59,200 EXERCISE 1-13 MENDEZ COMPANY Balance Sheet December 31, 2008 Assets Cash ................................................................................................................ Accounts receivable.................................................................................. Supplies......................................................................................................... Equipment..................................................................................................... Total assets ......................................................................................... $15,000 8,500 8,000 46,000 $77,500 Liabilities and Owner’s Equity Liabilities Accounts payable.............................................................................. Owner’s equity Mendez, Capital ($67,500 – $10,000) ........................................... Total liabilities and owner’s equity..................................... $20,000 57,500 $77,500 EXERCISE 1-14 (a) Camping fee revenues ..................................................................... General store revenues ................................................................... Total revenue ............................................................................. Expenses.............................................................................................. Net income........................................................................................... (b) $140,000 50,000 190,000 150,000 $ 40,000 DEER PARK Balance Sheet December 31, 2008 Assets Cash ....................................................................................................... Supplies................................................................................................ Equipment............................................................................................ Total assets ................................................................................ 1-17 $ 23,000 2,500 105,500 $131,000 EXERCISE 1-14 (Continued) DEER PARK Balance Sheet (Continued) December 31, 2008 Liabilities and Owner’s Equity Liabilities Notes payable............................................................................. Accounts payable ..................................................................... Total liabilities ................................................................... Owner’s equity Jan Nab, Capital ($131,000 – $71,000)................................ Total liabilities and owner’s equity ............................ $ 60,000 11,000 71,000 60,000 $131,000 EXERCISE 1-15 SUMMERS CRUISE COMPANY Income Statement For the Year Ended December 31, 2008 Revenues Ticket revenue............................................................ Expenses Salaries expense ....................................................... Maintenance expense.............................................. Property tax expense............................................... Advertising expense ................................................ Total expenses.................................................. Net income ........................................................................... $325,000 $142,000 95,000 10,000 3,500 250,500 $ 74,500 EXERCISE 1-16 KEVIN JOHNSON, ATTORNEY Owner’s Equity Statement For the Year Ended December 31, 2008 Kevin Johnson, Capital, January 1 ............................................... Add: Net income ............................................................................... Less: Drawings................................................................................... Kevin Johnson, Capital, December 31......................................... 1-18 $ 23,000 (a) 139,000 (b) 162,000 79,000 $ 83,000 (c) EXERCISE 1-16 (Continued) Supporting Computations (a) Assets, January 1, 2008 .................................................................. Liabilities, January 1, 2008............................................................. Capital, January 1, 2008 .................................................................. $85,000 62,000 $23,000 (b) Legal service revenue...................................................................... Total expenses ................................................................................... Net income........................................................................................... $350,000 211,000 $139,000 (c) Assets, December 31, 2008 ............................................................ Liabilities, December 31, 2008 ...................................................... Capital, December 31, 2008............................................................ $168,000 85,000 $ 83,000 1-19 (a) BARONE REPAIR SHOP Cash 1. + Accounts Receivable + Supplies + Equipment +$10,000 4. 5,000 + –400 + 4,600 + –500 + 4,100 1-20 6. + 9. 10. 11. + + + + + –2,000 –140 + 6,060 6,060 – +120 +$ 6,180 + 500 + + 500 + 500 + + 500 + + + + 750 + + 5,000 + 5,000 + 5,000 + 5,000 + + 5,000 + 5,000 + = +$250 = + 250 + +0000 = + –400 + 9,600 + 250 + 9,600 + –250 + 9,350 – +5,100 + –1,000 = + 250 + +0000 = + 250 + –2,000 + +0000 = +00,000 +0250 +0000 +$630 –140 Drawings Salaries Expense Utilities Expense + 11,310 – +750 + + 500 + + 5,000 = +0250 + + 12,060 + +$500 + +$5,000 = +$250 + +$12,060 $12,310 Service Revenue + 11,450 + + Adv. Expense + 13,450 +–120 + Rent Expense + 14,450 +0000 +00,000 + + 10,000 +000,000 +00,000 +0000 +$750 + + 500 = +00,000 +0000 + + 5,000 +00,000 +0000 +000,000 + = +00,000 +0000 8,200 + + +0000 9,200 6,200 + 500 +0000 4,100 + + 5,000 +00,000 +$500 –1,000 7. 8. + – +5,100 + +000,000 +00,000 +000,000 + + 10,000 +$5,000 + Investment $12,310 Service Revenue PROBLEM 1-1A 5. = + –5,000 + N. Barone, Capital SOLUTIONS TO PROBLEMS 3. Accounts Payable + +$10,000 + 10,000 2. = PROBLEM 1-1A (Continued) (b) Ending capital....................................................................................... Add: Drawings.................................................................................... Deduct: Investments ........................................................................ Net income............................................................................................. $12,060 1,000 13,060 10,000 $ 3,060 OR Service revenue($5,100 + $750) .................................. Expenses Salaries ...................................................................... Rent ............................................................................. Advertising ............................................................... Utilities ....................................................................... Net income ....................................................... 1-21 $5,850 $2,000 400 250 140 2,790 $3,060 (a) MARIA GONZALEZ, VETERINARIAN Cash Bal. 1. $ 9,000 1-22 5. + + 400 + 400 + 5,900 + 5,900 + 600 600 + 600 + 600 6,000 6,000 + 8,100 = 700 = 700 8,100 2,000 2,000 = 8,100 + 2,000 13,700 000,000 + 13,700 +8,000 + + –2,900 5,200 7. + 000,000 5,200 8. 00,000 + 00,000 + 5,900 + $5,900 600 000,000 + 0000 + 00,000 +10,000 $15,200 5,900 0000 600 $29,800 $600 2,000 = + + 8,100 + +170 000,000 0000 + 8,100 00,000 2,170 = 000,000 +$10,000 00,000 $ 8,100 = +$10,000 + $2,170 $29,800 Rent Expense –300 Adv. Expense 17,800 17,630 000,000 + Salaries Exp. –900 –170 + Drawings 20,700 –1,700 6. Serv. Revenue 21,700 –1,000 00,000 = 13,700 000,000 00,000 000,000 + + +1,300 = $13,700 000,000 00,000 000,000 + + –2,900 +2,100 0000 + $3,600 = 000,000 0000 00,000 + 600 $ 6,000 000,000 0000 +5,500 + + 0000 00,000 –1,000 8,100 1,700 $600 0000 –1,300 +2,500 9,100 + Notes Accounts M. Gonzalez, Payable + Payable + Capital $17,630 Utilities Exp. PROBLEM 1-2A 4. + –800 6,600 $1,700 00,000 +1,300 7,400 3. + –2,900 6,100 2. Accounts Office + Receivable + Supplies + Equipment = PROBLEM 1-2A (Continued) (b) MARIA GONZALEZ, VETERINARIAN Income Statement For the Month Ended September 30, 2008 Revenues Service revenue .......................................................... Expenses Salaries expense......................................................... Rent expense ............................................................... Advertising expense.................................................. Utilities expense.......................................................... Total expenses ................................................... Net income............................................................................. $8,000 $1,700 900 300 170 3,070 $4,930 MARIA GONZALEZ, VETERINARIAN Owner’s Equity Statement For the Month Ended September 30, 2008 M. Gonzalez, Capital, September 1 ................................................ Add: Net income................................................................................ Less: Drawings ................................................................................... M. Gonzalez, Capital, September 30.............................................. 1-23 $13,700 4,930 18,630 1,000 $17,630 PROBLEM 1-2A (Continued) MARIA GONZALEZ, VETERINARIAN Balance Sheet September 30, 2008 Assets Cash ......................................................................................................... Accounts receivable ........................................................................... Supplies .................................................................................................. Office equipment.................................................................................. Total assets................................................................................... $15,200 5,900 600 8,100 $29,800 Liabilities and Owner’s Equity Liabilities Notes payable............................................................................... Accounts payable ....................................................................... Total liabilities ..................................................................... Owner’s equity M. Gonzalez, Capital................................................................... Total liabilities and owner’s equity .............................. 1-24 $10,000 2,170 12,170 17,630 $29,800 PROBLEM 1-3A (a) SKYLINE FLYING SCHOOL Income Statement For the Month Ended May 31, 2008 Revenues Lesson revenue.................................................... Expenses Fuel expense ......................................................... Rent expense ........................................................ Advertising expense........................................... Insurance expense .............................................. Repair expense..................................................... Total expenses ............................................ Net income...................................................................... $7,500 $2,500 1,200 500 400 400 5,000 $2,500 SKYLINE FLYING SCHOOL Owner’s Equity Statement For the Month Ended May 31, 2008 Jeff Wilkins, Capital, May 1 ....................................... Add: Investments....................................................... Net income......................................................... $ $45,000 2,500 Less: Drawings ............................................................ Jeff Wilkins, Capital, May 31..................................... 0 47,500 47,500 1,500 $46,000 SKYLINE FLYING SCHOOL Balance Sheet May 31, 2008 Assets Cash ......................................................................................................... Accounts receivable........................................................................... Equipment.............................................................................................. Total assets .................................................................................. 1-25 $ 5,600 7,200 64,000 $76,800 PROBLEM 1-3A (Continued) SKYLINE FLYING SCHOOL Balance Sheet (Continued) May 31, 2008 Liabilities and Owner’s Equity Liabilities Notes payable............................................................................... Accounts payable ....................................................................... Total liabilities ..................................................................... Owner’s equity Jeff Wilkins, Capital.................................................................... Total liabilities and owner’s equity .............................. (b) $30,000 800 30,800 46,000 $76,800 SKYLINE FLYING SCHOOL Income Statement For the Month Ended May 31, 2008 Revenues Lesson revenue ($7,500 + $900)..................... Expenses Fuel expense ($2,500 + $1,500) ...................... Rent expense........................................................ Advertising expense .......................................... Insurance expense ............................................. Repair expense .................................................... Total expenses............................................ Net income ..................................................................... $8,400 $4,000 1,200 500 400 400 6,500 $1,900 SKYLINE FLYING SCHOOL Owner’s Equity Statement For the Month Ended May 31, 2008 Jeff Wilkins, Capital, May 1....................................... Add: Investments ...................................................... Net income ....................................................... Less: Drawings ........................................................... Jeff Wilkins, Capital, May 31.................................... 1-26 $ $45,000 1,900 0 46,900 46,900 1,500 $45,400 (a) MILLER DELIVERIES Assets Date + Liabilities + Owner’s Equity Accounts Delivery Notes Accounts M. Miller, Receivable + Supplies + Van = Payable + Payable + Capital $10,000) (2,000) (500) ($10,000) $12,000 ( ($4,400) (200) $150 1,250) (500) 4,400) (200) Rent Expense Service Revenue Drawings (100) 1,500) Gasoline Expense Service Revenue ($150) (1,250) ( 100) 1,500) (500) (250) (100) (1,000) ($ 8,200) + Investment ($10,000) ( (500) ) (100) ($3,150) + $150 + $12,000 = ($ 9,500) + ($150) (250) Utilities Expense (1,000) + ( $13,850) Salaries Expense PROBLEM 1-4A 1-27 June 1 2 3 5 9 12 15 17 20 23 26 29 30 Cash = PROBLEM 1-4A (Continued) (b) MILLER DELIVERIES Income Statement For the Month Ended June 30, 2008 Revenues Service revenue ($4,400 + $1,500) ....................... Expenses Salaries expense ....................................................... Rent expense.............................................................. Utilities expense ........................................................ Gasoline expense ..................................................... Total expenses.................................................. Net income ........................................................................... (c) $5,900 $1,000 500 250 100 1,850 $4,050 MILLER DELIVERIES Balance Sheet June 30, 2008 Assets Cash ......................................................................................................... Accounts receivable ........................................................................... Supplies .................................................................................................. Delivery van ........................................................................................... Total assets................................................................................... $ 8,200 3,150 150 12,000 $23,500 Liabilities and Owner’s Equity Liabilities Notes payable............................................................................... Accounts payable ....................................................................... Total liabilities ..................................................................... Owner’s equity M. Miller, Capital .......................................................................... Total liabilities and owner’s equity .............................. 1-28 $ 9,500 150 9,650 13,850 $23,500 PROBLEM 1-5A (a) (b) Karma Company (a) $ 45,000 (b) 115,000 (c) 10,000 Yates Company (d) $50,000 (e) 62,000 (f) 48,000 McCain Company (g) $120,000 (h) 70,000 (i) 431,000 Dench Company (j) $ 80,000 (k) 250,000 (l) 435,000 YATES COMPANY Owner’s Equity Statement For the Year Ended December 31, 2008 Capital, January 1 ....................................................... Add: Investment ....................................................... Net income....................................................... Less: Drawings .......................................................... Capital, December 31 ................................................ $ 60,000 $15,000 35,000 50,000 110,000 48,000 $ 62,000 (c) The sequence of preparing financial statements is income statement, owner’s equity statement, and balance sheet. The interrelationship of the owner’s equity statement to the other financial statements results from the fact that net income from the income statement is reported in the owner’s equity statement and ending capital reported in the owner’s equity statement is the amount reported for owner’s equity on the balance sheet. 1-29 (a) MATRIX TRAVEL AGENCY Cash 1. + Accounts Receivable + Supplies Office + Equipment = 3. + –400 + 9,600 6. 7. 8. 9. + –600 + 6,500 9,500 + –200 + 9,300 + –300 + 9,000 10. + 6,800 + + + 6,500 + + 6,500 + + 6,500 + + 6,500 + +$2,500 + 600 + 600 + 600 + $16,400 +$600 = + 2,500 + 2,500 + + 2,500 = + 2,500 = + 2,500 = = +$2,500 + 300 + + 9,600 + 300 + 300 + 9,600 + –300 + 9,300 + Rent Expense 9,300 + –200 +000,000 + 0 + 18,600 +0000 + –2,200 + 16,400 0 +000,000 + Serv. Revenue Drawings + 18,600 +–300 +$ Adv. Expense + 18,800 + +0000 = + – +9,500 = +00,000 + –400 +000,000 +0000 +00,000 + + +0000 +00,000 + + 300 +0000 +00,000 +0000 +–4,000 + + +0000 + 0,000 + + 600 + 2,500 +00,000 +0000 + 0,000 + + +0000 + 0,000 + + 600 +0000 +$6,500 – +4,000 +$10,800 +$300 +00,000 +$600 + –2,200 + = +00,000 – +3,000 + + 2,500 + +000,000 +$2,500 +000,000 7,100 + 10,000 = + Investment +$16,400 $16,400 Salaries Exp. PROBLEM 1-1B 1-30 5. = 7,100 + Jenny Russo, Capital +$10,000 + –2,500 + 4. + +$10,000 + 10,000 2. Accounts Payable PROBLEM 1-1B (Continued) (b) Ending capital........................................................................................ Add: Drawings..................................................................................... Deduct: Investments ......................................................................... Net income.............................................................................................. $16,400 200 16,600 10,000 $ 6,600 OR Service revenue ............................................................... Expenses Salaries ...................................................................... Rent ............................................................................. Advertising ............................................................... Net income ....................................................... 1-31 $9,500 $2,200 400 300 2,900 $6,600 (a) CINDY BELTON, ATTORNEY AT LAW Cash Bal. $4,000 1. +1,400 5,400 2. + 100 100 + 6,100 + 6,100 + + 500 00,000 = 4,200 + 5,000 1,500 00,000 + 5,000 6,000 + 1,500 = + 2,100 + + + 6,100 + 6,100 + $6,100 + + 500 + 500 + + 0000 + $14,900 $500 6,000 2,100 = + 6,000 + + 15,800 15,800 2,100 00,000 +$2,000 00,000 6,000 = + 2,000 + 2,100 00,000 +00,000 +250 $6,000 = +$2,000 + $2,350 $14,900 + Salaries Expense –900 Rent Expense –350 Advertising Expense 11,550 –750 00,000 = Service Revenue 000,000 00,000 00,000 0000 00,000 + 500 00,000 0000 00,000 00,000 $2,300 6,100 0000 00,000 +2,000 2,300 6,800 +9,000 +600 = 6,800 000,000 00,000 +1,000 + 000,000 –2,700 = $ 6,800 –3,000 –750 300 8. 500 5,000 + –4,250 1,050 7. 500 $4,200 = 00,000 0000 00,000 6. + 0000 00,000 + 500 $5,000 00,000 0000 +6,000 + + 0000 00,000 + $500 Cindy Belton, Capital Drawings 10,800 000,000 + 10,800 –250 + $10,550 Utilities Expense PROBLEM 1-2B 1-32 5. + –400 5,300 $1,500 –1,400 +3,000 5,700 4. + –2,700 2,700 3. Accounts Office Notes Accounts + Receivable + Supplies + Equipment = Payable + Payable + PROBLEM 1-2B (Continued) (b) CINDY BELTON, ATTORNEY AT LAW Income Statement For the Month Ended August 31, 2008 Revenues Service revenue ..................................................... Expenses Salaries expense.................................................... Rent expense .......................................................... Advertising expense............................................. Utilities expense..................................................... Total expenses .............................................. Net income........................................................................ $9,000 $3,000 900 350 250 4,500 $4,500 CINDY BELTON, ATTORNEY AT LAW Owner’s Equity Statement For the Month Ended August 31, 2008 Cindy Belton, Capital, August 1...................................................... Add: Net income................................................................................ Less: Drawings ................................................................................... Cindy Belton, Capital, August 31 ................................................... 1-33 $ 6,800 4,500 11,300 750 $10,550 PROBLEM 1-2B (Continued) CINDY BELTON, ATTORNEY AT LAW Balance Sheet August 31, 2008 Assets Cash ......................................................................................................... Accounts receivable ........................................................................... Supplies .................................................................................................. Office equipment.................................................................................. Total assets................................................................................... $ 2,300 6,100 500 6,000 $14,900 Liabilities and Owner’s Equity Liabilities Notes payable............................................................................... Accounts payable ....................................................................... Total liabilities ..................................................................... Owner’s equity Cindy Belton, Capital ................................................................. Total liabilities and owner’s equity .............................. 1-34 $ 2,000 2,350 4,350 10,550 $14,900 PROBLEM 1-3B (a) DIVINE COSMETICS CO. Income Statement For the Month Ended June 30, 2008 Revenues Service revenue ................................................... Expenses Supplies expense ................................................ Gas and oil expense ........................................... Advertising expense........................................... Utilities expense................................................... Total expenses ............................................ Net income...................................................................... $6,000 $1,600 800 500 300 3,200 $2,800 DIVINE COSMETICS CO. Owner’s Equity Statement For the Month Ended June 30, 2008 Michelle Bullock, Capital, June 1 ............................ Add: Investments....................................................... Net income......................................................... $ $26,200 2,800 Less: Drawings ............................................................ Michelle Bullock, Capital, June 30.......................... 0 29,000 29,000 1,200 $27,800 DIVINE COSMETICS CO. Balance Sheet June 30, 2008 Assets Cash ......................................................................................................... Accounts receivable........................................................................... Cosmetic supplies............................................................................... Equipment.............................................................................................. Total assets .................................................................................. 1-35 $11,000 4,000 2,000 25,000 $42,000 PROBLEM 1-3B (Continued) DIVINE COSMETICS CO. Balance Sheet (Continued) June 30, 2008 Liabilities and Owner’s Equity Liabilities Notes payable............................................................................... Accounts payable ....................................................................... Total liabilities ..................................................................... Owner’s equity Michelle Bullock, Capital .......................................................... Total liabilities and owner’s equity .............................. (b) $13,000 1,200 14,200 27,800 $42,000 DIVINE COSMETICS CO. Income Statement For the Month Ended June 30, 2008 Revenues Service revenue ($6,000 + $800) .................... Expenses Supplies expense................................................ Gas and oil expense ($800 + $100)................ Advertising expense .......................................... Utilities expense .................................................. Total expenses............................................ Net income ..................................................................... $6,800 $1,600 900 500 300 3,300 $3,500 DIVINE COSMETICS CO. Owner’s Equity Statement For the Month Ended June 30, 2008 Michelle Bullock, Capital, June 1............................ Add: Investments ...................................................... Net income ........................................................ Less: Drawings............................................................ Michelle Bullock, Capital, June 30 ......................... 1-36 $ $26,200 3,500 0 29,700 29,700 1,200 $28,500 (a) GELLER CONSULTING Assets Cash May 1 2 3 5 9 12 15 17 20 23 26 29 30 ($ 8,000) (800) Liabilities + Owner’s Equity Accounts Office Notes Accounts L. Geller, + Receivable + Supplies + Equipment = Payable + Payable + Capital ($ 8,000) (800) $500 ($ 500) (50) (3,000) (700) (50) ( 3,000) (700) (5,300) (3,000) ($5,300) (3,000) (500) (3,000) (5,000) (150) ($13,800) + Investment Rent Expense Advertising Expense Service Revenue Drawings Service Revenue Salaries Expense (500) (3,000) $5,000 ($2,300) + $500 + $2,800 (2,800) $2,800 ( (150) = $5,000 + ($2,800) + ($11,600) Utilities Expense PROBLEM 1-4B 1-37 Date = PROBLEM 1-4B (Continued) (b) GELLER CONSULTING Income Statement For the Month Ended May 31, 2008 Revenues Service revenue ($3,000 + $5,300) ................... Expenses Salaries expense ................................................... Rent expense.......................................................... Utilities expense .................................................... Advertising expense ............................................ Total expenses.............................................. Net income ....................................................................... (c) $8,300 $3,000 800 150 50 4,000 $4,300 GELLER CONSULTING Balance Sheet May 31, 2008 Assets Cash ......................................................................................................... Accounts receivable ........................................................................... Supplies .................................................................................................. Office equipment.................................................................................. Total assets................................................................................... $13,800 2,300 500 2,800 $19,400 Liabilities and Owner’s Equity Liabilities Notes payable............................................................................... Accounts payable ....................................................................... Total liabilities ..................................................................... Owner’s equity L. Geller, Capital .......................................................................... Total liabilities and owner’s equity .............................. 1-38 $ 5,000 2,800 7,800 11,600 $19,400 PROBLEM 1-5B (a) (b) McKane Company (a) $30,000 (b) 95,000 (c) 5,000 Selara Company (d) $40,000 (e) 45,000 (f) 28,000 Gordon Company (g) $124,000 (h) 80,000 (i) 413,000 Hindi Company (j) $ 50,000 (k) 225,000 (l) 460,000 McKANE COMPANY Owner’s Equity Statement For the Year Ended December 31, 2008 Capital, January 1......................................................... Add: Investment ......................................................... Net income......................................................... Less: Drawings ............................................................ Capital, December 31 .................................................. $30,000 $ 5,000 15,000 20,000 50,000 10,000 $40,000 (c) The sequence of preparing financial statements is income statement, owner’s equity statement, and balance sheet. The interrelationship of the owner’s equity statement to the other financial statements results from the fact that net income from the income statement is reported in the owner’s equity statement and ending capital reported in the owner’s equity statement is the amount reported for owner’s equity on the balance sheet. 1-39 BYP 1-1 FINANCIAL REPORTING PROBLEM (a) PepsiCo’s total assets at December 31, 2005 were $31,727 million and at December 25, 2004 were $27,987 million. (b) PepsiCo had $1,716 million of cash and cash equivalents at December 31, 2005. (c) PepsiCo had accounts payable (and other current liabilities) totaling $5,971 million on December 31, 2005 and $5,599 million on December 25, 2004. (d) PepsiCo reports net sales for three consecutive years as follows: 2003 2004 2005 $26,971 million $29,261 million $32,562 million (e) From 2004 to 2005, PepsiCo’s net income decreased $134 million from $4,212 million to $4,078 million. 1-40 BYP 1-2 (a) 1. 2. 3. 4. COMPARATIVE ANALYSIS PROBLEM (in millions) Total assets Accounts receivable (net) Net sales Net income PepsiCo $31,727 $ 3,261 $32,562 $ 4,078 Coca-Cola $29,427 $ 2,281 $23,104 $ 4,872 (b) PepsiCo’s total assets were approximately 8% greater than Coca-Cola’s total assets, and PepsiCo’s net sales were 41% greater than Coca-Cola’s net sales. In addition, PepsiCo’s accounts receivable were 43% greater than Coca-Cola’s and represent 10% of its net sales. Coca-Cola’s accounts receivable amount to 9.9% of its net sales. Both PepsiCo’s and Coca-Cola’s accounts receivable are at satisfactory levels, being comparable to a 30-day collection period. Coca-Cola’s net income was 119.5% of PepsiCo’s. It appears that these two companies’ operations are comparable in some ways, with Coca-Cola’s operations slightly more profitable. 1-41 BYP 1-3 EXPLORING THE WEB (a) The field is normally divided into three broad areas: auditing, financial/ tax, and management accounting. (b) The skills required in these areas: People skills, sales skills, communication skills, analytical skills, ability to synthesize, creative ability, initiative, computer skills. (c) The skills required in these areas differ as follows: People skills Sales skills Communication skills Analytical skills Ability to synthesize Creative ability Initiative Computer skills Auditing Medium Medium Medium High Medium Low Medium High Financial and Tax Medium Medium Medium Very High Low Medium Medium High Management Accounting Medium Low High High High Medium Medium Very High (d) Some key job functions in accounting: Auditing: Work in audit involves checking accounting ledgers and financial statements within corporations and government. This work is becoming increasingly computerized and can rely on sophisticated random sampling methods. Audit is the bread-and-butter work of accounting. This work can involve significant travel and allows you to really understand how money is being made in the company that you are analyzing. It’s great background! Budget Analysis: Budget analysts are responsible for developing and managing an organization’s financial plans. There are plentiful jobs in this area in government and private industry. Besides quantitative skills many budget analyst jobs require good people skills because of negotiations involved in the work. 1-42 BYP 1-3 (Continued) Financial: Financial accountants prepare financial statements based on general ledgers and participate in important financial decisions involving mergers and acquisitions, benefits/ERISA planning, and long-term financial projections. This work can be varied over time. One day you may be running spreadsheets. The next day you may be visiting a customer or supplier to set up a new account and discuss business. This work requires a good understanding of both accounting and finance. Management Accounting: Management accountants work in companies and participate in decisions about capital budgeting and line of business analysis. Major functions include cost analysis, analysis of new contracts, and participation in efforts to control expenses efficiently. This work often involves the analysis of the structure of organizations. Is responsibility to spend money in a company at the right level of our organization? Are goals and objectives to control costs being communicated effectively? Historically, many management accountants have been derided as “bean counters.” This mentality has undergone major change as management accountants now often work side by side with marketing and finance to develop new business. Tax: Tax accountants prepare corporate and personal income tax statements and formulate tax strategies involving issues such as financial choice, how to best treat a merger or acquisition, deferral of taxes, when to expense items and the like. This work requires a thorough understanding of economics and the tax code. Increasingly, large corporations are looking for persons with both an accounting and a legal background in tax. A person, for example, with a JD and a CPA would be especially desirable to many firms. (e) Junior Staff Accountant $36-63,000 1-43 BYP 1-4 DECISION MAKING ACROSS THE ORGANIZATION (a) The estimate of the $6,100 loss was based on the difference between the $25,000 invested in the driving range and the bank balance of $18,900 at March 31. This is not a valid basis for determining income because it only shows the change in cash between two points in time. (b) The balance sheet at March 31 is as follows: CHIP-SHOT DRIVING RANGE Balance Sheet March 31, 2008 Assets Cash ......................................................................................................... Caddy shack .......................................................................................... Equipment .............................................................................................. Total assets................................................................................... $18,900 8,000 800 $27,700 Liabilities and Owner’s Equity Liabilities Accounts payable ($150 + $100) ............................................ Owner’s equity Mary and Jack Gray, Capital ................................................... Total liabilities and owner’s equity .............................. $ 250 27,450 $27,700 As shown in the balance sheet, the owner’s capital at March 31 is $27,450. The estimate of $2,450 of net income is the difference between the initial investment of $25,000 and $27,450. This was not a valid basis for determining net income because changes in owner’s equity between two points in time may have been caused by factors unrelated to net income. For example, there may be drawings and/or additional capital investments by the owner(s). 1-44 BYP 1-4 (Continued) (c) Actual net income for March can be determined by adding owner’s drawings to the change in owner’s capital during the month as shown below: Owner’s capital, March 31, per balance sheet ........................... Owner’s capital, March 1................................................................... Increase in owner’s capital .............................................................. Add: Drawings.................................................................................... Net income............................................................................................. $27,450 25,000 2,450 1,000 $ 3,450 Alternatively, net income can be found by determining the revenues earned [described in (d) below] and subtracting expenses. (d) Revenues earned can be determined by adding expenses incurred during the month to net income. March expenses were Rent, $1,000; Wages, $400; Advertising, $750; and Utilities, $100 for a total of $2,250. Revenues earned, therefore, were $5,700 ($2,250 + $3,450). Alternatively, since all revenues are received in cash, revenues earned can be computed from an analysis of the changes in cash as follows: Beginning cash balance............................................... Less: Cash payments Caddy shack ................................................ Golf balls and clubs................................... Rent................................................................. Advertising ................................................... Wages............................................................. Drawings ....................................................... Cash balance before revenues .................................. Cash balance, March 31 ............................................... Revenues earned............................................................ 1-45 $25,000 $8,000 800 1,000 600 400 1,000 11,800 13,200 18,900 $ 5,700 BYP 1-5 To: From: COMMUNICATION ACTIVITY Lynn Benedict Student I have received the balance sheet of New York Company as of December 31, 2008. A number of items in this balance sheet are not properly reported. They are: 1. The balance sheet should be dated as of a specific date, not for a period of time. Therefore, it should be dated “December 31, 2008.” 2. Equipment should be shown as an asset and reported below Supplies on the balance sheet. 3. Accounts receivable should be shown as an asset, not a liability, and reported between Cash and Supplies on the balance sheet. 4. Accounts payable should be shown as a liability, not an asset. The note payable is also a liability and should be reported in the liability section. 5. Liabilities and owner’s equity should be shown on the balance sheet. Don Wenger, Capital and Don Wenger, Drawing are not liabilities. 6. Don Wenger, Capital and Don Wenger, Drawing are part of owner’s equity. The Drawing account is not reported on the balance sheet but is subtracted from Don Wenger, Capital to arrive at owner’s equity at the end of the period. 1-46 BYP 1-5 (Continued) A correct balance sheet is as follows: NEW YORK COMPANY Balance Sheet December 31, 2008 Assets Cash .................................................................................................................. Accounts receivable.................................................................................... Supplies........................................................................................................... Equipment....................................................................................................... $ 9,000 6,000 2,000 25,500 $42,500 Liabilities and Owner’s Equity Liabilities Notes payable ....................................................................................... Accounts payable................................................................................ Total liabilities ............................................................................. Owner’s equity Don Wenger, Capital ($26,000 – $2,000) ...................................... Total liabilities and owner’s equity....................................... 1-47 $10,500 8,000 18,500 24,000 $42,500 BYP 1-6 ETHICS CASE (a) The students should identify all of the stakeholders in the case; that is, all the parties that are affected, either beneficially or negatively, by the action or decision described in the case. The list of stakeholders in this case are:
Steve Baden, interviewee.
Both Baltimore firms.
Great Northern College. (b) The students should identify the ethical issues, dilemmas, or other considerations pertinent to the situation described in the case. In this case the ethical issues are:
Is it proper that Steve charged both firms for the total travel costs rather than split the actual amount of $296 between the two firms?
Is collecting $592 as reimbursement for total costs of $296 ethical behavior?
Did Steve deceive both firms or neither firm? (c) Each student must answer the question for himself/herself. Would you want to start your first job having deceived your employer before your first day of work? Would you be embarrassed if either firm found out that you double-charged? Would your school be embarrassed if your act was uncovered? Would you be proud to tell your professor that you collected your expenses twice? 1-48 BYP 1-7 (a) ALL ABOUT YOU: THE ETHICS OF FINANCIAL AID Answers to the following will vary depending on students’ opinions. (1) This does not represent the hiding of assets, but rather a choice as to the order of use of assets. This would seem to be ethical. (2) This does not represent the hiding of assets, but rather is a change in the nature of assets. Since the expenditure was necessary, although perhaps accelerated, it would seem to be ethical. (3) This represents an intentional attempt to deceive the financial aid office. It would therefore appear to be both unethical and potentially illegal. (4) This is a difficult issue. By taking the leave, actual net income would be reduced. The form asks the applicant to report actual net income. However, it is potentially deceptive since you do not intend on taking unpaid absences in the future, thus future income would be higher than reported income. (b) Companies might want to overstate net income in order to potentially increase the stock price by improving investors’ perceptions of the company. Also, a higher net income would make it easier to receive debt financing. Finally, managers would want a higher net income to increase the size of their bonuses. (c) Sometimes companies want to report a lower income if they are negotiating with employees. For example, professional sports teams frequently argue that they can not increase salaries because they aren’t making enough money. This also occurs in negotiations with unions. For tax accounting (as opposed to the financial accounting in this course) companies frequently try to minimize the amount of reported taxable income. (d) Unfortunately many times people who are otherwise very ethical will make unethical decisions regarding financial reporting. They might be driven to do this because of greed. Frequently it is because their superiors have put pressure on them to take an unethical action, and they are afraid to not follow directions because they might lose their job. Also, in some instances top managers will tell subordinates that they should be a team player, and do the action because it would help the company, and therefore would help fellow employees. 1-49 CHAPTER 2 The Recording Process ASSIGNMENT CLASSIFICATION TABLE Brief Exercises A Problems B Problems 1A, 2A, 3A, 5A 1B, 2B, 3B, 5B 1A, 2A, 3A, 5A 1B, 2B, 3B, 5B 9, 12 2A, 3A, 5A 2B, 3B, 5B 9, 10, 11, 13, 14 2A, 3A, 4A, 5A 2B, 3B, 4B, 5B Study Objectives Questions Exercises 1. Explain what an account is and how it helps in the recording process. 1 2. Define debits and credits and explain their use in recording business transactions. 2, 3, 4, 5, 6, 7, 8, 9, 14 1, 2, 5 2, 4, 6, 7, 14 3. Identify the basic steps in the recording process. 10, 19 4 6, 7 4. Explain what a journal is and how it helps in the recording process. 11, 12, 13, 14, 16 3, 6 3, 5, 6, 7 10, 11, 12 5. Explain what a ledger is and how it helps in the recording process. 17 6. Explain what posting is and how it helps in the recording process. 15, 17 7, 8 7. Prepare a trial balance and explain its purposes. 18, 20 9, 10 1 8 2-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Journalize a series of transactions. Simple 20–30 2A Journalize transactions, post, and prepare a trial balance. Simple 30–40 3A Journalize and post transactions, and prepare a trial balance. Moderate 40–50 4A Prepare a correct trial balance. Moderate 30–40 5A Journalize transactions, post, and prepare a trial balance. Moderate 40–50 1B Journalize a series of transactions. Simple 20–30 2B Journalize transactions, post, and prepare a trial balance. Simple 30–40 3B Journalize transactions, post, and prepare a trial balance. Moderate 40–50 4B Prepare a correct trial balance. Moderate 30–40 5B Journalize transactions, post, and prepare a trial balance. Moderate 40–50 2-2 Study Objective Knowledge Comprehension Application Analysis Evaluation Q2-1 E2-1 Explain what an account is and how it helps in the recording process. 2. Define debits and credits and explain their use in recording business transactions. 3. Identify the basic steps in the recording process. Q2-10 Q2-19 BE2-4 E2-6 E2-7 4. Explain what a journal is and how it helps in the recording process. Q2-12 Q2-11 Q2-13 Q2-14 Q2-16 BE2-3 BE2-6 E2-3 E2-5 E2-6 E2-7 E2-10 E2-11 E2-12 P2-1A P2-2A 5. Explain what a ledger is and how it helps in the recording process. E2-8 Q2-17 6. Explain what posting is and how it helps in the recording process. Q2-15 Q2-17 BE2-7 BE2-8 E2-9 E2-12 P2-2A P2-3B P2-3A P2-5B P2-5A P2-2B 7. Prepare a trial balance and explain its purposes. Q2-18 BE2-9 E2-9 E2-10 E2-11 E2-14 P2-2B Q2-20 P2-2A P2-3B BE2-10 P2-3A P2-5B E2-13 P2-4A P2-5A 2-3 1. Broadening Your Perspective Synthesis Q2-2 Q2-3 Q2-4 Q2-5 Q2-6 Q2-7 Q2-8 Q2-9 Q2-14 BE2-1 BE2-2 BE2-5 E2-2 E2-4 E2-6 E2-7 E2-14 P2-1A P2-2A P2-2B P2-3A P2-3B P2-5A P2-5B P2-1B P2-3A P2-5A P2-1B P2-2B P2-3B P2-5B Financial Reporting Decision Making Across the Organization Exploring the Web P2-4B Comparative Analysis Communication All About You Decision Making Ethics Case Across the Organization BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. A T account has the following parts: (a) the title, (b) the left or debit side, and (c) the right or credit side. 2. Disagree. The terms debit and credit mean left and right respectively. 3. Jeff is incorrect. The double-entry system merely records the dual effect of a transaction on the accounting equation. A transaction is not recorded twice; it is recorded once, with a dual effect. 4. Maria is incorrect. A debit balance only means that debit amounts exceed credit amounts in an account. Conversely, a credit balance only means that credit amounts are greater than debit amounts in an account. Thus, a debit or credit balance is neither favorable nor unfavorable. 5. (a) Asset accounts are increased by debits and decreased by credits. (b) Liability accounts are decreased by debits and increased by credits. (c) Revenues and owner’s capital are increased by credits and decreased by debits. Expenses and owner’s drawing are increased by debits and decreased by credits. 6. (a) Accounts Receivable—debit balance. (b) Cash—debit balance. (c) Owner’s Drawing—debit balance. (d) Accounts Payable—credit balance. (e) Service Revenue—credit balance. (f) Salaries Expense—debit balance. (g) Owner’s Capital—credit balance. 7. (a) Accounts Receivable—asset—debit balance. (b) Accounts Payable—liability—credit balance (c) Equipment—asset—debit balance. (d) Owner’s Drawing—owner’s equity—debit balance. (e) Supplies—asset—debit balance. 8. (a) Debit Supplies and credit Accounts Payable. (b) Debit Cash and credit Notes Payable. (c) Debit Salaries Expense and credit Cash. 9. (1) (2) (3) (4) (5) (6) 10. Cash—both debit and credit entries. Accounts Receivable—both debit and credit entries. Owner’s Drawing—debit entries only. Accounts Payable—both debit and credit entries. Salaries Expense—debit entries only. Service Revenue—credit entries only. The basic steps in the recording process are: (1) Analyze each transaction for its effect on the accounts. (2) Enter the transaction information in a journal. (3) Transfer the journal information to the appropriate accounts in the ledger. 2-4 Questions Chapter 2 (Continued) 11. The advantages of using the journal in the recording process are: (1) It discloses in one place the complete effects of a transaction. (2) It provides a chronological record of all transactions. (3) It helps to prevent or locate errors because the debit and credit amounts for each entry can be easily compared. 12. (a) (b) 13. When three or more accounts are required in one journal entry, the entry is referred to as a compound entry. An example of a compound entry is the purchase of equipment, part of which is paid for with cash and the remainder is on account. 14. (a) (b) 15. The advantage of the last step in the posting process is to indicate that the item has been posted. 16. (a) Cash............................................................................................................. Hector Molina, Capital.................................................................... (Invested cash in the business) (b) (c) (d) 17. The debit should be entered first. The credit should be indented. No, debits and credits should not be recorded directly in the ledger. The advantages of using the journal are: 1. It discloses in one place the complete effects of a transaction. 2. It provides a chronological record of all transactions. 3. It helps to prevent or locate errors because the debit and credit amounts for each entry can be easily compared. 9,000 9,000 Prepaid Insurance ..................................................................................... Cash .................................................................................................. (Paid one-year insurance policy) 800 Supplies....................................................................................................... Accounts Payable ........................................................................... (Purchased supplies on account) 2,000 Cash............................................................................................................. Service Revenue............................................................................. (Received cash for services rendered) 7,500 800 2,000 7,500 (a) The entire group of accounts maintained by a company, including all the asset, liability, and owner’s equity accounts, is referred to collectively as the ledger. (b) A chart of accounts is a list of accounts and the account numbers that identify their location in the ledger. The chart of accounts is important, particularly for a company that has a large number of accounts, because it helps organize the accounts and identify their location in the ledger. The numbering system used to identify the accounts usually starts with the balance sheet accounts and follows with the income statement accounts. 2-5 Questions Chapter 2 (Continued) 18. A trial balance is a list of accounts and their balances at a given time. The primary purpose of a trial balance is to prove (check) that the debits equal the credits after posting. A trial balance also facilitates the discovery of errors in journalizing and posting. In addition, it is useful in preparing financial statements. 19. No, Jim is not correct. The proper sequence is as follows: (b) Business transaction occurs. (c) Information entered in the journal. (a) Debits and credits posted to the ledger. (e) Trial balance is prepared. (d) Financial statements are prepared. 20. (a) (b) The trial balance would balance. The trial balance would not balance. 2-6 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 2-1 1. 2. 3. 4. 5. 6. Accounts Payable Advertising Expense Service Revenue Accounts Receivable A. J. Ritter, Capital A. J. Ritter, Drawing (a) Debit Effect Decrease Increase Decrease Increase Decrease Increase (b) Credit Effect Increase Decrease Increase Decrease Increase Decrease (c) Normal Balance Credit Debit Credit Debit Credit Debit BRIEF EXERCISE 2-2 June 1 2 3 12 Account Debited Cash Equipment Rent Expense Accounts Receivable Account Credited Hank Norris, Capital Accounts Payable Cash Service Revenue BRIEF EXERCISE 2-3 June 1 2 3 12 Cash.................................................................................. Hank Norris, Capital ........................................... 5,000 Equipment ...................................................................... Accounts Payable ............................................... 900 Rent Expense ................................................................ Cash......................................................................... 800 Accounts Receivable .................................................. Service Revenue.................................................. 300 2-7 5,000 900 800 300 BRIEF EXERCISE 2-4 The basic steps in the recording process are: 1. Analyze each transaction. In this step, business documents are examined to determine the effects of the transaction on the accounts. 2. Enter each transaction in a journal. This step is called journalizing and it results in making a chronological record of the transactions. 3. Transfer journal information to ledger accounts. This step is called posting. Posting makes it possible to accumulate the effects of journalized transactions on individual accounts. BRIEF EXERCISE 2-5 (a) Aug. Effect on Accounting Equation (b) Debit-Credit Analysis 1 The asset Cash is increased; the owner’s equity account T. J. Carlin, Capital is increased. Debits increase assets: debit Cash $8,000. Credits increase owner’s equity: credit T. J. Carlin, Capital $8,000. 4 The asset Prepaid Insurance is increased; the asset Cash is decreased. Debits increase assets: debit Prepaid Insurance $1,800. Credits decrease assets: credit Cash $1,800. 16 The asset Cash is increased; the revenue Service Revenue is increased. Debits increase assets: debit Cash $800. Credits increase revenues: credit Service Revenue $800. 27 The expense Salaries Expense is increased; the asset Cash is decreased. Debits increase expenses: debit Salaries Expense $1,000. Credits decrease assets: credit Cash $1,000. 2-8 BRIEF EXERCISE 2-6 Aug. 1 4 16 27 Cash .................................................................................. T. J. Carlin, Capital .............................................. 8,000 Prepaid Insurance ........................................................ Cash ......................................................................... 1,800 Cash .................................................................................. Service Revenue .................................................. 800 Salaries Expense .......................................................... Cash ......................................................................... 1,000 8,000 1,800 800 1,000 BRIEF EXERCISE 2-7 Cash 5/12 2,400 5/15 3,000 Ending Bal. 5,400 5/5 Accounts Receivable 5,000 5/12 Service Revenue 5/5 5,000 5/15 3,000 Ending Bal. 8,000 2,400 Ending Bal. 2,600 BRIEF EXERCISE 2-8 Cash Date May 12 15 Explanation Ref. J1 J1 2-9 Debit 2,400 3,000 Credit Balance 2,400 5,400 BRIEF EXERCISE 2-8 (Continued) Accounts Receivable Date Explanation May 5 12 Ref. J1 J1 Debit 5,000 Service Revenue Date Explanation May 5 15 Ref. J1 J1 Debit Credit 2,400 Balance 5,000 2,600 Credit 5,000 3,000 Balance 5,000 8,000 Debit $ 8,800 3,000 17,000 Credit BRIEF EXERCISE 2-9 CLELAND COMPANY Trial Balance June 30, 2008 Cash ......................................................................................... Accounts Receivable.......................................................... Equipment .............................................................................. Accounts Payable................................................................ Cleland, Capital .................................................................... Cleland, Drawing.................................................................. Service Revenue .................................................................. Salaries Expense ................................................................. Rent Expense ........................................................................ 2-10 $ 9,000 20,000 1,200 8,000 6,000 1,000 $37,000 $37,000 BRIEF EXERCISE 2-10 KWUN COMPANY Trial Balance December 31, 2008 Cash .......................................................................................... Prepaid Insurance ................................................................ Accounts Payable ................................................................ Unearned Revenue............................................................... P. Kwun, Capital.................................................................... P. Kwun, Drawing ................................................................. Service Revenue ................................................................... Salaries Expense .................................................................. Rent Expense......................................................................... 2-11 Debit $14,800 3,500 Credit $ 3,000 2,200 13,000 4,500 25,600 18,600 2,400 $43,800 $43,800 SOLUTIONS TO EXERCISES EXERCISE 2-1 1. False. An account is an accounting record of a specific asset, liability, or owner’s equity item. 2. False. An account shows increases and decreases in the item it relates to. 3. False. Each asset, liability, and owner’s equity item has a separate account. 4. False. An account has a left, or debit side, and a right, or credit side. 5. True. 2-12 Transaction (a) Basic Type (b) Specific Account Jan. 2 Asset 3 (c) Account Credited 2-13 Effect (d) Normal Balance (a) Basic Type (b) Specific Account Cash Increase Debit Owner’s Equity Asset Equipment Increase Debit 9 Asset Supplies Increase 11 Asset Accounts Receivable 16 Owner’s Equity 20 (c) Effect (d) Normal Balance D. Reyes, Capital Increase Credit Asset Cash Decrease Debit Debit Liability Accounts Payable Increase Credit Increase Debit Owner’s Equity Service Revenue Increase Credit Advertising Expense Increase Debit Asset Cash Decrease Debit Asset Cash Increase Debit Asset Accounts Receivable Decrease Debit 23 Liability Accounts Payable Decrease Credit Asset Cash Decrease Debit 28 Owner’s Equity D. Reyes, Drawing Increase Debit Asset Cash Decrease Debit EXERCISE 2-2 Account Debited EXERCISE 2-3 General Journal Date Account Titles and Explanation Jan. 2 Cash ............................................................ D. Reyes, Capital............................ 10,000 Equipment................................................. Cash ................................................... 4,000 Supplies..................................................... Accounts Payable.......................... 500 Accounts Receivable............................. Service Revenue ............................ 1,800 Advertising Expense ............................. Cash ................................................... 200 Cash ............................................................ Accounts Receivable.................... 700 Accounts Payable................................... Cash ................................................... 300 D. Reyes, Drawing .................................. Cash ................................................... 1,000 3 9 11 16 20 23 28 Ref. Debit J1 Credit 10,000 4,000 500 1,800 200 700 300 1,000 EXERCISE 2-4 Oct. 1 Debits increase assets: debit Cash $15,000. Credits increase owner’s equity: credit Pete Hanshew, Capital $15,000. 2 No transaction. 3 Debits increase assets: debit Office Furniture $1,900. Credits increase liabilities: credit Accounts Payable $1,900. 2-14 EXERCISE 2-4 (Continued) Oct. 6 Debits increase assets: debit Accounts Receivable $3,200. Credits increase revenues: credit Service Revenue $3,200. 27 Debits decrease liabilities: debit Accounts Payable $700. Credits decrease assets: credit Cash $700. 30 Debits increase expenses: debit Salaries Expense $2,500. Credits decrease assets: credit Cash $2,500. EXERCISE 2-5 General Journal Date Oct. 1 Account Titles and Explanation Cash............................................................. Pete Hanshew, Capital ................ Ref. Debits 15,000 15,000 2 No entry. 3 Office Furniture........................................ Accounts Payable......................... 1,900 Accounts Receivable ............................. Service Revenue ........................... 3,200 Accounts Payable ................................... Cash .................................................. 700 Salaries Expense..................................... Cash .................................................. 2,500 6 27 30 2-15 Credit 1,900 3,200 700 2,500 EXERCISE 2-6 (a) 1. 2. 3. Increase the asset Cash, increase the liability Notes Payable. Increase the asset Computer, decrease the asset Cash. Increase the asset Supplies, increase the liability Accounts Payable. (b) 1. Cash.............................................................................. Notes Payable ................................................... Computer .................................................................... Cash...................................................................... Supplies ...................................................................... Accounts Payable ............................................ 2. 3. 5,000 5,000 2,500 2,500 700 700 EXERCISE 2-7 (a) Assets = Liabilities + Owners’ Equity 1. + + (Investment) 2. – – (Expense) 3. + + (Revenue) 4. – – (Drawings) (b) 1. 2. 3. 4. Cash.............................................................................. A. Rowand, Capital .......................................... Rent Expense ............................................................ Cash...................................................................... Accounts Receivable .............................................. Consulting Revenue........................................ A. Rowand, Drawing................................................ Cash...................................................................... 4,000 4,000 1,100 1,100 5,200 5,200 700 700 EXERCISE 2-8 1. 2. 3. 4. 5. False. The general ledger contains all the asset, liability, and owner’s equity accounts. True. False. The accounts in the general ledger are arranged in financial statement order: first the assets, then the liabilities, owner’s capital, owner’s drawing, revenues, and expenses. True. False. The general ledger is not a book of original entry; transactions are first recorded in the general journal, then in the general ledger. 2-16 EXERCISE 2-9 (a) Aug. 1 10 31 Bal. Cash 5,000 Aug. 12 2,400 900 7,300 Accounts Receivable Aug. 25 1,600 Aug. 31 Bal. 700 Notes Payable Aug. 12 1,000 Teresa Gonzalez, Capital Aug. 1 5,000 900 Service Revenue Aug. 10 25 Bal. Office Equipment Aug. 12 5,000 (b) 4,000 2,400 1,600 4,000 TERESA GONZALEZ, INVESTMENT BROKER Trial Balance August 31, 2008 Cash ..................................................................................... Accounts Receivable...................................................... Office Equipment............................................................. Notes Payable................................................................... Teresa Gonzalez, Capital .............................................. Service Revenue .............................................................. Debit $ 7,300 700 5,000 $13,000 2-17 Credit $ 4,000 5,000 4,000 $13,000 EXERCISE 2-10 (a) General Journal Date Apr. 1 12 15 25 29 30 Account Titles and Explanation Ref. Cash .............................................................. J. Simon, Capital.................................. (Owner’s investment of cash in business) Debit 15,000 15,000 Cash .............................................................. Service Revenue .................................. (Received cash for services provided) 900 Salaries Expense ...................................... Cash ......................................................... (Paid salaries to date) 600 Accounts Payable..................................... Cash ......................................................... (Paid creditors on account) 1,500 Cash .............................................................. Accounts Receivable.......................... (Received cash in payment of account) 400 Cash .............................................................. Unearned Revenue.............................. (Received cash for future services) 1,000 2-18 Credit 900 600 1,500 400 1,000 EXERCISE 2-10 (Continued) (b) SIMON LANDSCAPING COMPANY Trial Balance April 30, 2008 Cash....................................................................................... Accounts Receivable ....................................................... Supplies................................................................................ Accounts Payable ............................................................. Unearned Revenue ........................................................... J. Simon, Capital ............................................................... Service Revenue................................................................ Salaries Expense............................................................... Debit $15,200 2,800 1,800 Credit $ 300 1,000 15,000 4,100 600 $20,400 $20,400 EXERCISE 2-11 (a) Oct. 1 Cash ....................................................................... Heerey, Capital............................................ (Owner’s investment of cash in business) 5,000 10 Cash ....................................................................... Service Revenue ........................................ (Received cash for services provided) 650 10 Cash ....................................................................... Notes Payable ............................................. (Obtained loan from bank) 4,000 20 Cash ....................................................................... Accounts Receivable................................ (Received cash in payment of account) 500 20 Accounts Receivable........................................ Service Revenue ........................................ (Billed clients for services provided) 940 2-19 5,000 650 4,000 500 940 EXERCISE 2-11 (Continued) (b) HEEREY CO. Trial Balance October 31, 2008 Cash ................................................................................ Accounts Receivable................................................. Supplies ......................................................................... Furniture ........................................................................ Notes Payable.............................................................. Accounts Payable....................................................... Heerey, Capital ............................................................ Heerey, Drawing.......................................................... Service Revenue ......................................................... Store Wages Expense ............................................... Rent Expense ............................................................... Debit $ 9,200 1,240 400 2,000 Credit $ 4,000 500 7,000 300 2,390 500 250 $13,890 $13,890 EXERCISE 2-12 (a) General Journal Date Sept. 1 5 25 30 Account Titles and Explanation Cash ........................................................... Tina Cordero, Capital .................. Ref. 101 301 Debit 10,000 Equipment ................................................ Cash .................................................. Accounts Payable......................... 157 101 201 12,000 Accounts Payable.................................. Cash .................................................. 201 101 3,000 Tina Cordero, Drawing ......................... Cash .................................................. 306 101 500 2-20 J1 Credit 10,000 5,000 7,000 3,000 500 EXERCISE 2-12 (Continued) (b) Cash Date Sept. 1 5 25 30 Explanation Equipment Date Explanation Sept. 5 Accounts Payable Date Explanation Sept. 5 25 Tina Cordero, Capital Date Explanation Sept. 1 Tina Cordero, Drawing Date Explanation Sept. 30 Ref. J1 J1 J1 J1 Ref. J1 Ref. J1 J1 Ref. J1 Ref. J1 2-21 Debit 10,000 Credit 5,000 3,000 500 Debit 12,000 Debit Credit No. 157 Balance 12,000 Credit 7,000 No. 201 Balance 7,000 4,000 3,000 Debit Debit 500 No. 101 Balance 10,000 5,000 2,000 1,500 Credit 10,000 Credit No. 301 Balance 10,000 No. 306 Balance 500 EXERCISE 2-13 Error 1. 2. 3. 4. 5. 6. (a) In Balance No Yes Yes No Yes No (b) Difference $400 — — 300 — 18 (c) Larger Column Debit — — Credit — Credit EXERCISE 2-14 SANFORD DELIVERY SERVICE Trial Balance July 31, 2008 Debit Cash ($82,907 – Debit total without Cash $66,340) .............................................................................. Accounts Receivable.......................................................... Prepaid Insurance ............................................................... Delivery Equipment............................................................. Notes Payable....................................................................... Accounts Payable................................................................ Salaries Payable .................................................................. Sanford, Capital ................................................................... Sanford, Drawing................................................................. Service Revenue .................................................................. Salaries Expense ................................................................. Repair Expense .................................................................... Gas and Oil Expense .......................................................... Insurance Expense ............................................................. 2-22 Credit $16,567 7,642 1,968 49,360 $18,450 8,396 815 44,636 700 10,610 4,428 961 758 523 $82,907 $82,907 SOLUTIONS TO PROBLEMS PROBLEM 2-1A Date Apr. 1 4 8 11 Account Titles and Explanation Cash................................................................. C. J. Mendez, Capital ........................ (Owner’s investment of cash in business) Ref. Debit 40,000 40,000 Land ................................................................. Cash ....................................................... (Purchased land for cash) 30,000 Advertising Expense .................................. Accounts Payable .............................. (Incurred advertising expense on account) 1,800 Salaries Expense ......................................... Cash ....................................................... (Paid salaries) 1,500 30,000 1,800 1,500 12 No entry—Not a transaction. 13 Prepaid Insurance ....................................... Cash ....................................................... (Paid for one-year insurance policy) 1,500 C. J. Mendez, Drawing ............................... Cash ....................................................... (Withdrew cash for personal use) 1,000 Cash................................................................. Admission Revenue .......................... (Received cash for services provided) 5,700 17 20 2-23 J1 Credit 1,500 1,000 5,700 PROBLEM 2-1A (Continued) Date Account Titles and Explanation Apr. 25 Cash ............................................................... Unearned Admission Revenue......... (Received cash for future services) 2,500 Cash ............................................................... Admission Revenue ......................... (Received cash for services provided) 8,900 Accounts Payable...................................... Cash....................................................... (Paid creditor on account) 900 30 30 2-24 Ref. Debit Credit 2,500 8,900 900 PROBLEM 2-2A (a) Date Account Titles and Explanation Ref. Debit May 1 Cash................................................................. Jane Kent, Capital.............................. (Owner’s investment of cash in business) 101 301 25,000 25,000 2 No entry—not a transaction. 3 Supplies.......................................................... Accounts Payable.............................. (Purchased supplies on account) 126 201 2,500 Rent Expense................................................ Cash ....................................................... (Paid office rent) 729 101 900 Accounts Receivable ................................. Service Revenue ................................ (Billed client for services provided) 112 400 2,100 Cash................................................................. Unearned Revenue ............................ (Received cash for future services) 101 205 3,500 Cash................................................................. Service Revenue ................................ (Received cash for services provided) 101 400 1,200 Salaries Expense ......................................... Cash ....................................................... (Paid salaries) 726 101 2,000 7 11 12 17 31 2-25 J1 Credit 2,500 900 2,100 3,500 1,200 2,000 PROBLEM 2-2A (Continued) Date Account Titles and Explanation Ref. May 31 Accounts Payable ($2,500 X 40%)............. Cash...................................................... (Paid creditor on account) 201 101 Debit Credit 1,000 1,000 (b) Cash Date May 1 7 12 17 31 31 Explanation Accounts Receivable Date Explanation May 11 Supplies Date Explanation May 3 Accounts Payable Date Explanation May 3 31 Unearned Revenue Date Explanation May 12 Ref. J1 J1 J1 J1 J1 J1 Ref. J1 Ref. J1 Ref. J1 J1 Ref. J1 2-26 Debit 25,000 Credit 900 3,500 1,200 2,000 1,000 Debit 2,100 Debit 2,500 Debit No. 101 Balance 25,000 24,100 27,600 28,800 26,800 25,800 Credit No. 112 Balance 2,100 Credit No. 126 Balance 2,500 Credit 2,500 No. 201 Balance 1,000 1,500 Debit No. 205 Balance 3,500 Credit 3,500 PROBLEM 2-2A (Continued) Jane Kent, Capital Date Explanation May 1 Service Revenue Date Explanation May 11 17 Salaries Expense Date Explanation May 31 Rent Expense Date Explanation May 7 (c) Ref. J1 Ref. J1 J1 Ref. J1 Ref. J1 Debit Debit Debit 2,000 Debit 900 Credit 25,000 No. 301 Balance 25,000 Credit 2,100 1,200 No. 400 Balance 2,100 3,300 Credit No. 726 Balance 2,000 Credit No. 729 Balance 900 JANE KENT, CPA Trial Balance May 31, 2008 Debit Cash................................................................................. $25,800 Accounts Receivable ................................................. 2,100 Supplies.......................................................................... 2,500 Accounts Payable ....................................................... Unearned Revenue ..................................................... Jane Kent, Capital....................................................... Service Revenue.......................................................... Salaries Expense......................................................... 2,000 Rent Expense ............................................................... 900 $33,300 2-27 Credit $ 1,500 3,500 25,000 3,300 $33,300 PROBLEM 2-3A (a) & (c) Balance (4) (7) Cash 8,000 (1) (3) 14,000 (5) 6,000 (8) (9) 4,000 Jack Shellenkamp, Capital Balance 41,000 41,000 1,000 2,000 15,000 Jack Shellenkamp, Drawing (9) 3,000 3,000 3,000 3,000 Repair Services Revenue (7) 15,000 15,000 Accounts Receivable Balance 15,000 (4) 14,000 (7) 9,000 10,000 Balance (2) Balance Parts Inventory 13,000 4,000 (6) 13,000 (1) Advertising Expense 1,000 1,000 (3) Miscellaneous Expense 2,000 2,000 (6) Repair Parts Expense 4,000 4,000 (8) Wage Expense 3,000 3,000 4,000 Prepaid Rent 3,000 3,000 Shop Equipment Balance 21,000 21,000 (5) Accounts Payable Balance (2) 15,000 19,000 4,000 8,000 2-28 PROBLEM 2-3A (Continued) (b) Trans. 1. 2. 3. 4. 5. 6. 7. 8. 9. Account Titles and Explanation Debit Advertising Expense..................................... Cash......................................................... 1,000 Parts Inventory................................................ Accounts Payable ............................... 4,000 Miscellaneous Expense ............................... Cash......................................................... 2,000 Cash.................................................................... Accounts Receivable ......................... 14,000 Accounts Payable .......................................... Cash......................................................... 15,000 Repair Parts Expense ................................... Parts Inventory..................................... 4,000 Cash.................................................................... Accounts Receivable .................................... Repair Services Revenue.................. 6,000 9,000 Wage Expense ................................................ Cash......................................................... 3,000 Jack Shellenkamp, Drawing ....................... Cash......................................................... 3,000 2-29 Credit 1,000 4,000 2,000 14,000 15,000 4,000 15,000 3,000 3,000 PROBLEM 2-3A (Continued) (d) BYTE REPAIR SERVICE Trial Balance January 31, 2008 Cash ................................................................................ Accounts Receivable................................................. Parts Inventory ............................................................ Prepaid Rent................................................................. Shop Equipment ......................................................... Accounts Payable....................................................... Jack Shellenkamp, Capital ...................................... Jack Shellenkamp, Drawing.................................... Repair Services Revenue......................................... Advertising Expense ................................................. Miscellaneous Expense............................................ Repair Parts Expense................................................ Wage Expense ............................................................. 2-30 Debit $ 4,000 10,000 13,000 3,000 21,000 Credit $ 8,000 41,000 3,000 15,000 1,000 2,000 4,000 3,000 $64,000 $64,000 PROBLEM 2-4A STERLING COMPANY Trial Balance May 31, 2008 Cash ($5,850 + $520 – $405) ............................................... Accounts Receivable ($2,570 – $210).............................. Prepaid Insurance ($700 + $100)....................................... Supplies ($0 + $520) .............................................................. Equipment ($8,000 – $520) .................................................. Accounts Payable ($4,500 – $100 + $520 – $210)........ Property Taxes Payable ....................................................... M. Sterling, Capital ($11,700 + $1,000) ............................ M. Sterling, Drawing ($0 + $1,000) .................................... Service Revenue..................................................................... Salaries Expense ($4,200 + $200) ..................................... Advertising Expense ($1,100 + $405) .............................. Property Tax Expense ($800 + $100) ............................... 2-31 Debit $ 5,965 2,360 800 520 7,480 Credit $ 4,710 560 12,700 1,000 6,960 4,400 1,505 900 $24,930 $24,930 PROBLEM 2-5A (a) & (c) Cash Date Apr. 1 2 9 10 12 25 29 30 30 Explanation Balance Accounts Receivable Date Explanation Apr. 30 Prepaid Rentals Date Explanation Apr. 30 Land Date Apr. 1 Explanation Balance Buildings Date Explanation Apr. 1 Balance Ref.
J1 J1 J1 J1 J1 J1 J1 J1 Ref. J1 Ref. J1 Ref.
Ref.
2-32 Debit Credit 800 2,800 3,000 500 5,200 2,000 85 900 Debit 85 Debit 900 Debit Debit No. 101 Balance 6,000 5,200 8,000 5,000 4,500 9,700 7,700 7,785 6,885 Credit No. 112 Balance 85 Credit No. 136 Balance 900 Credit No. 140 Balance 10,000 Credit No. 145 Balance 8,000 PROBLEM 2-5A (Continued) Equipment Date Explanation Apr. 1 Balance Accounts Payable Date Explanation Apr. 1 Balance 10 20 Mortgage Payable Date Explanation Apr. 1 Balance 10 Tony Carpino, Capital Date Explanation Apr. 1 Balance Admission Revenue Date Explanation Apr. 9 25 Concession Revenue Date Explanation Apr. 30 Ref.
Ref.
J1 J1 Ref.
J1 Ref.
Ref. J1 J1 Ref. J1 2-33 Debit Debit Credit Credit 1,000 1,000 Debit Debit Debit No. 201 Balance 2,000 1,000 2,000 Credit No. 275 Balance 8,000 6,000 Credit No. 301 Balance 20,000 2,000 Debit No. 157 Balance 6,000 Credit 2,800 5,200 No. 405 Balance 2,800 8,000 Credit 170 No. 406 Balance 170 PROBLEM 2-5A (Continued) Advertising Expense Date Explanation Apr. 12 Film Rental Expense Date Explanation Apr. 2 20 Salaries Expense Date Explanation Apr. 29 Ref. J1 Ref. J1 J1 Ref. J1 Debit 500 Debit 800 1,000 Debit 2,000 Credit No. 610 Balance 500 Credit No. 632 Balance 800 1,800 Credit No. 726 Balance 2,000 (b) Date Apr. 2 Account Titles and Explanation Film Rental Expense ............................... Cash................................................... (Paid film rental) Ref. 632 101 Debit 800 800 3 No entry—not a transaction. 9 Cash ............................................................. Admission Revenue ..................... (Received cash for services provided) 101 405 2,800 Mortgage Payable .................................... Accounts Payable.................................... Cash................................................... (Made payments on mortgage and accounts payable) 275 201 101 2,000 1,000 10 2-34 J1 Credit 2,800 3,000 PROBLEM 2-5A (Continued) Date Account Titles and Explanation Ref. Debit Apr. 11 No entry—not a transaction. Advertising Expense................................. Cash ..................................................... (Paid advertising expenses) 610 101 500 20 Film Rental Expense ................................. Accounts Payable ........................... (Rented film on account) 632 201 1,000 25 Cash................................................................ Admission Revenue........................ (Received cash for services provided) 101 405 5,200 Salaries Expense........................................ Cash ..................................................... (Paid salaries expense) 726 101 2,000 Cash................................................................ Accounts Receivable ................................ Concession Revenue ..................... (17% X $1,000) (Received cash and balance on account for concession revenue) 101 112 406 85 85 Prepaid Rentals .......................................... Cash ..................................................... (Paid cash for future film rentals) 136 101 900 12 29 30 30 2-35 Credit 500 1,000 5,200 2,000 170 900 PROBLEM 2-5A (Continued) (d) LAKE THEATER Trial Balance April 30, 2008 Cash ................................................................................ Accounts Receivable................................................. Prepaid Rentals ........................................................... Land ................................................................................ Buildings ....................................................................... Equipment..................................................................... Accounts Payable....................................................... Mortgage Payable....................................................... Tony Carpino, Capital ............................................... Admission Revenue................................................... Concession Revenue ................................................ Advertising Expense ................................................. Film Rental Expense.................................................. Salaries Expense ........................................................ 2-36 Debit $ 6,885 85 900 10,000 8,000 6,000 Credit $ 2,000 6,000 20,000 8,000 170 500 1,800 2,000 $36,170 $36,170 PROBLEM 2-1B Date Mar. 1 3 5 6 10 18 19 Account Titles and Explanation Cash .................................................................. Jerry Glover, Capital .......................... (Owner’s investment of cash in business) Ref. Debit 50,000 50,000 Land .................................................................. Buildings ......................................................... Equipment....................................................... Cash ........................................................ (Purchased Lee’s Golf Land) 23,000 9,000 6,000 Advertising Expense ................................... Cash ........................................................ (Paid for advertising) 1,600 Prepaid Insurance ........................................ Cash ........................................................ (Paid for one-year insurance policy) 1,480 Equipment....................................................... Accounts Payable............................... (Purchased equipment on account) 2,600 Cash .................................................................. Golf Revenue........................................ (Received cash for services provided) 800 Cash .................................................................. Unearned Revenue ............................. (Received cash for coupon books sold) 1,500 2-37 J1 Credit 38,000 1,600 1,480 2,600 800 1,500 PROBLEM 2-1B (Continued) Date Mar. 25 30 30 31 Account Titles and Explanation Jerry Glover, Drawing ............................ Cash .................................................... (Withdrew cash for personal use) Ref. Debit 2,000 2,000 Salaries Expense ..................................... Cash .................................................... (Paid salaries) 600 Accounts Payable.................................... Cash .................................................... (Paid creditor on account) 2,600 Cash ............................................................. Golf Revenue.................................... (Received cash for services provided) 500 2-38 Credit 600 2,600 500 PROBLEM 2-2B (a) Date Account Titles and Explanation Ref. Debit Apr. 1 Cash .................................................................. Rosa Perez, Capital ............................ (Owner’s investment of cash in business) 101 301 30,000 30,000 1 No entry—not a transaction. 2 Rent Expense................................................. Cash ........................................................ (Paid monthly office rent) 729 101 800 Supplies ........................................................... Accounts Payable............................... (Purchased supplies on account from Halo Company) 126 201 1,500 Accounts Receivable................................... Service Revenue ................................. (Billed clients for services provided) 112 400 1,200 Cash .................................................................. Unearned Revenue ............................. (Received cash for future service) 101 205 500 Cash .................................................................. Service Revenue ................................. (Received cash for services provided) 101 400 1,500 Salaries Expense .......................................... Cash ........................................................ (Paid monthly salary) 726 101 2,000 3 10 11 20 30 2-39 J1 Credit 800 1,500 1,200 500 1,500 2,000 PROBLEM 2-2B (Continued) Date Account Titles and Explanation Ref. Debits Apr. 30 Accounts Payable .................................... Cash .................................................... (Paid Halo Company on account) 201 101 600 Credit 600 (b) Cash Date Apr. Explanation 1 2 11 20 30 30 Accounts Receivable Date Explanation Apr. 10 Supplies Date Apr. 3 Explanation Accounts Payable Date Explanation Apr. 3 30 Unearned Revenue Date Explanation Apr. 11 Ref. Debit J1 J1 J1 J1 J1 J1 30,000 Ref. J1 Ref. J1 Ref. J1 J1 Ref. J1 2-40 Credit 800 500 1,500 2,000 600 Debit 1,200 Debit 1,500 Debit 30,000 29,200 29,700 31,200 29,200 28,600 Credit No. 112 Balance 1,200 Credit No. 126 Balance 1,500 Credit 1,500 No. 201 Balance 1,500 900 600 Debit No. 101 Balance Credit 500 No. 205 Balance 500 PROBLEM 2-2B (Continued) Rosa Perez, Capital Date Explanation Apr. 1 Service Revenue Date Explanation Apr. 10 20 Salaries Expense Date Explanation Apr. 30 Rent Expense Date Explanation Apr. 2 (c) Ref. J1 Ref. J1 J1 Ref. J1 Ref. J1 Debit Debit Debit 2,000 Debit 800 Credit 30,000 No. 301 Balance 30,000 Credit 1,200 1,500 No. 400 Balance 1,200 2,700 Credit No. 726 Balance 2,000 Credit No. 729 Balance 800 ROSA PEREZ, ARCHITECT Trial Balance April 30, 2008 Cash................................................................................. Accounts Receivable ................................................. Supplies.......................................................................... Accounts Payable ....................................................... Unearned Revenue ..................................................... Rosa Perez, Capital .................................................... Service Revenue.......................................................... Salaries Expense......................................................... Rent Expense ............................................................... 2-41 Debit $28,600 1,200 1,500 Credit $ 900 500 30,000 2,700 2,000 800 $34,100 $34,100 PROBLEM 2-3B (a) Trans. 1. Account Titles and Explanation Cash ........................................................... Ronald Slocombe, Capital ....... Debit 100,000 100,000 2. No entry—Not a transaction. 3. Prepaid Rent............................................ Cash ................................................ 36,000 Furniture & Equipment ........................ Cash ................................................ Accounts Payable....................... 60,000 Prepaid Insurance ................................. Cash ................................................ 3,000 Office Supplies ....................................... Cash ................................................ 1,000 Office Supplies ....................................... Accounts Payable....................... 3,000 Cash ........................................................... Accounts Receivable ........................... Service Revenue ......................... 10,000 20,000 Accounts Payable ................................. Cash ................................................ 800 Cash ........................................................... Accounts Receivable................. 5,000 Utility Expense ....................................... Accounts Payable....................... 400 4. 5. 6. 7. 8. 9. 10. 11. 2-42 Credit 36,000 20,000 40,000 3,000 1,000 3,000 30,000 800 5,000 400 PROBLEM 2-3B (Continued) Trans. 12. Account Titles and Explanation Salaries Expense .................................. Cash ................................................. Debit 6,000 Credit 6,000 (b) (1) (8) (10) (8) (6) (7) (5) (3) Cash 100,000 (3) (4) (5) (6) 10,000 (9) 5,000 (12) 48,200 (4) 36,000 20,000 3,000 1,000 800 (9) 6,000 Accounts Receivable 20,000 (10) 5,000 15,000 Furniture & Equipment 60,000 60,000 Accounts Payable (4) 40,000 (7) 3,000 800 (11) 400 42,600 Ronald Slocombe, Capital (1) 100,000 100,000 Service Revenue (8) Office Supplies 1,000 3,000 4,000 Prepaid Insurance 3,000 3,000 Prepaid Rent 36,000 36,000 2-43 (12) Salaries Expense 6,000 6,000 (11) Utility Expense 400 400 30,000 30,000 PROBLEM 2-3B (Continued) (c) SLOCOMBE SERVICES Trial Balance May 31, 2008 Cash............................................................................ Accounts Receivable ............................................ Office Supplies........................................................ Prepaid Insurance.................................................. Prepaid Rent ............................................................ Furniture & Equipment ......................................... Accounts Payable .................................................. Ronald Slocombe, Capital................................... Service Revenue..................................................... Salaries Expense.................................................... Utility Expense ........................................................ 2-44 Debit $ 48,200 15,000 4,000 3,000 36,000 60,000 Credit $ 42,600 100,000 30,000 6,000 400 $172,600 $172,600 PROBLEM 2-4B DON KELSO CO. Trial Balance June 30, 2008 Cash ($2,840 + $270)........................................................... Accounts Receivable ($3,231 – $270) ........................... Supplies ($800 – $340) ....................................................... Equipment ($3,000 + $340) ............................................... Accounts Payable ($2,666 – $206 – $260) ................... Unearned Revenue.............................................................. D. Kelso, Capital................................................................... D. Kelso, Drawing ($800 + $500) ..................................... Service Revenue ($2,380 + $801).................................... Salaries Expense ($3,400 + $600 – $500)..................... Office Expense ..................................................................... 2-45 Debit $ 3,110 2,961 460 3,340 Credit $ 2,200 1,200 9,000 1,300 3,181 3,500 910 $15,581 $15,581 PROBLEM 2-5B (a) & (c) Cash Date Mar. 1 2 9 10 12 20 20 31 31 31 Explanation Balance Accounts Receivable Date Explanation Mar. 31 Land Date Mar. 1 Explanation Balance Buildings Date Explanation Mar. 1 Balance Equipment Date Explanation Mar. 1 Balance Ref.
J1 J1 J1 J1 J1 J1 J1 J1 J1 Ref. J1 Ref.
Ref.
Ref.
2-46 Debit Credit No. 101 Balance 400 11,000 16,000 13,000 19,500 12,500 11,700 18,900 15,900 11,100 11,500 22,500 Debit 400 Credit No. 112 Balance 400 Credit No. 140 Balance 42,000 Credit No. 145 Balance 18,000 Credit No. 157 Balance 16,000 3,000 6,500 7,000 800 7,200 3,000 4,800 Debit Debit Debit PROBLEM 2-5B (Continued) Accounts Payable Date Explanation Mar. 1 Balance 2 10 M. Quinn, Capital Date Explanation Mar. 1 Balance Admission Revenue Date Explanation Mar. 9 20 31 Concession Revenue Date Explanation Mar.31 Advertising Expense Date Explanation Mar.12 Film Rental Expense Date Explanation Mar. 2 20 Ref.
J1 J1 Ref.
Ref. J1 J1 J1 Ref. J1 Ref. J1 Ref. J1 J1 2-47 Debit Credit 3,000 7,000 Debit Debit Debit Debit 800 Debit 6,000 3,000 Credit No. 201 Balance 12,000 15,000 8,000 No. 301 Balance 80,000 Credit 6,500 7,200 11,000 No. 405 Balance 6,500 13,700 24,700 Credit 800 No. 406 Balance 800 Credit No. 610 Balance 800 Credit No. 632 Balance 6,000 9,000 PROBLEM 2-5B (Continued) Salaries Expense Date Explanation Mar. 31 Ref. J1 Debit 4,800 Credit No. 726 Balance 4,800 (b) Date Account Titles and Explanation Ref. Debit Mar. 2 Film Rental Expense .................................. Accounts Payable............................. Cash ...................................................... (Rented films for cash and on account) 632 201 101 6,000 3,000 3,000 3 No entry. 9 Cash................................................................. Admission Revenue......................... (Received cash for services provided) 101 405 6,500 Accounts Payable ($3,000 + $4,000)......... Cash ...................................................... (Paid creditors on account) 201 101 7,000 10 6,500 7,000 11 No entry. 12 Advertising Expense.................................. Cash ...................................................... (Paid advertising expense) 610 101 800 Cash................................................................. Admission Revenue......................... (Received cash for services provided) 101 405 7,200 Film Rental Expense .................................. Cash ...................................................... (Paid film rental) 632 101 3,000 20 20 2-48 J1 Credit 800 7,200 3,000 PROBLEM 2-5B (Continued) Date Account Titles and Explanation Ref. Debit Mar.31 Salaries Expense......................................... Cash...................................................... (Paid salaries expense) 726 101 4,800 Cash................................................................. Accounts Receivable ................................. Concession Revenue ...................... (10% X $8,000) (Received cash and balance on account for concession revenue) 101 112 406 400 400 Cash................................................................. Admission Revenue ........................ (Received cash for services provided) 101 405 11,000 31 31 (d) Credit 4,800 800 11,000 QUINN THEATER Trial Balance March 31, 2008 Cash ............................................................................. Accounts Receivable.............................................. Land ............................................................................. Buildings .................................................................... Equipment.................................................................. Accounts Payable ................................................... M. Quinn, Capital ..................................................... Admission Revenue................................................ Concession Revenue ............................................. Advertising Expense .............................................. Film Rental Expense............................................... Salaries Expense .................................................... 2-49 Debit $ 22,500 400 42,000 18,000 16,000 Credit $ 800 9,000 4,800 $113,500 8,000 80,000 24,700 800 $113,500 BYP 2-1 FINANCIAL REPORTING PROBLEM (a) Account Accounts Payable (1) Increase Side Right (1) Decrease Side Left (2) Normal Balance Credit Accounts Receivable Left Right Debit Property, Plant, and Equipment Left Right Debit Income Taxes Payable Right Left Credit Interest Expense Left Right Debit Inventory Left Right Debit (b) (1) Cash is increased. (2) Cash is decreased. (3) Cash is decreased or Accounts Payable is increased. (c) (1) Cash is decreased. (2) Cash is decreased or Notes or Mortgage Payable is increased. 2-50 BYP 2-2 (a) 1. COMPARATIVE ANALYSIS PROBLEM PepsiCo Inventory: debit 1. Coca-Cola Accounts Receivable: debit 2. Property, Plant, and Equipment: debit 2. Cash and Equivalents: debit 3. Accounts Payable: credit 3. Cost of Goods Sold: debit 4. Interest Expense: debit 4. Sales (Revenue): credit (b) The following other accounts are ordinarily involved: (1) Increase in Accounts Receivable: Service Revenue or Sales is increased (credited). (2) Decrease in Wages Payable: Cash is decreased (credited). (3) Increase in Property, Plant, and Equipment: Notes Payable is increased (credited) or Cash is decreased (credited). (4) Increase in Interest Expense: Cash is decreased (credited). 2-51 BYP 2-3 EXPLORING THE WEB The answer is dependent upon the company selected by the student. 2-52 BYP 2-4 DECISION MAKING ACROSS THE ORGANIZATION (a) May 1 5 7 14 15 20 Correct. Cash................................................................... Lesson Revenue.................................... 250 Cash................................................................... Unearned Boarding Revenue ............ 300 Office Equipment........................................... Cash........................................................... 800 Lisa Ortega, Drawing ................................... Cash........................................................... 400 Cash................................................................... Riding Revenue...................................... 184 30 Correct. 31 Hay and Feed Supplies ............................... Accounts Payable ................................. 250 300 800 400 184 1,700 1,700 (b) The errors in the entries of May 14 and 20 would prevent the trial balance from balancing. (c) Net income as reported ................................................... Add: 5/15, Salaries expense (Lisa Ortega, Drawing) .............................................................. 5/31, Hay and feed expense (still on hand)..................................................................... $4,500 $ 400 1,700 Less: 5/7, Boarding revenue unearned ..................... Correct net income............................................................ (d) Cash as reported................................................................ Add: 5/20, Transposition error.................................... 5/31, Purchase on account ................................ 2-53 2,100 6,600 300 $6,300 $12,475 $ 36 1,700 1,736 $14,211 BYP 2-5 COMMUNICATION ACTIVITY Date: May 25, 2008 To: Accounting Instructor From: Student In the first transaction, bills totaling $6,000 were sent to customers for services rendered. Therefore, the asset Accounts Receivable is increased $6,000 and the revenue Service Revenue is increased $6,000. Debits increase assets and credits increase revenues, so the journal entry is: Accounts Receivable ........................................................................ Service Revenue........................................................................ (Bill customers for services provided) 6,000 6,000 The $6,000 amount is then posted to the debit side of the general ledger account Accounts Receivable and to the credit side of the general ledger account Service Revenue. In the second transaction, $2,000 was paid in salaries to employees. Therefore, the expense Salaries Expense is increased $2,000 and the asset Cash is decreased $2,000. Debits increase expenses and credits decrease assets, so the journal entry is: Salaries Expense................................................................................ Cash............................................................................................... (Salaries paid) 2,000 2,000 The $2,000 amount is then posted to the debit side of the general ledger account Salaries Expense and to the credit side of the general ledger account Cash. 2-54 BYP 2-6 ETHICS CASE (a) The stakeholders in this situation are:


Mary Jansen, assistant chief accountant. Users of the company’s financial statements. The Casey Company. (b) By adding $1,000 to the Equipment account, that account total is intentionally misstated. By not locating the error causing the imbalance, some other account may also be misstated by $1,000. If the amount of $1,000 is determined to be immaterial, and the intent is not to commit fraud (cover up an embezzlement or other misappropriation of assets), Mary’s action might not be considered unethical in the preparation of interim financial statements. However, if Mary is violating a company accounting policy by her action, then she is acting unethically. (c) Mary’s alternatives are: 1. Miss the deadline but find the error causing the imbalance. 2. Tell her supervisor of the imbalance and suffer the consequences. 3. Do as she did and locate the error later, making the adjustment in the next quarter. 2-55 BYP 2-7 ALL ABOUT YOU ACTIVITY (a) Students’ responses to this question will vary. It is important that the steps that they identify be as specific as possible, and clearly directed toward achieving their goal. You may wish to ask a follow-up question asking them to explain how each step will assist them in achieving their goal. (b) There are many sites on the Internet that provide information about preparing a résumé. For example, you can find extensive resources at: http://www.rileyguide.com/resprep.html. Many schools also have resources in their placement centers or writing labs. The Writing Center at Rensselaer Polytechnic Institute provides useful, concise information on its website at http://www.rpi.edu/web/writingcenter/resume.html. A wide variety of sample résumés can be found. For example, Monster.com provides samples for a wide variety of professions and situations at http://content.monster.com/experts/resume/library/ (c) As noted in the All About You feature in chapter 2 of the text, overstating accomplishments on a résumé can result in many problems. It is important to provide accurate and complete documentation of all relevant training, education, and employment experiences so as to provide assurance to the potential employer, and also to enable that employer to do follow-up work. If you say you have certain skills, such as computer skills, try to substantiate the claim with recognized proof of proficiency. Make sure that all addresses and phone numbers are accurate and up-to-date. Also, ensure that the people you use as references have a copy of your résumé and cover letter, and that they are informed that you are interviewing so they know to expect a call. (d) See the sample résumés provided in the websites above for various format options. You might also mention to students that there are electronic résumé templates available on the Internet. 2-56 CHAPTER 3 Adjusting the Accounts ASSIGNMENT CLASSIFICATION TABLE Brief Exercises A Problems B Problems 5, 6, 7, 8, 9, 10, 11, 12, 13, 15 1A, 2A, 3A, 4A, 5A, 6A 1B, 2B, 3B, 4B, 5B 7 5, 6, 7, 8, 9, 10, 11, 12, 13, 15 1A, 2A, 3A, 4A, 5A, 6A 1B, 2B, 3B, 4B, 5B 21 9, 10 10, 11, 12, 13, 14 1A, 2A, 3A, 5A, 6A 1B, 2B, 3B, 5B 22 11 16, 17 6A Study Objectives Questions Exercises *1. Explain the time period assumption. 1 1 *2. Explain the accrual basis of accounting. 2, 3, 4, 5 2, 3, 10 *3. Explain the reasons for adjusting entries. 6, 7 1 *4. Identify the major types of adjusting entries. 8, 18 2, 8 4, 6, 11 *5. Prepare adjusting entries for deferrals. 8, 9, 10, 11, 12, 13, 18, 19, 20 3, 4, 5, 6 *6. Prepare adjusting entries for accruals. 8, 14, 15, 16, 17, 18, 19, 20 *7. Describe the nature and purpose of an adjusted trial balance. *8. Prepare adjusting entries for the alternative treatment of deferrals. *Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix to the chapter. 3-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Prepare adjusting entries, post to ledger accounts, and prepare an adjusted trial balance. Simple 40–50 2A Prepare adjusting entries, post, and prepare adjusted trial balance and financial statements. Simple 50–60 3A Prepare adjusting entries and financial statements. Moderate 40–50 4A Prepare adjusting entries. Moderate 30–40 5A Journalize transactions and follow through accounting cycle to preparation of financial statements. Moderate 60–70 Prepare adjusting entries, adjusted trial balance, and financial statements using appendix. Moderate 40–50 *6A* 1B Prepare adjusting entries, post to ledger accounts, and prepare an adjusted trial balance. Simple 40–50 2B Prepare adjusting entries, post, and prepare adjusted trial balance and financial statements. Simple 50–60 3B Prepare adjusting entries and financial statements. Moderate 40–50 4B Prepare adjusting entries. Moderate 30–40 5B Journalize transactions and follow through accounting cycle to preparation of financial statements. Moderate 60–70 3-2 Study Objective Knowledge Comprehension Application Analysis Synthesis Explain the time period assumption. Q3-1 E3-1 *2. Explain the accrual basis of accounting. Q3-2 Q3-3 Q3-4 Q3-5 E3-3 *3. Explain the reasons for adjusting entries. Q3-6 Q3-7 BE3-1 *4. Identify the major types of adjusting entries. Q3-8 Q3-18 BE3-2 BE3-8 E3-6 E3-4 E3-11 *5. Prepare adjusting entries for deferrals. Q3-8 Q3-9 Q3-10 Q3-11 Q3-12 Q3-13 Q3-19 Q3-20 Q3-18 BE3-3 BE3-4 BE3-5 BE3-6 E3-5 E3-6 E3-7 E3-8 E3-9 E3-10 E3-11 E3-12 E3-13 E3-15 P3-1A P3-2A P3-3A P3-4A E3-15 P3-5A P3-6A P3-1B P3-2B P3-3B P3-4B P3-5B *6. Prepare adjusting entries for accruals. Q3-8 Q3-14 Q3-15 Q3-19 Q3-20 Q3-17 Q3-16 Q3-18 BE3-7 E3-5 E3-6 E3-7 E3-8 E3-9 E3-10 E3-11 E3-12 E3-13 E3-15 P3-1A P3-2A P3-3A P3-4A E3-15 P3-5A P3-6A P3-1B P3-2B P3-3B P3-4B P3-5B *7. Describe the nature and purpose of an adjusted trial balance. Q3-21 BE3-9 BE3-10 E3-14 E3-10 E3-11 E3-12 E3-13 P3-1A P3-2A P3-2B P3-3A P3-3B P3-5A P3-5B P3-6A P3-1B *8. Prepare adjusting entries for the alternative treatment of deferrals. Q3-22 BE3-11 E3-16 3-3 *1. Broadening Your Perspective Communication E3-10 Evaluation E3-2 E3-17 P3-6A Decision Making All About You Financial Reporting Ethics Case Comparative Analysis Across the Organization Exploring the Web BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. (a) Under the time period assumption, an accountant is required to determine the relevance of each business transaction to specific accounting periods. (b) An accounting time period of one year in length is referred to as a fiscal year. A fiscal year that extends from January 1 to December 31 is referred to as a calendar year. Accounting periods of less than one year are called interim periods. 2. The two generally accepted accounting principles that relate to adjusting the accounts are: The revenue recognition principle, which states that revenue should be recognized in the accounting period in which it is earned. The matching principle, which states that efforts (expenses) be matched with accomplishments (revenues). 3. The law firm should recognize the revenue in April. The revenue recognition principle states that revenue should be recognized in the accounting period in which it is earned. 4. Information presented on an accrual basis is more useful than on a cash basis because it reveals relationships that are likely to be important in predicting future results. To illustrate, under accrual accounting, revenues are recognized when earned so they can be related to the economic environment in which they occur. Trends in revenues are thus more meaningful. 5. Expenses of $4,500 should be deducted from the revenues in April. Under the matching principle efforts (expenses) should be matched with accomplishments (revenues). 6. No, adjusting entries are required by the revenue recognition and matching principles. 7. A trial balance may not contain up-to-date information for financial statements because: (1) Some events are not journalized daily because it is not efficient to do so. (2) The expiration of some costs occurs with the passage of time rather than as a result of daily transactions. (3) Some items may be unrecorded because the transaction data are not known. 8. The two categories of adjusting entries are deferrals and accruals. Deferrals consist of prepaid expenses and unearned revenues. Accruals consist of accrued revenues and accrued expenses. 9. In the adjusting entry for a prepaid expense, an expense is debited and an asset is credited. 10. No. Depreciation is the process of allocating the cost of an asset to expense over its useful life in a rational and systematic manner. Depreciation results in the presentation of the book value of the asset, not its market value. 11. Depreciation expense is an expense account whose normal balance is a debit. This account shows the cost that has expired during the current accounting period. Accumulated depreciation is a contra asset account whose normal balance is a credit. The balance in this account is the depreciation that has been recognized from the date of acquisition to the balance sheet date. 12. Equipment .................................................................................................................. Less: Accumulated Depreciation.......................................................................... 3-4 $18,000 6,000 $12,000 Questions Chapter 3 (Continued) *13. In the adjusting entry for an unearned revenue, a liability is debited and a revenue is credited. *14. Asset and revenue. An asset would be debited and a revenue would be credited. *15. An expense is debited and a liability is credited. *16. Net income was understated $200 because prior to adjustment, revenues are understated by $900 and expenses are understated by $700. The difference in this case is $200 ($900 – $700). *17. The entry is: Jan. 9 Salaries Payable ......................................................................................... Salaries Expense........................................................................................ Cash ..................................................................................................... 2,000 3,000 5,000 *18. (a) (b) (c) Accrued revenues. Unearned revenues. Accrued expenses. (d) (e) (f) Accrued expenses or prepaid expenses. Prepaid expenses. Accrued revenues or unearned revenues. *19. (a) (b) (c) Salaries Payable. Accumulated Depreciation. Interest Expense. (d) (e) (f) Supplies Expense. Service Revenue. Service Revenue. *20. Disagree. An adjusting entry affects only one balance sheet account and one income statement account. *21. Financial statements can be prepared from an adjusted trial balance because the balances of all accounts have been adjusted to show the effects of all financial events that have occurred during the accounting period. *22. For Supplies Expense (prepaid expense): expenses are overstated and assets are understated. The adjusting entry is: Assets (Supplies)...................................................................................................... XX Expenses (Supplies Expense)........................................................................ XX For Rent Revenue (unearned revenues): revenues are overstated and liabilities are understated. The adjusting entry is: Revenues (Rent Revenue) ..................................................................................... XX Liabilities (Unearned Rent Revenue) ............................................................ XX 3-5 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 3-1 (a) Prepaid Insurance—to recognize insurance expired during the period. (b) Depreciation Expense—to account for the depreciation that has occurred on the asset during the period. (c) Unearned Revenue—to record revenue earned for services provided. (d) Interest Payable—to recognize interest accrued but unpaid on notes payable. BRIEF EXERCISE 3-2 (a) Type of Adjustment (b) Account Balances before Adjustment 1. Prepaid Expenses Assets Overstated Expenses Understated 2. Accrued Revenues Assets Understated Revenues Understated 3. Accrued Expenses Expenses Understated Liabilities Understated 4. Unearned Revenues Liabilities Overstated Revenues Understated Item BRIEF EXERCISE 3-3 Dec. 31 Advertising Supplies Expense.................................. Advertising Supplies ($6,700 – $2,700) ......... Advertising Supplies 6,700 12/31 4,000 12/31 Bal. 2,700 4,000 4,000 Advertising Supplies Expense 12/31 4,000 3-6 BRIEF EXERCISE 3-4 Dec. 31 Depreciation Expense—Equipment........................ Accumulated Depreciation— Equipment.......................................................... Depr. Expense—Equipment 12/31 5,000 5,000 5,000 Accum. Depreciation—Equipment 12/31 5,000 Balance Sheet: Equipment....................................................................... Less: Accumulated Depreciation........................... $30,000 5,000 $25,000 BRIEF EXERCISE 3-5 July 1 Dec. 31 Prepaid Insurance.................................................... Cash..................................................................... 18,000 Insurance Expense [($18,000 ÷ 3) X 1/2] .......... Prepaid Insurance........................................... 3,000 Prepaid Insurance 7/1 18,000 12/31 12/31 Bal. 15,000 3,000 12/31 18,000 3,000 Insurance Expense 3,000 BRIEF EXERCISE 3-6 July 1 Dec. 31 Cash ............................................................................. Unearned Insurance Revenue .................... 18,000 Unearned Insurance Revenue ............................. Insurance Revenue......................................... 3,000 Unearned Insurance Revenue 12/31 3,000 7/1 18,000 12/31 Bal. 15,000 18,000 Insurance Revenue 12/31 3-7 3,000 3,000 BRIEF EXERCISE 3-7 1. 2. 3. Dec. 31 31 31 Interest Expense................................................... Interest Payable ........................................... 400 Accounts Receivable .......................................... Service Revenue .......................................... 1,500 Salaries Expense .................................................. Salaries Payable .......................................... 900 400 1,500 900 BRIEF EXERCISE 3-8 Account (a) Type of Adjustment (b) Related Account Accounts Receivable Prepaid Insurance Accum. Depr.—Equipment Interest Payable Unearned Service Revenue Accrued Revenues Prepaid Expenses Prepaid Expenses Accrued Expenses Unearned Revenues Service Revenue Insurance Expense Depreciation Expense Interest Expense Service Revenue BRIEF EXERCISE 3-9 HARMONY COMPANY Income Statement For the Year Ended December 31, 2008 Revenues Service revenue.............................................................. Expenses Salaries expense ............................................................ Rent expense................................................................... Insurance expense ........................................................ Supplies expense........................................................... Depreciation expense................................................... Total expenses....................................................... Net income ................................................................................ 3-8 $35,400 $16,000 4,000 2,000 1,500 1,300 24,800 $10,600 BRIEF EXERCISE 3-10 HARMONY COMPANY Owner’s Equity Statement For the Year Ended December 31, 2008 Capital, January 1.......................................................................................... Add: Net income........................................................................................... Less: Drawings ............................................................................................. Capital, December 31 ................................................................................... $15,600 10,600 26,200 6,000 $20,200 *BRIEF EXERCISE 3-11 (a) Apr. 30 (b) 30 Supplies................................................................... Supplies Expense........................................ 1,000 Service Revenue................................................... Unearned Service Revenue...................... 3,000 3-9 1,000 3,000 SOLUTIONS TO EXERCISES EXERCISE 3-1 1. True. 2. True. 3. False. Many business transactions affect more than one of these artificial time periods. For example, the purchase of a building affects expenses for many years. 4. True. 5. False. A time period that lasts less than one year, such as monthly or quarterly periods, is called an interim period. 6. False. All calendar years are fiscal years, but not all fiscal years are calendar years. An accounting time period that is one year in length is referred to as a fiscal year. A fiscal year that starts on January 1 and ends on December 31 is a calendar year. EXERCISE 3-2 (a) Accrual-basis accounting records the transactions that change a company’s financial statements in the periods in which the events occur rather than in the periods in which the company receives or pays cash. Information presented on an accrual basis is useful because it reveals relationships that are likely to be important in predicting future results. Conversely, under cash-basis accounting, revenue is recorded only when cash is received, and an expense is recognized only when cash is paid. As a result, the cash basis of accounting often leads to misleading financial statements. (b) Politicians might desire a cash-basis accounting system over an accrualbasis system because if an accrual-accounting system is used, it could mean that billions in government liabilities presently unrecorded would have to be reported in the federal budget immediately. The recognition of these additional liabilities would make the deficit even worse. This is not what politicians would like to see and be held responsible for. 3-10 (c) Dear Senator, It is my understanding, after having taken a beginning course in accounting principles, that the Federal government uses a cash-basis system rather than an accrual-basis accounting system. I am shocked at such a practice! There must be billions of dollars of liabilities hidden in many contracts that have not been recorded yet for the mere reason that they haven’t been paid yet. I realize that the deficit would dramatically increase if we were to implement an accrual system, but in all fairness, we citizens should be given a more accurate picture of what our government is up to. Sincerely, CONCERNED STUDENT EXERCISE 3-3 (a) Cash received from revenue................................................... Cash paid for expenses............................................................ Cash-basis net income................................................... $100,000 (70,000) $ 30,000 (b) Revenues [($100,000 – $25,000) + $40,000]........................ Expenses [($70,000 – $30,000) + $42,000] .......................... Accrual-basis net income.............................................. $115,000 (82,000) $ 33,000 EXERCISE 3-4 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Unearned revenue. Accrued expense. Accrued expense. Accrued revenue. Prepaid expense. Unearned revenue. Accrued revenue. Prepaid expense. Prepaid expense. Prepaid expense. Accrued expense. 3-11 EXERCISE 3-5 1. 2. 3. 4. 5. 6. 7. Interest Expense............................................................... Interest Payable ........................................................ ($10,000 X 12% X 4/12) 400 Supplies Expense ............................................................ Supplies ...................................................................... ($2,450 – $800) 1,650 Depreciation Expense..................................................... Accumulated Depreciation—Equipment .......... 1,000 Insurance Expense .......................................................... Prepaid Insurance.................................................... ($2,100 X 7/12) 1,225 Unearned Consulting Revenue.................................... Consulting Revenue................................................ ($40,000 X 1/4) 10,000 Accounts Receivable ...................................................... Consulting Revenue................................................ 4,200 Salaries Expense.............................................................. Salaries Payable ....................................................... ($9,000 X 3/5) 5,400 3-12 400 1,650 1,000 1,225 10,000 4,200 5,400 EXERCISE 3-6 Item (a) Type of Adjustment (b) Accounts before Adjustment 1. Accrued Revenues Assets Understated Revenues Understated 2. Prepaid Expenses Assets Overstated Expenses Understated 3. Accrued Expenses Expenses Understated Liabilities Understated 4. Unearned Revenues Liabilities Overstated Revenues Understated 5. Accrued Expenses Expenses Understated Liabilities Understated 6. Prepaid Expenses Assets Overstated Expenses Understated EXERCISE 3-7 1. 2. 3. 4. 5. Mar. 31 31 31 31 31 Depreciation Expense ($400 X 3) .................... Accumulated Depreciation— Equipment ................................................. 1,200 Unearned Rent....................................................... Rent Revenue ($9,900 X 1/3) .................... 3,300 Interest Expense................................................... Interest Payable ........................................... 500 Supplies Expense................................................. Supplies ($2,800 – $700) ........................... 2,100 Insurance Expense ($200 X 3).......................... Prepaid Insurance ....................................... 600 3-13 1,200 3,300 500 2,100 600 EXERCISE 3-8 1. 2. 3. Jan. 31 31 31 31 4. 5. 31 31 Accounts Receivable........................................... Service Revenue .......................................... 875 Utilities Expense ................................................... Utilities Payable............................................ 520 Depreciation Expense ......................................... Accumulated Depreciation— Dental Equipment.................................... 400 Interest Expense ................................................... Interest Payable............................................ 500 Insurance Expense ($12,000 ÷ 12) .................. Prepaid Insurance........................................ 1,000 Supplies Expense ($1,600 – $400)................... Supplies .......................................................... 1,200 Advertising Supplies Expense ......................... Advertising Supplies .................................. ($2,500 – $500) 2,000 Insurance Expense............................................... Prepaid Insurance........................................ 100 Depreciation Expense ......................................... Accumulated Depreciation— Office Equipment..................................... 50 Unearned Revenue............................................... Service Revenue .......................................... 600 Accounts Receivable........................................... Service Revenue .......................................... 300 875 520 400 500 1,000 1,200 EXERCISE 3-9 1. 2. 3. 4. 5. Oct. 31 31 31 31 31 3-14 2,000 100 50 600 300 EXERCISE 3-9 (Continued) 6. 7. Oct. 31 31 Interest Expense............................................ Interest Payable .................................... 70 Salaries Expense........................................... Salaries Payable ................................... 1,500 70 1,500 EXERCISE 3-10 BENNING CO. Income Statement For the Month Ended July 31, 2008 Revenues Service revenue ($5,500 + $500)................................... Expenses Wages expense ($2,300 + $300).................................... Supplies expense ($1,200 – $200)................................ Utilities expense................................................................. Insurance expense............................................................ Depreciation expense ...................................................... Total expenses .......................................................... Net income.................................................................................... $6,000 $2,600 1,000 600 400 150 4,750 $1,250 EXERCISE 3-11 Answer Computation (a) Supplies balance = $1,300 Supplies expense Add: Supplies (1/31) Less: Supplies purchased Supplies (1/1) (b) Total premium = $4,800 Total premium = Monthly premium X 12; $400 X 12 = $4,800 Purchase date = Aug. 1, 2007 $ 950 850 (500) $1,300 Purchase date: On Jan. 31, there are 6 months’ coverage remaining ($400 X 6). Thus, the purchase date was 6 months earlier on Aug. 1, 2007. 3-15 EXERCISE 3-11 (Continued) (c) Salaries payable = $2,500 Cash paid Salaries payable (1/31/08) $3,500 800 4,300 1,800 $2,500 Less: Salaries expense Salaries payable (12/31/07) (d) Unearned revenue = $1,150 Service revenue Unearned service revenue (1/31/08) $2,000 750 2,750 1,600 Cash received in January Unearned service revenue (12/31/07) $1,150 EXERCISE 3-12 (a) July 10 14 15 20 (b) July 31 31 31 31 Supplies ................................................................... Cash ................................................................. 400 Cash .......................................................................... Service Revenue .......................................... 2,000 Salaries Expense .................................................. Cash ................................................................. 1,200 Cash .......................................................................... Unearned Revenue ...................................... 1,000 Supplies Expense................................................. Supplies .......................................................... 800 Accounts Receivable........................................... Service Revenue .......................................... 500 Salaries Expense .................................................. Salaries Payable........................................... 1,200 Unearned Revenue............................................... Service Revenue .......................................... 900 3-16 400 2,000 1,200 1,000 800 500 1,200 900 EXERCISE 3-13 Aug. 31 31 31 31 31 31 Accounts Receivable............................................ Service Revenue ........................................... 1,000 Office Supplies Expense..................................... Office Supplies .............................................. 1,600 Insurance Expense................................................ Prepaid Insurance ........................................ 1,500 Depreciation Expense .......................................... Accumulated Depreciation—Office Equipment .................................................. 900 Salaries Expense ................................................... Salaries Payable............................................ 1,100 Unearned Rent........................................................ Rent Revenue................................................. 900 1,000 1,600 1,500 900 1,100 900 EXERCISE 3-14 GARCIA COMPANY Income Statement For the Year Ended August 31, 2008 Revenues Service revenue ................................................................. Rent revenue....................................................................... Total revenues ........................................................... Expenses Salaries expense................................................................ Rent expense ...................................................................... Office supplies expense.................................................. Insurance expense............................................................ Depreciation expense ...................................................... Total expenses .......................................................... Net income.................................................................................... 3-17 $35,000 11,900 46,900 $18,100 15,000 1,600 1,500 900 37,100 $ 9,800 EXERCISE 3-14 (Continued) GARCIA COMPANY Owner’s Equity Statement For the Year Ended August 31, 2008 Capital, September 1, 2007 ........................................................................ Add: Net income ......................................................................................... Capital, August 31, 2008............................................................................. $15,600 9,800 $25,400 GARCIA COMPANY Balance Sheet August 31, 2008 Assets Cash ................................................................................................ Accounts receivable .................................................................. Office supplies............................................................................. Prepaid insurance....................................................................... Office equipment......................................................................... Less: Accum. depreciation—office equipment ............... Total assets................................................................. $10,400 9,800 700 2,500 $14,000 4,500 9,500 $32,900 Liabilities and Owner’s Equity Liabilities Accounts payable ................................................................................ Salaries payable ................................................................................... Unearned rent........................................................................................ Total liabilities.............................................................................. Owner’s equity T. Garcia, Capital.................................................................................. Total liabilities and owner’s equity ....................................... 3-18 $ 5,800 1,100 600 7,500 25,400 $32,900 EXERCISE 3-15 (a) 1. 2. 3. 4. 5. Cash ............................................................................... Fees Receivable ................................................ 9,000 Unearned Fees ........................................................... Fees Revenue .................................................... 25,000 (a) Cash ...................................................................... Unearned Fees.......................................... 35,000 (b) Unearned Fees .................................................. ($35,000 – $17,000) Fees Revenue ........................................... 18,000 Fees Receivable......................................................... Fees Revenue .................................................... ($153,000 – $25,000 – $18,000) 110,000 Cash ............................................................................... Fees Receivable ................................................ ($110,000 – $14,000) 96,000 9,000 25,000 35,000 18,000 110,000 96,000 (b) Cash received with respect to fees = $9,000 + $96,000 + $35,000 = $140,000 *EXERCISE 3-16 1. 2. 3. Prepaid Insurance ........................................................... Insurance Expense ................................................. ($2,100 X 5/12) 875 Consulting Revenue ....................................................... Unearned Consulting Revenue........................... ($40,000 X 3/4) 30,000 Supplies.............................................................................. Supplies Expense.................................................... 800 3-19 875 30,000 800 *EXERCISE 3-17 (a) Jan. 2 10 15 1/2 1/15 Insurance Expense............................................. Cash ............................................................... 1,800 Supplies Expense............................................... Cash ............................................................... 1,700 Cash ........................................................................ Service Revenue ........................................ 6,100 Insurance Expense 1,800 Cash 6,100 1/2 1/10 (b) Jan. 31 31 31 1/10 1,800 1,700 6,100 Supplies Expense 1,700 Service Revenue 1/15 1,800 1,700 Prepaid Insurance ($150 X 11 months)........ Insurance Expense.................................... 1,650 Supplies ................................................................. Supplies Expense ...................................... 800 Service Revenue ................................................. Unearned Revenue .................................... 3,600 Insurance Expense 1/2 1,800 1/31 1,650 Bal. 150 Prepaid Insurance 1/31 1,650 Supplies Expense 1/10 1,700 1/31 800 Bal. 900 1/31 Supplies 800 1,650 800 3,600 Service Revenue 1/31 3,600 1/15 6,100 Bal. 2,500 Unearned Revenue 1/31 3,600 (c) Insurance expense ................................................................................. Supplies expense.................................................................................... Service revenue....................................................................................... Prepaid insurance................................................................................... Supplies ..................................................................................................... Unearned revenue .................................................................................. 3-20 6,100 $ 150 900 2,500 1,650 800 3,600 SOLUTIONS TO PROBLEMS PROBLEM 3-1A (a) Date 2008 June 30 30 30 30 30 30 30 Account Titles and Explanation Ref. Debit Supplies Expense................................. Supplies ........................................ ($2,000 – $600) 631 126 1,400 Utilities Expense ................................... Utilities Payable.......................... 732 244 150 Insurance Expense .............................. Prepaid Insurance...................... ($3,000 ÷ 12 months) 722 130 250 Unearned Service Revenue............... Service Revenue......................... 209 400 2,500 Salaries Expense .................................. Salaries Payable ......................... 726 212 2,000 Depreciation Expense......................... Accumulated Depreciation— Office Equipment................... ($15,000 ÷ 60 months) 711 250 Accounts Receivable .......................... Service Revenue......................... 112 400 J3 Credit 1,400 150 250 2,500 2,000 158 250 1,000 1,000 (b) Cash Date 2008 June 30 No. 101 Explanation Balance Ref.
3-21 Debit Credit Balance 7,150 PROBLEM 3-1A (Continued) Accounts Receivable Date 2008 June 30 30 Supplies Date 2008 June 30 30 Explanation Balance Adjusting Explanation Balance Adjusting No. 112 Ref.
J3 Ref. Debit Credit 1,000 6,000 7,000 Debit No. 126 Balance
J3 Credit 1,400 Prepaid Insurance Date 2008 June 30 30 Explanation Balance Adjusting Office Equipment Date Explanation 2008 June 30 Balance Ref. Debit
J3 Ref. Credit 250 Debit Credit
Balance Balance 3,000 2,750 No. 157 Balance 15,000 Credit 250 Accounts Payable Explanation 2,000 600 No. 130 Accumulated Depreciation—Office Equipment Date Explanation Ref. Debit 2008 June 30 Adjusting J3 Date 2008 June 30 Balance No. 158 Balance 250 No. 201 Ref.
3-22 Debit Credit Balance 4,500 PROBLEM 3-1A (Continued) Unearned Service Revenue Date 2008 June 30 30 Explanation Balance Adjusting No. 209 Ref.
J3 Debit Credit 4,000 1,500 2,500 Salaries Payable Date 2008 June 30 Explanation Adjusting Utilities Payable Date Explanation 2008 June 30 Adjusting No. 212 Ref. Debit J3 Ref. Debit J3 Credit Balance 2,000 2,000 Credit No. 244 Balance 150 150 T. Masasi, Capital Date 2008 June 30 Explanation Balance No. 301 Ref. Debit Credit
Explanation Balance Adjusting Adjusting No. 400 Ref. Debit
J3 J3 Credit Balance 2,500 1,000 7,900 10,400 11,400 Supplies Expense Date 2008 June 30 Explanation Adjusting Balance 21,750 Service Revenue Date 2008 June 30 30 30 Balance No. 631 Ref. Debit J3 1,400 3-23 Credit Balance 1,400 PROBLEM 3-1A (Continued) Depreciation Expense Date 2008 June 30 Explanation Adjusting No. 711 Ref. Debit J3 250 Credit 250 Insurance Expense Date 2008 June 30 Explanation Adjusting No. 722 Ref. Debit J3 250 Credit Explanation Balance Adjusting Rent Expense Date Explanation 2008 June 30 Balance Utilities Expense Date Explanation 2008 June 30 Adjusting Balance 250 Salaries Expense Date 2008 June 30 30 Balance No. 726 Ref.
J3 Ref. Debit Credit 2,000 4,000 6,000 Debit No. 729 Balance Credit
1,000 Ref. Debit J3 150 3-24 Balance Credit No. 732 Balance 150 PROBLEM 3-1A (Continued) (c) MASASI COMPANY Adjusted Trial Balance June 30, 2008 Cash................................................................................. Accounts Receivable ................................................. Supplies.......................................................................... Prepaid Insurance....................................................... Office Equipment......................................................... Accumulated Depreciation—Office Equipment................................................................. Accounts Payable ....................................................... Utilities Payable ........................................................... Salaries Payable .......................................................... Unearned Service Revenue ..................................... T. Masasi, Capital ........................................................ Service Revenue.......................................................... Supplies Expense ....................................................... Depreciation Expense................................................ Insurance Expense ..................................................... Salaries Expense......................................................... Rent Expense ............................................................... Utilities Expense.......................................................... 3-25 Debit $ 7,150 7,000 600 2,750 15,000 Credit $ 250 4,500 150 2,000 1,500 21,750 11,400 1,400 250 250 6,000 1,000 150 $41,550 $41,550 PROBLEM 3-2A (a) Date Aug. 31 31 31 31 31 31 31 31 Account Titles and Explanation Insurance Expense ($400 X 3) ............ Prepaid Insurance ........................ Ref. 722 130 Debit 1,200 Supplies Expense ($3,300 – $600) ......... Supplies........................................... 631 126 2,700 Depreciation Expense—Cottages ..... ($6,000 X 1/4) Accumulated Depreciation— Cottages...................................... 620 1,500 Depreciation Expense—Furniture..... ($2,400 X 1/4) Accumulated Depreciation— Furniture ..................................... 621 Unearned Rent......................................... Rent Revenue ................................ 208 429 4,100 Salaries Expense .................................... Salaries Payable ........................... 726 212 400 Accounts Receivable............................. Rent Revenue ................................ 112 429 1,000 Interest Expense ..................................... Interest Payable ............................ [($80,000 X 9%) X 1/12] 718 230 600 J1 Credit 1,200 2,700 144 1,500 600 150 600 4,100 400 1,000 600 (b) Cash Date Explanation Aug. 31 Balance Ref.
3-26 Debit Credit No. 101 Balance 19,600 PROBLEM 3-2A (Continued) Accounts Receivable Date Explanation Aug. 31 Adjusting No. 112 Ref. J1 Debit 1,000 Credit Supplies Date Explanation Aug. 31 Balance 31 Adjusting Prepaid Insurance Date Explanation Aug. 31 Balance 31 Adjusting No. 126 Ref.
J1 Ref.
J1 Debit Credit 2,700 Debit Credit 1,200 Land Date Explanation Aug. 31 Balance Cottages Date Explanation Aug. 31 Balance Ref.
Ref.
Debit Debit Credit Credit No. 130 Balance 6,000 4,800 Ref. J1 Balance 25,000 No. 143 Balance 125,000 No. 144 Debit Credit 1,500 Furniture Date Explanation Aug. 31 Balance Balance 3,300 600 No. 140 Accumulated Depreciation—Cottages Date Explanation Aug. 31 Adjusting Balance 1,000 Balance 1,500 No. 149 Ref.
3-27 Debit Credit Balance 26,000 PROBLEM 3-2A (Continued) Accumulated Depreciation—Furniture Date Explanation Aug. 31 Adjusting Ref. J1 No. 150 Debit Credit 600 Accounts Payable Date Explanation Aug. 31 Balance No. 201 Ref.
Debit Credit Unearned Rent Date Explanation Aug. 31 Balance 31 Adjusting Ref.
J1 Debit Credit 4,100 Mortgage Payable Date Explanation Aug. 31 Balance P. Harder, Capital Date Explanation Aug. 31 Balance Balance 7,400 3,300 No. 212 Ref. J1 Debit Credit 400 Interest Payable Date Explanation Aug. 31 Adjusting Balance 6,500 No. 208 Salaries Payable Date Explanation Aug. 31 Adjusting Balance 600 Balance 400 No. 230 Ref. J1 Ref.
Ref.
3-28 Debit Debit Debit Credit 600 Balance 600 Credit No. 275 Balance 80,000 Credit No. 301 Balance 100,000 PROBLEM 3-2A (Continued) P. Harder, Drawing Date Explanation Aug. 31 Balance No. 306 Ref.
Debit Credit Rent Revenue Date Aug. 31 31 31 Explanation Balance Adjusting Adjusting No. 429 Ref.
J1 J1 Debit Credit 4,100 1,000 Depreciation Expense—Cottages Date Explanation Aug. 31 Adjusting Explanation Aug. 31 Adjusting Ref. J1 Debit 1,500 Credit Ref. J1 Debit Credit 600 No. 622 Ref.
Debit Credit Balance 3,600 No. 631 Ref. J1 Debit 2,700 Credit Interest Expense Date Explanation Aug. 31 Adjusting Balance 600 Supplies Expense Date Explanation Aug. 31 Adjusting Balance 1,500 No. 621 Repair Expense Date Explanation Aug. 31 Balance Balance 80,000 84,100 85,100 No. 620 Depreciation Expense—Furniture Date Balance 5,000 Balance 2,700 No. 718 Ref. J1 3-29 Debit 600 Credit Balance 600 PROBLEM 3-2A (Continued) Insurance Expense Date Explanation Aug. 31 Adjusting No. 722 Ref. J1 Debit 1,200 Credit Salaries Expense Date Explanation Aug. 31 Balance 31 Adjusting No. 726 Ref.
J1 Debit Credit 400 Utilities Expense Date Explanation Aug. 31 Balance Balance 1,200 Balance 51,000 51,400 No. 732 Ref.
3-30 Debit Credit Balance 9,400 PROBLEM 3-2A (Continued) (c) NEOSHO RIVER RESORT Adjusted Trial Balance August 31, 2008 Cash................................................................................. Accounts Receivable ................................................. Supplies.......................................................................... Prepaid Insurance....................................................... Land................................................................................. Cottages ......................................................................... Accumulated Depreciation—Cottages................. Furniture......................................................................... Accumulated Depreciation—Furniture ................ Accounts Payable ....................................................... Unearned Rent ............................................................. Salaries Payable .......................................................... Interest Payable ........................................................... Mortgage Payable ....................................................... P. Harder, Capital ........................................................ P. Harder, Drawing...................................................... Rent Revenue ............................................................... Depreciation Expense—Cottages.......................... Depreciation Expense—Furniture ......................... Repair Expense............................................................ Supplies Expense ....................................................... Interest Expense.......................................................... Insurance Expense ..................................................... Salaries Expense......................................................... Utilities Expense.......................................................... 3-31 Debit $ 19,600 1,000 600 4,800 25,000 125,000 Credit $ 1,500 26,000 600 6,500 3,300 400 600 80,000 100,000 5,000 85,100 1,500 600 3,600 2,700 600 1,200 51,400 9,400 $278,000 $278,000 PROBLEM 3-2A (Continued) (d) NEOSHO RIVER RESORT Income Statement For the Three Months Ended August 31, 2008 Revenues Rent revenue .......................................................... Expenses Salaries expense ................................................... Utilities expense .................................................... Repair expense ...................................................... Supplies expense.................................................. Depreciation expense—cottages..................... Insurance expense ............................................... Interest expense .................................................... Depreciation expense—furniture..................... Total expenses.............................................. Net income ....................................................................... $ 85,100 $51,400 9,400 3,600 2,700 1,500 1,200 600 600 71,000 $ 14,100 NEOSHO RIVER RESORT Owner’s Equity Statement For the Three Months Ended August 31, 2008 P. Harder, Capital, June 1................................................................ Investment by owner ........................................................................ Add: Net income................................................................................ Less: Drawings.................................................................................. P. Harder, Capital, August 31......................................................... 3-32 $ 0 100,000 14,100 114,100 5,000 $109,100 PROBLEM 3-2A (Continued) NEOSHO RIVER RESORT Balance Sheet August 31, 2008 Assets Cash .............................................................................. Accounts receivable................................................ Supplies....................................................................... Prepaid insurance .................................................... Land .............................................................................. Cottages ...................................................................... Less: Accum. depreciation—cottages ............. Furniture ...................................................................... Less: Accum. depreciation—furniture ............. Total assets .............................................. $ 19,600 1,000 600 4,800 25,000 $125,000 1,500 26,000 600 123,500 25,400 $199,900 Liabilities and Owner’s Equity Liabilities Accounts payable............................................ Mortgage payable ............................................ Unearned rent ................................................... Interest payable................................................ Salaries payable............................................... Total liabilities.......................................... Owner’s equity P. Harder, Capital............................................. Total liabilities and owner’s equity...................................................... 3-33 $ 6,500 80,000 3,300 600 400 90,800 109,100 $199,900 PROBLEM 3-3A (a) Dec. 31 31 31 31 31 31 31 (b) Accounts Receivable ................................... Advertising Revenue........................... 2,500 Unearned Advertising Fees ....................... Advertising Revenue........................... 1,600 Art Supplies Expense .................................. Art Supplies............................................ 3,600 Depreciation Expense.................................. Accumulated Depreciation................ 6,000 Interest Expense............................................ Interest Payable .................................... 150 Insurance Expense ....................................... Prepaid Insurance ................................ 850 Salaries Expense ........................................... Salaries Payable ................................... 1,300 2,500 1,600 3,600 6,000 150 850 1,300 FERNETTI ADVERTISING AGENCY Income Statement For the Year Ended December 31, 2008 Revenues Advertising revenue................................................. Expenses Salaries expense ....................................................... Depreciation expense.............................................. Rent expense.............................................................. Art supplies expense ............................................... Insurance expense ................................................... Interest expense ........................................................ Total expenses.................................................. Net income ........................................................................... 3-34 $62,700 $11,300 6,000 4,000 3,600 850 500 26,250 $36,450 PROBLEM 3-3A (Continued) FERNETTI ADVERTISING AGENCY Owner’s Equity Statement For the Year Ended December 31, 2008 J. Fernetti, Capital, January 1........................................................... Add: Net income................................................................................. Less: Drawing....................................................................................... J. Fernetti, Capital, December 31 .................................................... $25,500 36,450 61,950 12,000 $49,950 FERNETTI ADVERTISING AGENCY Balance Sheet December 31, 2008 Assets Cash .................................................................................... Accounts receivable...................................................... Art supplies ...................................................................... Prepaid insurance .......................................................... Printing equipment ........................................................ Less: Accumulated depreciation ............................. Total assets .................................................... $11,000 22,500 5,000 2,500 $60,000 34,000 26,000 $67,000 Liabilities and Owner’s Equity Liabilities Notes payable ......................................................... Accounts payable.................................................. Unearned advertising fees ................................. Salaries payable..................................................... Interest payable...................................................... Total liabilities................................................ Owner’s equity J. Fernetti, Capital ................................................. Total liabilities and owner’s equity............................................................ 3-35 $ 5,000 5,000 5,600 1,300 150 17,050 49,950 $67,000 PROBLEM 3-3A (Continued) (c) (1) I = P X R X T $150 = $5,000 X R X 1/2 $150 = $2,500R R = $150 $2,500 R = 6% (2) Salaries Expense, $11,300 less Salaries Payable 12/31/08, $1,300 = $10,000. Total payments, $12,500 – $10,000 = $2,500 Salaries Payable 12/31/07. 3-36 PROBLEM 3-4A 1. 2. 3. 4. Dec. 31 31 31 31 Salaries Expense............................................. Salaries Payable ..................................... [5 X $800 X 2/5 = $1,600 [3 X $600 X 2/5 = 720 $2,320] 2,320 Unearned Rent.................................................. Rent Revenue .......................................... [5 X $4,000 X 2 = $40,000) (4 X $8,500 X 1 = 34,000) $74,000] 74,000 Advertising Expense ...................................... Prepaid Advertising............................... [A650 – $450 per month for 8 months = $3,600) (B974 – $400 per month for 3 months = 1,200) $4,800] 4,800 Interest Expense.............................................. Interest Payable ...................................... ($120,000 X 9% X 7/12) 6,300 3-37 2,320 74,000 4,800 6,300 PROBLEM 3-5A (a), (c) & (e) Cash Date Sept. Explanation 1 Balance 8 10 12 20 22 25 29 Accounts Receivable Date Explanation Sept. 1 Balance 10 27 Ref.
J1 J1 J1 J1 J1 J1 J1 Ref.
J1 J1 Debit Credit 1,400 1,200 3,400 4,500 500 1,250 650 Debit Credit 1,200 1,500 Supplies Date Sept. Explanation 1 Balance 17 30 Adjusting Explanation 1 Balance 15 No. 112 Balance 3,520 2,320 3,820 No. 126 Ref.
J1 J1 Debit Credit 1,200 2,000 Store Equipment Date Sept. No. 101 Balance 4,880 3,480 4,680 8,080 3,580 3,080 1,830 2,480 Balance 2,000 3,200 1,200 No. 153 Ref.
J1 3-38 Debit 3,000 Credit Balance 15,000 18,000 PROBLEM 3-5A (Continued) Accumulated Depreciation—Equipment Date Sept. 1 30 Explanation Balance Adjusting Ref.
J1 No. 154 Debit Credit 100 Accounts Payable Date Sept. 1 15 17 20 Explanation Balance Unearned Service Revenue Date Explanation Sept. 1 Balance 29 30 Adjusting Salaries Payable Date Explanation Sept. 1 Balance 8 30 Adjusting No. 201 Ref.
J1 J1 J1 Ref.
J1 J1 Ref.
J1 J1 Debit Credit 3,000 1,200 4,500 Debit Credit 650 1,450 Debit Credit 500 400 J. Rand, Capital Date Sept. Explanation 1 Balance Balance 1,500 1,600 Balance 3,400 6,400 7,600 3,100 No. 209 Balance 1,400 2,050 600 No. 212 Balance 500 0 400 No. 301 Ref.
3-39 Debit Credit Balance 18,600 PROBLEM 3-5A (Continued) Service Revenue Date Sept. 12 27 30 Explanation Adjusting No. 407 Ref. J1 J1 J1 Debit Credit 3,400 1,500 1,450 Depreciation Expense Date Explanation Sept. 30 Adjusting No. 615 Ref. J1 Debit 100 Credit Supplies Expense Date Explanation Sept. 30 Adjusting Explanation 8 25 30 Adjusting Ref. J1 Debit 2,000 Credit Balance 2,000 No. 726 Ref. J1 J1 J1 Debit 900 1,250 400 Credit Rent Expense Date Explanation Sept. 22 Balance 100 No. 631 Salaries Expense Date Sept. Balance 3,400 4,900 6,350 Balance 900 2,150 2,550 No. 729 Ref. J1 3-40 Debit 500 Credit Balance 500 PROBLEM 3-5A (Continued) (b) General Journal J1 Date Sept. 8 10 12 15 17 20 22 25 27 29 Account Titles Salaries Payable...................................... Salaries Expense .................................... Cash .................................................... Ref. 212 726 101 Debit 500 900 Cash ............................................................ Accounts Receivable..................... 101 112 1,200 Cash ............................................................ Service Revenue ............................. 101 407 3,400 Store Equipment ..................................... Accounts Payable........................... 153 201 3,000 Supplies ..................................................... Accounts Payable........................... 126 201 1,200 Accounts Payable................................... Cash .................................................... 201 101 4,500 Rent Expense........................................... Cash .................................................... 729 101 500 Salaries Expense .................................... Cash .................................................... 726 101 1,250 Accounts Receivable............................. Service Revenue ............................. 112 407 1,500 Cash ............................................................ Unearned Service Revenue ........... 101 209 650 3-41 Credit 1,400 1,200 3,400 3,000 1,200 4,500 500 1,250 1,500 650 PROBLEM 3-5A (Continued) (d) & (f) RAND EQUIPMENT REPAIR Trial Balances September 30, 2008 Before Adjustment Cash .................................................... Accounts Receivable..................... Supplies ............................................. Store Equipment ............................. Accumulated Depreciation .......... Accounts Payable........................... Unearned Service Revenue......... Salaries Payable.............................. J. Rand, Capital ............................... Service Revenue ............................. Depreciation Expense ................... Supplies Expense........................... Salaries Expense ............................ Rent Expense................................... (e) 1. Sept. 30 2. 3. 4. 30 30 30 Dr. $ 2,480 3,820 3,200 18,000 Cr. After Adjustment Dr. $ 2,480 3,820 1,200 18,000 $ 1,500 3,100 2,050 -018,600 4,900 Cr. $ 1,600 3,100 600 400 18,600 6,350 100 2,000 2,550 2,150 500 500 $30,150 $30,150 $30,650 $30,650 Supplies Expense............................ Supplies ($3,200 – $1,200) ....... 631 126 2,000 Salaries Expense ............................. Salaries Payable ....................... 726 212 400 Depreciation Expense .................... Accumulated Depreciation— Equipment .............................. 615 100 Unearned Service Revenue.......... Service Revenue ....................... 209 407 3-42 2,000 400 154 100 1,450 1,450 PROBLEM 3-5A (Continued) (g) RAND EQUIPMENT REPAIR Income Statement For the Month Ended September 30, 2008 Revenues Service revenue .......................................................... Expenses Salaries expense......................................................... Supplies expense ....................................................... Rent expense ............................................................... Depreciation expense ............................................... Total expenses ................................................... Net income............................................................................. $6,350 $2,550 2,000 500 100 5,150 $1,200 RAND EQUIPMENT REPAIR Owner’s Equity Statement For the Month Ended September 30, 2008 J. Rand, Capital, September 1 .......................................................... Add: Net income ................................................................................. J. Rand, Capital, September 30........................................................ 3-43 $18,600 1,200 $19,800 PROBLEM 3-5A (Continued) RAND EQUIPMENT REPAIR Balance Sheet September 30, 2008 Assets Cash ................................................................................... Accounts receivable ..................................................... Supplies ............................................................................ Equipment ........................................................................ Less: Accumulated depreciation— equipment ....................................................... Total assets............................................................. $ 2,480 3,820 1,200 $18,000 1,600 16,400 $23,900 Liabilities and Owner’s Equity Liabilities Accounts payable ....................................................................... Unearned service revenue ....................................................... Salaries payable .......................................................................... Total liabilities ..................................................................... Owner’s equity J. Rand, Capital............................................................................ Total liabilities and owner’s equity .............................. 3-44 $ 3,100 600 400 4,100 19,800 $23,900 *PROBLEM 3-6A (a) 1. 2. 3. 4. 5. 6. June 30 30 30 30 30 30 Supplies ......................................................... Supplies Expense .............................. 1,300 Interest Expense ......................................... ($20,000 X 9% X 5/12) Interest Payable.................................. 750 Prepaid Insurance ...................................... [($1,800 ÷ 12) X 8] Insurance Expense............................ 1,200 Consulting Revenue .................................. Unearned Consulting Revenue........ 1,500 Accounts Receivable................................. Graphic Revenue ............................... 2,000 Depreciation Expense ............................... ($2,000 ÷ 2) Accumulated Depreciation— Equipment ....................................... 1,000 3-45 1,300 750 1,200 1,500 2,000 1,000 *PROBLEM 3-6A (Continued) (b) GIVENS GRAPHICS COMPANY Adjusted Trial Balance June 30, 2008 Cash ............................................................................. Accounts Receivable ($14,000 + $2,000) ......... Supplies ...................................................................... Prepaid Insurance ................................................... Equipment.................................................................. Accumulated Depreciation ................................... Notes Payable........................................................... Accounts Payable.................................................... Interest Payable ....................................................... Unearned Consulting Revenue ........................... Sue Givens, Capital................................................. Graphic Revenue ($52,100 + $2,000)................. Consulting Revenue ($6,000 – $1,500) ............. Salaries Expense ..................................................... Supplies Expense ($3,700 – $1,300) .................. Advertising Expense .............................................. Rent Expense............................................................ Utilities Expense ...................................................... Depreciation Expense ............................................ Insurance Expense ($1,800 – $1,200)................ Interest Expense ...................................................... 3-46 Debit $ 9,500 16,000 1,300 1,200 45,000 Credit $ 30,000 2,400 1,900 1,500 1,700 1,000 600 750 $112,850 1,000 20,000 9,000 750 1,500 22,000 54,100 4,500 $112,850 *PROBLEM 3-6A (Continued) (c) GIVENS GRAPHICS COMPANY Income Statement For the Six Months Ended June 30, 2008 Revenues Graphic revenue..................................................... Consulting revenue............................................... Total revenues ............................................... Expenses Salaries expense.................................................... Supplies expense .................................................. Advertising expense............................................. Utilities expense..................................................... Rent expense .......................................................... Depreciation expense .......................................... Interest expense..................................................... Insurance expense ................................................ Total expenses .............................................. Net income........................................................................ $54,100 4,500 58,600 $30,000 2,400 1,900 1,700 1,500 1,000 750 600 39,850 $18,750 GIVENS GRAPHICS COMPANY Owner’s Equity Statement For the Six Months Ended June 30, 2008 Sue Givens, Capital, January 1........................................................ Investment by owner ........................................................................... Add: Net income.................................................................................. Sue Givens, Capital, June 30............................................................ 3-47 $ 0 22,000 18,750 $40,750 *PROBLEM 3-6A (Continued) GIVENS GRAPHICS COMPANY Balance Sheet June 30, 2008 Assets Cash ................................................................................... Accounts receivable ..................................................... Supplies ............................................................................ Prepaid insurance.......................................................... Equipment ........................................................................ Less: Accumulated depreciation............................. Total assets.................................................... $ 9,500 16,000 1,300 1,200 $45,000 1,000 44,000 $72,000 Liabilities and Owner’s Equity Liabilities Notes payable......................................................... Accounts payable ................................................. Unearned consulting revenue .......................... Interest payable ..................................................... Total liabilities ............................................... Owner’s equity Sue Givens, Capital .............................................. Total liabilities and owner’s equity ........... 3-48 $20,000 9,000 1,500 750 31,250 40,750 $72,000 PROBLEM 3-1B (a) Date Account Titles 2008 May 31 Supplies Expense...................................... Supplies ............................................. Ref. Debit 631 126 500 31 Travel Expense......................................... Travel Payable ............................... 736 229 200 31 Insurance Expense ................................... Prepaid Insurance......................... ($4,800 ÷ 24 months) 722 130 200 31 Unearned Service Revenue.................... Service Revenue ............................. ($3,000 – $1,000) 209 400 2,000 31 Salaries Expense ..................................... Salaries Payable.............................. [(3/5 X $700) X 2 employees] 726 212 840 31 Depreciation Expense............................ Accumulated Depreciation— Office Furniture......................... ($9,600 ÷ 60 months) 717 160 31 Accounts Receivable.............................. Service Revenue ............................. 112 400 J4 Credit 500 200 200 2,000 840 150 160 1,000 1,000 (b) Cash Date Explanation 2008 May 31 Balance No. 101 Ref.
3-49 Debit Credit Balance 7,700 PROBLEM 3-1B (Continued) Accounts Receivable Date Explanation 2008 May 31 Balance 31 Adjusting No. 112 Ref.
J4 Debit Credit 4,000 5,000 1,000 Supplies Date Explanation 2008 May 31 Balance 31 Adjusting No. 126 Ref. Debit
J4 Credit Balance 500 1,500 1,000 Prepaid Insurance Date Explanation 2008 May 31 Balance 31 Adjusting No. 130 Ref. Debit
J4 Credit Balance 200 4,800 4,600 Office Furniture Date Explanation 2008 May 31 Balance No. 149 Ref. Debit Credit
Ref. No. 150 Debit J4 Credit Balance 160 160 Accounts Payable Date Explanation 2008 May 31 Balance Balance 9,600 Accumulated Depreciation—Office Furniture Date Explanation 2008 May 31 Adjusting Balance No. 201 Ref.
3-50 Debit Credit Balance 3,500 PROBLEM 3-1B (Continued) Unearned Service Revenue Date Explanation 2008 May 31 Balance 31 Adjusting No. 209 Ref.
J4 Debit Credit 3,000 1,000 2,000 Salaries Payable Date Explanation 2008 May 31 Adjusting No. 212 Ref. Debit J4 Credit Balance 840 840 Travel Payable Date Explanation 2008 May 31 Adjusting No. 229 Ref. Debit J4 Credit Balance 200 200 L. Ace, Capital Date Explanation 2008 May 31 Balance Service Revenue Date Explanation 2008 May 31 Balance 31 Adjusting 31 Adjusting No. 301 Ref. Debit Credit
Ref. Explanation Adjusting Balance 19,100 Debit
J4 J4 Credit No. 400 Balance 2,000 1,000 6,000 8,000 9,000 Supplies Expense Date 2008 May 31 Balance No. 631 Ref. J4 3-51 Debit 500 Credit Balance 500 PROBLEM 3-1B (Continued) Depreciation Expense Date 2008 May 31 Explanation Adjusting No. 717 Ref. J4 Debit Credit 160 160 Insurance Expense Date Explanation 2008 May 31 Adjusting No. 722 Ref. J4 Debit Credit 200 No. 726 Ref.
J4 Debit Credit 840 No. 729 Ref. Debit Credit
Balance 1,000 Travel Expense Date Explanation 2008 May 31 Adjusting Balance 3,000 3,840 Rent Expense Date Explanation 2008 May 31 Balance Balance 200 Salaries Expense Date Explanation 2008 May 31 Balance 31 Adjusting Balance No. 736 Ref. J4 3-52 Debit 200 Credit Balance 200 PROBLEM 3-1B (Continued) (c) MODINE CONSULTING Adjusted Trial Balance May 31, 2008 Cash................................................................................. Accounts Receivable ................................................. Supplies.......................................................................... Prepaid Insurance....................................................... Office Furniture............................................................ Accumulated Depreciation—Office Furniture .................................................................... Accounts Payable ....................................................... Travel Payable.............................................................. Salaries Payable .......................................................... Unearned Service Revenue ..................................... L. Ace, Capital .............................................................. Service Revenue.......................................................... Supplies Expense ....................................................... Depreciation Expense................................................ Insurance Expense ..................................................... Salaries Expense......................................................... Rent Expense ............................................................... Travel Expense ............................................................ 3-53 Debit $ 7,700 5,000 1,000 4,600 9,600 Credit $ 160 3,500 200 840 1,000 19,100 9,000 500 160 200 3,840 1,000 200 $33,800 $33,800 PROBLEM 3-2B (a) Date May 31 31 31 31 31 31 31 Account Titles Insurance Expense.................................... Prepaid Insurance ........................... Ref. 722 130 Debit 200 Supplies Expense ...................................... Supplies ($1,900 – $500) ............... 631 126 1,400 Depreciation Expense—Lodge.............. ($3,600 X 1/12) Accumulated Depreciation— Lodge.............................................. 619 300 Depreciation Expense—Furniture........ ($3,000 X 1/12) Accumulated Depreciation— Furniture ........................................ 621 Interest Expense ........................................ Interest Payable ............................... [($40,000 X 12%) X 1/12] 718 230 400 Unearned Rent ............................................ Rent Revenue ................................... 208 429 2,500 Salaries Expense ....................................... Salaries Payable .............................. 726 212 800 J1 Credit 200 1,400 142 300 250 150 250 400 2,500 800 (b) Cash Date Explanation May 31 Balance No. 101 Ref.
3-54 Debit Credit Balance 2,500 PROBLEM 3-2B (Continued) Supplies Date Explanation May 31 Balance 31 Adjusting No. 126 Ref.
J1 Debit Credit 1,400 Prepaid Insurance Date Explanation May 31 Balance 31 Adjusting No. 130 Ref.
J1 Debit Credit 200 Land Date Explanation May 31 Balance Accumulated Depreciation—Lodge Date Explanation May 31 Adjusting Ref.
Debit Credit Ref.
Ref. J1 Debit Debit Credit Credit 300 Balance 70,000 No. 142 Balance 300 No. 149 Ref.
Debit Credit Accumulated Depreciation—Furniture Date Explanation May 31 Adjusting Balance 15,000 No. 141 Furniture Date Explanation May 31 Balance Balance 2,400 2,200 No. 140 Lodge Date Explanation May 31 Balance Balance 1,900 500 Ref. J1 3-55 Balance 16,800 No. 150 Debit Credit 250 Balance 250 PROBLEM 3-2B (Continued) Accounts Payable Date Explanation May 31 Balance No. 201 Ref.
Debit Credit Unearned Rent Date Explanation May 31 Balance 31 Adjusting Salaries Payable Date Explanation May 31 Adjusting No. 208 Ref.
J1 Ref. J1 Debit Credit 2,500 Debit Credit 800 Interest Payable Date Explanation May 31 Adjusting Mary Lerner, Capital Date Explanation May 31 Balance Rent Revenue Date Explanation May 31 Balance 31 Adjusting Balance 3,600 1,100 No. 212 Balance 800 No. 230 Ref. J1 Debit Credit 400 Mortgage Payable Date Explanation May 31 Balance Balance 5,300 Balance 400 No. 275 Ref.
Ref.
Ref.
J1 3-56 Debit Debit Debit Credit Credit Credit 2,500 Balance 40,000 No. 301 Balance 55,000 No. 429 Balance 9,200 11,700 PROBLEM 3-2B (Continued) Advertising Expense Date Explanation May 31 Balance No. 610 Ref.
Debit Credit Depreciation Expense—Lodge Date Explanation May 31 Adjusting No. 619 Ref. J1 Debit 300 Credit Depreciation Expense—Furniture Date Explanation May 31 Adjusting Explanation Adjusting Ref. J1 Debit 250 Credit Ref. J1 Debit 1,400 Credit Ref. J1 Debit 400 Credit Balance 400 No. 722 Ref. J1 Debit 200 Credit Salaries Expense Date Explanation May 31 Balance 31 Adjusting Balance 1,400 No. 718 Insurance Expense Date Explanation May 31 Adjusting Balance 250 No. 631 Interest Expense Date Explanation May 31 Adjusting Balance 300 No. 621 Supplies Expense Date May 31 Balance 500 Balance 200 No. 726 Ref.
J1 3-57 Debit 800 Credit Balance 3,000 3,800 PROBLEM 3-2B (Continued) Utilities Expense Date May 31 (c) Explanation Balance No. 732 Ref.
Debit Credit Balance 1,000 Debit $ 2,500 500 2,200 15,000 70,000 Credit ELSTON MOTEL Adjusted Trial Balance May 31, 2008 Cash ............................................................................. Supplies ...................................................................... Prepaid Insurance ................................................... Land ............................................................................. Lodge........................................................................... Accumulated Depreciation—Lodge .................. Furniture ..................................................................... Accumulated Depreciation—Furniture............. Accounts Payable.................................................... Unearned Rent.......................................................... Salaries Payable....................................................... Interest Payable ....................................................... Mortgage Payable.................................................... Mary Lerner, Capital ............................................... Rent Revenue............................................................ Advertising Expense .............................................. Depreciation Expense—Lodge ........................... Depreciation Expense—Furniture...................... Supplies Expense.................................................... Interest Expense ...................................................... Insurance Expense.................................................. Salaries Expense ..................................................... Utilities Expense ...................................................... 3-58 $ 300 16,800 250 5,300 1,100 800 400 40,000 55,000 11,700 500 300 250 1,400 400 200 3,800 1,000 $114,850 $114,850 PROBLEM 3-2B (Continued) (d) ELSTON MOTEL Income Statement For the Month Ended May 31, 2008 Revenues Rent revenue ............................................................ Expenses Salaries expense..................................................... Supplies expense ................................................... Utilities expense...................................................... Advertising expense.............................................. Interest expense...................................................... Depreciation expense—lodge ............................ Depreciation expense—furniture ...................... Insurance expense ................................................. Total expenses ............................................... Net income......................................................................... $11,700 $3,800 1,400 1,000 500 400 300 250 200 7,850 $ 3,850 ELSTON MOTEL Owner’s Equity Statement For the Month Ended May 31, 2008 Mary Lerner, Capital, May 1............................................................... Investment by owner ........................................................................... Add: Net income ................................................................................. Mary Lerner, Capital, May 31 ............................................................ 3-59 $ 0 55,000 3,850 $58,850 PROBLEM 3-2B (Continued) ELSTON MOTEL Balance Sheet May 31, 2008 Assets Cash ................................................................................ Supplies ......................................................................... Prepaid insurance....................................................... Land................................................................................. Lodge .............................................................................. Less: Accumulated depreciation—lodge........... Furniture ........................................................................ Less: Accumulated depreciation—furniture........ Total assets................................................. $ $70,000 300 16,800 250 2,500 500 2,200 15,000 69,700 16,550 $106,450 Liabilities and Owner’s Equity Liabilities Accounts payable .............................................. Mortgage payable .............................................. Unearned rent...................................................... Salaries payable ................................................. Interest payable .................................................. Total liabilities ............................................ Owner’s equity Mary Lerner, Capital.......................................... Total liabilities and owner’s equity ......... 3-60 $ 5,300 40,000 1,100 800 400 47,600 58,850 $106,450 PROBLEM 3-3B (a) Sept. 30 30 30 30 30 30 30 (b) Accounts Receivable..................................... Commission Revenue ............................ 500 Rent Expense................................................... Prepaid Rent .............................................. 600 Supplies Expense........................................... Supplies ...................................................... 200 Depreciation Expense................................... Accum. Depreciation—Equipment........ 350 Interest Expense ............................................. Interest Payable........................................ 50 Unearned Rent................................................. Rent Revenue ............................................ 400 Salaries Expense ............................................ Salaries Payable....................................... 600 500 600 200 350 50 400 600 ORTEGA CO. Income Statement For the Quarter Ended September 30, 2008 Revenues Commission revenue ................................................. Rent revenue ................................................................. Total revenues ..................................................... Expenses Salaries expense.......................................................... Rent expense ................................................................ Utilities expense........................................................... Depreciation expense ................................................ Supplies expense ........................................................ Interest expense........................................................... Total expenses .................................................... Net income.............................................................................. 3-61 $14,500 800 15,300 $9,600 1,500 510 350 200 50 12,210 $ 3,090 PROBLEM 3-3B (Continued) ORTEGA CO. Owner’s Equity Statement For the Quarter Ended September 30, 2008 Jose Ortega, Capital, July 1, 2008 .................................................. Investment by owner .......................................................................... Add: Net income ................................................................................ Less: Drawings.................................................................................... Jose Ortega, Capital, September 30, 2008................................... $ 0 14,000 3,090 17,090 600 $16,490 ORTEGA CO. Balance Sheet September 30, 2008 Assets Cash ................................................................................... Accounts receivable ..................................................... Supplies ............................................................................ Prepaid rent ..................................................................... Equipment ........................................................................ Less: Accum. depreciation—equipment............... Total assets.................................................... $ 6,700 900 1,000 900 $15,000 350 14,650 $24,150 Liabilities and Owner’s Equity Liabilities Notes payable......................................................... Accounts payable ................................................. Salaries payable .................................................... Unearned rent......................................................... Interest payable ..................................................... Total liabilities ............................................... Owner’s equity Jose Ortega, Capital............................................. Total liabilities and owner’s equity ........ $ 5,000 1,510 600 500 50 $ 7,660 16,490 $24,150 (c) Interest of 12% per year equals a monthly rate of 1%; monthly interest is $50 ($5,000 X 1%). Since total interest expense is $50, the note has been outstanding one month. 3-62 PROBLEM 3-4B 1. 2. 3. 4. Dec. 31 Dec. 31 Dec. 31 Dec. 31 Insurance Expense .............................................. Prepaid Insurance ....................................... [($6,000 ÷ 3) = $2,000 [($3,600 ÷ 2) = 1,800 $3,800] 3,800 Unearned Subscriptions .................................... Subscription Revenue ............................... [Oct. 200 X $50 X 3/12 = $2,500 [Nov. 300 X $50 X 2/12 = 2,500 [Dec. 480 X $50 X 1/12 = 2,000 $7,000] 7,000 Interest Expense................................................... Interest Payable ........................................... ($60,000 X 9% X 4/12) 1,800 Salaries Expense.................................................. Salaries Payable .......................................... [5 X $500 X 3/5 = $1,500 [3 X $750 X 3/5 = 1,350 $2,850] 2,850 3-63 3,800 7,000 1,800 2,850 PROBLEM 3-5B (a), (c) & (e) Cash Date Nov. 1 8 10 12 20 22 25 29 Explanation Balance Accounts Receivable Date Explanation Nov. 1 Balance 10 27 Ref.
J1 J1 J1 J1 J1 J1 J1 Ref.
J1 J1 Debit Credit 1,100 1,200 1,400 2,500 300 1,300 550 Debit Credit 1,200 400 Supplies Date Nov. 1 17 30 1 15 No. 112 Balance 2,510 1,310 1,710 No. 126 Explanation Balance Adjusting Ref.
J1 J1 Debit Credit 500 2,000 Store Equipment Date Nov. No. 101 Balance 2,790 1,690 2,890 4,290 1,790 1,490 190 740 Explanation Balance Balance 2,000 2,500 500 No. 153 Ref.
J1 3-64 Debit 3,000 Credit Balance 10,000 13,000 PROBLEM 3-5B (Continued) Accumulated Depreciation—Store Equipment Date Nov. 1 30 Explanation Balance Adjusting Ref.
J1 No. 154 Debit Credit 100 Accounts Payable Date Nov. 1 15 17 20 Explanation Balance Unearned Service Revenue Date Explanation Nov. 1 Balance 29 30 Adjusting Salaries Payable Date Explanation Nov. 1 Balance 8 30 Adjusting No. 201 Ref.
J1 J1 J1 Ref.
J1 J1 Ref.
J1 J1 Debit Credit 3,000 500 2,500 Debit Credit 550 1,150 Debit Credit 500 500 P. Rondeli, Capital Date Nov. 1 Explanation Balance Balance 500 600 Balance 2,100 5,100 5,600 3,100 No. 209 Balance 1,400 1,950 800 No. 212 Balance 500 0 500 No. 301 Ref.
3-65 Debit Credit Balance 12,800 PROBLEM 3-5B (Continued) Service Revenue Date Nov. 12 27 30 Explanation Adjusting No. 407 Ref. J1 J1 J1 Debit Credit 1,400 400 1,150 Depreciation Expense Date Nov. 30 Explanation Adjusting No. 615 Ref. J1 Debit 100 Credit Supplies Expense Date Nov. 30 Explanation Adjusting Explanation 8 25 30 Adjusting Ref. J1 Debit 2,000 Credit Balance 2,000 No. 726 Ref. J1 J1 J1 Debit 600 1,300 500 Credit Rent Expense Date Explanation Nov. 22 Balance 100 No. 631 Salaries Expense Date Nov. Balance 1,400 1,800 2,950 Balance 600 1,900 2,400 No. 729 Ref. J1 3-66 Debit 300 Credit Balance 300 PROBLEM 3-5B (Continued) (b) General Journal J1 Date Nov. 8 10 12 15 17 20 22 25 27 29 Account Titles and Explanation Salaries Payable........................................ Salaries Expense ...................................... Cash...................................................... Ref. 212 726 101 Debit 500 600 Cash .............................................................. Accounts Receivable ..................... 101 112 1,200 Cash .............................................................. Service Revenue .............................. 101 407 1,400 Store Equipment ....................................... Accounts Payable ........................... 153 201 3,000 Supplies ....................................................... Accounts Payable ........................... 126 201 500 Accounts Payable..................................... Cash ..................................................... 201 101 2,500 Rent Expense ............................................. Cash ..................................................... 729 101 300 Salaries Expense ...................................... Cash ..................................................... 726 101 1,300 Accounts Receivable............................... Service Revenue .............................. 112 407 400 Cash .............................................................. Unearned Service Revenue .......... 101 209 550 3-67 Credit 1,100 1,200 1,400 3,000 500 2,500 300 1,300 400 550 PROBLEM 3-5B (Continued) (d) & (f) RONDELI EQUIPMENT REPAIR Trial Balances November 30, 2008 Cash .................................................... Accounts Receivable..................... Supplies ............................................. Store Equipment ............................. Accumulated Depreciation .......... Accounts Payable........................... Unearned Service Revenue......... Salaries Payable.............................. P. Rondeli, Capital.......................... Service Revenue ............................. Depreciation Expense ................... Supplies Expense........................... Salaries Expense ............................ Rent Expense................................... (e) 1. Nov. 30 2. 3. 4. 30 30 30 Before After Adjustment Adjustment Dr. Cr. Dr. Cr. $ 740 $ 740 1,710 1,710 500 2,500 13,000 13,000 $ 500 $ 600 3,100 3,100 1,950 800 500 12,800 12,800 1,800 2,950 100 2,000 2,400 1,900 300 300 $20,150 $20,150 $20,750 $20,750 Supplies Expense ............................ Supplies ($2,500 – $500) ......... 631 126 2,000 Salaries Expense.............................. Salaries Payable ........................ 726 212 500 Depreciation Expense..................... Accumulated Depreciation— Store Equipment ................... 615 100 154 Unearned Service Revenue........... Service Revenue........................ 209 407 3-68 2,000 500 100 1,150 1,150 PROBLEM 3-5B (Continued) (g) RONDELI EQUIPMENT REPAIR Income Statement For the Month Ended November 30, 2008 Revenues Service revenue ...................................................... Expenses Salaries expense..................................................... Supplies expense ................................................... Rent expense ........................................................... Depreciation expense ........................................... Total expenses ............................................... Net loss ............................................................................... $ 2,950 $2,400 2,000 300 100 4,800 $(1,850) RONDELI EQUIPMENT REPAIR Owner’s Equity Statement For the Month Ended November 30, 2008 P. Rondeli, Capital, November 1...................................................... Less: Net loss...................................................................................... P. Rondeli, Capital, November 30.................................................... 3-69 $12,800 1,850 $10,950 PROBLEM 3-5B (Continued) RONDELI EQUIPMENT REPAIR Balance Sheet November 30, 2008 Assets Cash ................................................................................... Accounts receivable ..................................................... Supplies ............................................................................ Equipment ........................................................................ Less: Accumulated depreciation— equipment ....................................................... Total assets............................................................. $ 740 1,710 500 $13,000 600 12,400 $15,350 Liabilities and Owner’s Equity Liabilities Accounts payable ....................................................................... Unearned service revenue ....................................................... Salaries payable .......................................................................... Total liabilities ..................................................................... Owner’s equity P. Rondeli, Capital ...................................................................... Total liabilities and owner’s equity .............................. 3-70 $ 3,100 800 500 4,400 10,950 $15,350 BYP 3-1 FINANCIAL REPORTING PROBLEM (a) Items that may result in adjusting entries for prepayments are: 1. Prepaid expenses and other current assets (per balance sheet). 2. Property, plant, and equipment, net of depreciation (per balance sheet). 3. Amortizable intangibles assets, net (per balance sheet)—amortization is similar to depreciation (explained later in Chapter 10). (b) Accrual adjusting entries were probably made for accounts payable and other current liabilities, interest expense, and income taxes payable. (c) As indicated in the 5-Year Summary, the trend in net income has been positive. In every year since 2001 (except 2005), net income has increased. In 2001 net income was $2,400 million and in 2005 it was $4,078 million. 3-71 BYP 3-2 COMPARATIVE ANALYSIS PROBLEM PepsiCo Coca-Cola (a) Net increase (decrease) in property, plant, and equipment from 2004 to 2005. $ 532,000,000 ($ 305,000,000) (b) Increase (decrease) in selling, general, and administrative expenses from 2004 to 2005. $1,283,000,000 $ 849,000,000 (c) Increase (decrease) in longterm debt (obligations) from 2004 to 2005. ($ 84,000,000) ($ (d) Increase (decrease) in net income from 2004 to 2005. ($ 134,000,000) $ (e) Increase (decrease) in cash and cash equivalents from 2004 to 2005. ($ 436,000,000 3-72 3,000,000) 25,000,000 ($2,006,000,000) BYP 3-3 EXPLORING THE WEB (a) The categories are: 1. 2. 3. 4. 5. 6. 7. 8. 9. The Big 4 Professional Associations Education Finance Professors Taxation Audit and Law Government 10. 11. 12. 13. 14. 15. 16. 17. 18. Edgar FASB International Publishers Journals and Publications Softwares Other sites Entertainment Interest books (b) Student answers will vary depending on the category selected. 3-73 BYP 3-4 (a) DECISION MAKING ACROSS THE ORGANIZATION HAPPY CAMPER PARK Income Statement For the Quarter Ended March 31, 2008 Revenues Rental revenue ($90,000 – $15,000)................. Expenses Wages expense [$29,800 + ($300 X 2)]........... Advertising expense ($5,200 + $110).............. Supplies expense ($6,200 – $1,700)................ Repairs expense ($4,000 + $260) ..................... Insurance expense ($7,200 X 3/12).................. Utilities expense ($900 + $180)......................... Depreciation expense.......................................... Interest expense ($12,000 X 10% X 3/12)........... Total expenses.............................................. Net income ....................................................................... $75,000 $30,400 5,310 4,500 4,260 1,800 1,080 800 300 48,450 $26,550 (b) The generally accepted accounting principles pertaining to the income statement that were not recognized by Amaya were the revenue recognition principle and the matching principle. The revenue recognition principle states that revenue is recognized when it is earned. The fees of $15,000 for summer rentals have not been earned and, therefore, should not be reported in income for the quarter ended March 31. The matching principle dictates that efforts (expenses) be matched with accomplishments (revenues) whenever it is reasonable and practicable to do so. This means that the expenses should include amounts incurred in March but not paid until April. The difference in expenses was $7,750 ($48,450 – $40,700). The overstatement of revenues ($15,000) plus the understatement of expenses ($7,750) equals the difference in reported income of $22,750 ($49,300 – $26,550). 3-74 BYP 3-5 COMMUNICATION ACTIVITY Dear President Nickels: Upon reviewing the accounts of your company at the end of the year, I discovered that adjusting entries were not made. Adjusting entries are made at the end of the accounting period to ensure that the revenue recognition and matching principles required under generally accepted accounting principles are followed. The use of adjusting entries makes it possible to report on the balance sheet the appropriate assets, liabilities, and owner’s equity at the statement date and to report on the income statement the proper net income (or loss) for the year. Adjusting entries are needed because the trial balance may not contain an up-to-date and complete record of transactions and events for the following reasons: 1. Some events are not journalized daily because it is not efficient to do so. Examples are the use of supplies and the earning of wages by employees. 2. The expiration of some costs is 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 of such costs are building and equipment depreciation, rent, and insurance. 3. Some expenses, such as the cost of utility service and property taxes, may be unrecorded because the bills for the costs have not been received. There are four types of adjusting entries: 1. Prepaid expenses—expenses paid in cash and recorded as assets before they are used or consumed. 2. Unearned revenues—revenues received in cash and recorded as liabilities before they are earned. 3-75 BYP 3-5 (Continued) 3. Accrued revenues—revenues earned but not yet received in cash or recorded. 4. Accrued expenses—expenses incurred but not yet paid in cash or recorded. I will be happy to answer any questions you may have on adjusting entries. Signature 3-76 BYP 3-6 ETHICS CASE (a) The stakeholders in this situation are:
Cathi Bell, controller.
The president of Bluestem Company.
Bluestem Company stockholders. (b) 1. It is unethical for the president to place pressure on Cathi to misstate net income by requesting her to prepare incorrect adjusting entries. 2. It is customary for adjusting entries to be dated as of the balance sheet date although the entries are prepared at a later date. Cathi did nothing unethical by dating the adjusting entries December 31. (c) Cathi can accrue revenues and defer expenses through the preparation of adjusting entries and be ethical so long as the entries reflect economic reality. Intentionally misrepresenting the company’s financial condition and its results of operations is unethical (it is also illegal). 3-77 BYP 3-7 ALL ABOUT YOU ACTIVITY We address the issue of contingent liabilities with greater precision in Chapter 11. Our primary interest in this exercise is to engage students in a discussion regarding the general nature of the financial statement elements (assets, liabilities, equity, revenues and expenses). (a) By taking out the bank loan your friend has incurred a liability. You do not have a liability unless your friend defaults, or unless it becomes clear that he will default. The loan application may, however, require you to disclose any guarantees that you have signed, since they represent potential liabilities. (b) Accounting standards have specific requirements regarding accounting for situations where there is uncertainty regarding whether a liability has been incurred. Those standards require an evaluation of the probability of an amount being owed. Without going into detail regarding those standards, the basic idea is that if it is probable that you will owe money, then you should accrue a liability. If it is not probable, but it is possible that you will owe money, then you should disclose facts regarding the situation. The most important point is that this event has the potential to materially impact your finances, and therefore you have a responsibility to disclose it to the bank in some form. (c) Losing your job would not create a financial liability, although it would most certainly reduce your revenues. You are obviously concerned that you might lose your job, but you don’t have specific information that would suggest that it will happen. Therefore, you probably don’t have an obligation to disclose this information to the bank. However, unless you are relatively certain that you would be able to find suitable employment relatively quickly, you might want to wait until your job situation has stabilized before pursuing a loan of this size. 3-78 CHAPTER 4 Completing the Accounting Cycle ASSIGNMENT CLASSIFICATION TABLE Exercises A Problems B Problems 1, 2, 3 1, 2, 3, 5, 6, 17 1A, 2A, 3A, 4A, 5A 1B, 2B, 3B, 4B, 5B 6, 7, 11, 12 4, 5, 6 4, 7, 8, 11, 19 1A, 2A, 3A, 4A, 5A 1B, 2B, 3B, 4B, 5B *3. Describe the content and purpose of a post-closing trial balance. 8, 9 7 4, 7, 8 1A, 2A, 3A, 4A, 5A 1B, 2B, 3B, 4B, 5B *4. State the required steps in the accounting cycle. 10, 11, 12 8 10, 19 5A 5B *5. Explain the approaches to preparing correcting entries. 13 9 12, 13 6A *6. Identify the sections of a classified balance sheet. 14, 15, 16, 17, 18 10, 11 3, 9, 14 15, 16, 17 1A, 2A, 3A, 4A, 5A *7. Prepare reversing entries. 10, 19, 20 12 18, 19 Study Objectives Questions *1. Prepare a worksheet. 1, 2, 3, 4, 5 *2. Explain the process of closing the books. Brief Exercises 1B, 2B, 3B, 4B, 5B *Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix *to the chapter. 4-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) Simple 40–50 1A Prepare worksheet, financial statements, and adjusting and closing entries. 2A Complete worksheet; prepare financial statements, closing entries, and post-closing trial balance. Moderate 50–60 3A Prepare financial statements, closing entries, and postclosing trial balance. Moderate 40–50 4A Complete worksheet; prepare classified balance sheet, entries, and post-closing trial balance. Moderate 50–60 5A Complete all steps in accounting cycle. Complex 70–90 6A Analyze errors and prepare correcting entries and trial balance. Moderate 40–50 1B Prepare worksheet, financial statements, and adjusting and closing entries. Simple 40–50 2B Complete worksheet; prepare financial statements, closing entries, and post-closing trial balance. Moderate 50–60 3B Prepare financial statements, closing entries, and postclosing trial balance. Moderate 40–50 4B Complete worksheet; prepare classified balance sheet, entries, and post-closing trial balance. Moderate 50–60 5B Complete all steps in accounting cycle. Complex 70–90 Comprehensive Problem: Chapters 2 to 4 4-2 Study Objective Knowledge Comprehension Application Analysis 4-3 *1. Prepare a worksheet. BE4-1 Q4-1 Q4-2 Q4-3 Q4-4 Q4-5 BE4-3 E4-1 E4-2 E4-3 E4-17 P4-2A P4-3A P4-2B BE4-2 P4-3B E4-5 E4-6 P4-1A P4-4A P4-5A P4-1B P4-4B P4-5B *2. Explain the process of closing the books. Q4-6 Q4-11 Q4-12 Q4-7 BE4-4 BE4-5 BE4-6 E4-4 E4-7 E4-8 E4-11 P4-2A P4-3A P4-2B P4-3B E4-19 P4-1A P4-4A P4-5A P4-1B P4-4B P4-5B *3. Describe the content and purpose of a post-closing trial balance. Q4-8 Q4-9 BE4-7 E4-4 E4-7 E4-8 P4-2A P4-3A P4-1A P4-2B P4-4A P4-3B P4-5A P4-1B P4-4B P4-5B *4. State the required steps in the accounting cycle. *5. Explain the approaches to preparing correcting entries. *6. Identify the sections of a classified balance sheet. *7. Prepare reversing entries. Broadening Your Perspective Q4-11 Q4-12 BE4-8 Q4-14 Q4-15 Q4-16 Q4-10 E4-10 E4-19 P4-5A P4-5B Q4-13 BE4-9 E4-12 E4-13 P4-6A Q4-17 Q4-18 BE4-11 E4-15 BE4-10 E4-3 E4-9 E4-14 E4-16 E4-17 P4-1A P4-2A P4-4A P4-3A P4-5A P4-2B P4-1B P4-3B Synthesis Evaluation P4-4B P4-5B Q4-10 Q4-19 Q4-20 BE4-12 E4-18 E4-19 Communication Exploring the Web Financial Reporting Decision Making Across the Organization Comparative Analysis All About You Ethics Case Exploring the Web BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. No. A worksheet is not a permanent accounting record. The use of a worksheet is an optional step in the accounting cycle. 2. The worksheet is merely a device used to make it easier to prepare adjusting entries and the financial statements. 3. The amount shown in the adjusted trial balance column for an account equals the account balance in the ledger after adjusting entries have been journalized and posted. 4. The net income of $12,000 will appear in the income statement debit column and the balance sheet credit column. A net loss will appear in the income statement credit column and the balance sheet debit column. 5. Formal financial statements are needed because the columnar data are not properly arranged and classified for statement purposes. For example, a drawing account is listed with assets. 6. (1) (2) (3) (4) 7. Income Summary is a temporary account that is used in the closing process. The account is debited for expenses and credited for revenues. The difference, either net income or loss, is then closed to the owner’s capital account. 8. The post-closing trial balance contains only balance sheet accounts. Its purpose is to prove the equality of the permanent account balances that are carried forward into the next accounting period. 9. The accounts that will not appear in the post-closing trial balance are Depreciation Expense; Jennifer Shaeffer, Drawing; and Service Revenue. 10. A reversing entry is the exact opposite, both in amount and in account titles, of an adjusting entry and is made at the beginning of the new accounting period. Reversing entries are an optional step in the accounting cycle. 11. The steps that involve journalizing are: (1) journalize the transactions, (2) journalize the adjusting entries, and (3) journalize the closing entries. 12. The three trial balances are the: (1) trial balance, (2) adjusted trial balance, and (3) post-closing trial balance. 13. Correcting entries differ from adjusting entries because they: (1) are not a required part of the accounting cycle, (2) may be made at any time, and (3) may affect any combination of accounts. (Dr) Individual revenue accounts and (Cr) Income Summary. (Dr) Income Summary and (Cr) Individual expense accounts. (Dr) Income Summary and (Cr) Owner’s Capital (for net income). (Dr) Owner’s Capital and (Cr) Owner’s Drawing. 4-4 Questions Chapter 4 (Continued) *14. The standard classifications in a balance sheet are: Assets Current Assets Long-term Investments Property, Plant, and Equipment Intangible Assets Liabilities and Owner’s Equity Current Liabilities Long-term Liabilities Owner’s Equity *15. A company’s operating cycle is the average time required to go from cash to cash in producing revenues. The operating cycle of a company is the average time that it takes to purchase inventory, sell it on account, and then collect cash from customers. *16. Current assets are assets that a company expects to convert to cash or use up in one year. Some companies use a period longer than one year to classify assets and liabilities as current because they have an operating cycle longer than one year. Companies usually list current assets in the order in which they expect to convert them into cash. *17. Long-term investments are generally investments in stocks and bonds of other companies that are normally held for many years. Property, plant, and equipment are assets with relatively long useful lives that a company is currently using in operating the business. *18. (a) (b) The owner’s equity section for a corporation is called stockholders’ equity. The two accounts and the purpose of each are: (1) Capital stock is used to record investments of assets in the business by the owners (stockholders). (2) Retained earnings is used to record net income retained in the business. * *19. After reversing entries have been made, the balances will be Interest Payable, zero balance; Interest Expense, a credit balance. *20. (a) Jan. 10 Salaries Expense .................................................................................... Cash................................................................................................ 8,000 8,000 Because of the January 1 reversing entry that credited Salaries Expense for $3,500, Salaries Expense will have a debit balance of $4,500 which equals the expense for the current period. (b) Jan. 10 Salaries Payable ..................................................................................... Salaries Expense .................................................................................... Cash................................................................................................ Note that Salaries Expense will again have a debit balance of $4,500. 4-5 3,500 4,500 8,000 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 4-1 The steps in using a worksheet are performed in the following sequence: (1) prepare a trial balance on the worksheet, (2) enter adjustment data, (3) enter adjusted balances, (4) extend adjusted balances to appropriate statement columns and (5) total the statement columns, compute net income (loss), and complete the worksheet. Filling in the blanks, the answers are 1, 3, 4, 5, 2. The solution to BRIEF EXERCISE 4-2 is on page 4-7. BRIEF EXERCISE 4-3 Account Accumulated Depreciation Depreciation Expense N. Batan, Capital N. Batan, Drawing Service Revenue Supplies Accounts Payable Income Statement Dr. Cr. Balance Sheet Dr. Cr. X X X X X X X BRIEF EXERCISE 4-4 Dec. 31 31 31 31 Service Revenue ...................................................... Income Summary............................................ 50,000 Income Summary..................................................... Salaries Expense ............................................ Supplies Expense........................................... 31,000 Income Summary..................................................... D. Swann, Capital............................................ 19,000 D. Swann, Capital .................................................... D. Swann, Drawing ......................................... 2,000 4-6 50,000 27,000 4,000 19,000 2,000 BRIEF EXERCISE 4-2 LEY COMPANY Worksheet Trial Balance 4-7 Account Titles Prepaid Insurance Service Revenue Salaries Expense Accounts Receivable Salaries Payable Insurance Expense Dr. Cr. Dr. 3,000 58,000 25,000 Adjusted Trial Balance Adjustments Cr. Dr. (a) 1,200 (b) 1,100 1,800 (c) 800 (b) 1,100 Dr. 59,100 800 Dr. Cr. 59,100 25,800 1,100 800 1,200 Cr. Balance Sheet 1,800 25,800 1,100 (c) (a) 1,200 Cr. Income Statement 800 1,200 BRIEF EXERCISE 4-5 Salaries Expense 27,000 (2) 27,000 Income Summary (2) 31,000 (1) 50,000 (3) 19,000 50,000 50,000 Service Revenue (1) 50,000 50,000 Supplies Expense 4,000 (2) 4,000 D. Swann, Capital (4) 2,000 30,000 (3) 19,000 Bal. 47,000 D. Swann, Drawing 2,000 (4) 2,000 BRIEF EXERCISE 4-6 July 31 31 Date 7/31 7/31 Date 7/31 7/31 Green Fee Revenue ................................................. Income Summary............................................. 13,600 Income Summary ..................................................... Salaries Expense ............................................. Maintenance Expense.................................... 10,700 Explanation Balance Closing entry Explanation Balance Closing entry Green Fee Revenue Ref. Debit 13,600 8,200 2,500 Credit 13,600 Balance 13,600 0 Credit Balance 8,200 0 13,600 Salaries Expense Ref. Debit 8,200 8,200 4-8 BRIEF EXERCISE 4-6 (Continued) Date 7/31 7/31 Explanation Maintenance Expense Ref. Debit Balance Closing entry Credit Balance 2,500 2,500 0 2,500 BRIEF EXERCISE 4-7 The accounts that will appear in the post-closing trial balance are: Accumulated Depreciation N. Batan, Capital Supplies Accounts Payable BRIEF EXERCISE 4-8 The proper sequencing of the required steps in the accounting cycle is as follows: 1. 2. 3. 4. 5. 6. 7. 8. 9. Analyze business transactions. Journalize the transactions. Post to ledger accounts. Prepare a trial balance. Journalize and post adjusting entries. Prepare an adjusted trial balance. Prepare financial statements. Journalize and post closing entries. Prepare a post-closing trial balance. Filling in the blanks, the answers are 4, 2, 8, 7, 5, 3, 9, 6, 1. 4-9 BRIEF EXERCISE 4-9 1. 2. Service Revenue............................................................................. Accounts Receivable ........................................................... 780 Accounts Payable ($1,750 – $1,570) ........................................ Store Supplies........................................................................ 180 780 180 BRIEF EXERCISE 4-10 DIAZ COMPANY Partial Balance Sheet Current assets Cash......................................................................................................... Short-term investments .................................................................... Accounts receivable........................................................................... Supplies.................................................................................................. Prepaid insurance............................................................................... Total current assets................................................................... $15,400 6,700 12,500 5,200 3,600 $43,400 BRIEF EXERCISE 4-11 CL CA PPE PPE CA IA Accounts payable Accounts receivable Accumulated depreciation Building Cash Copyrights CL LTI PPE CA IA CA Income tax payable Investment in long-term bonds Land Merchandise inventory Patent Supplies *BRIEF EXERCISE 4-12 Nov. 1 Salaries Payable ................................................................... Salaries Expense ......................................................... 1,400 1,400 The balances after posting the reversing entry are Salaries Expense (Cr.) $1,400 and Salaries Payable $0. 4-10 SOLUTIONS TO EXERCISES EXERCISE 4-1 BRISCOE COMPANY Worksheet For the Month Ended June 30, 2008 Account Titles Trial Balance Dr. Cash Cr. Adjustments Dr. Adj. Trial Balance Cr. Dr. Cr. Income Statement Dr. Cr. Balance Sheet Dr. 2,320 2,320 2,320 2,440 2,440 2,440 Cr. Accounts Receivable Supplies 1,880 Accounts Payable 1,580 300 1,120 300 1,120 1,120 100 100 3,600 3,600 Unearned 240 Revenue 140 Lenny Briscoe, Capital 3,600 Service Revenue Salaries Expense 2,400 560 140 2,540 280 2,540 840 840 160 160 1,580 1,580 Miscellaneous Expense Totals Supplies Expense 160 7,360 7,360 1,580 280 Salaries Payable Totals 2,000 2,000 280 7,640 7,640 280 2,580 2,540 40 40 2,580 2,580 5,100 Net Loss Totals 4-11 5,060 5,100 5,100 EXERCISE 4-2 GOODE COMPANY (Partial) Worksheet For the Month Ended April 30, 2008 Adjusted Trial Balance Account Titles Cash Accounts Receivable Prepaid Rent Equipment Accum. Depreciation Notes Payable Accounts Payable T. Goode, Capital T. Goode, Drawing Service Revenue Salaries Expense Rent Expense Depreciation Expense Interest Expense Interest Payable Totals Net Income Totals Dr. 13,752 7,840 2,280 23,050 Cr. Income Statement Dr. Cr. Balance Sheet Dr. 13,752 7,840 2,280 23,050 4,921 5,700 5,672 30,960 4,921 5,700 5,672 30,960 3,650 3,650 15,590 10,840 760 671 57 62,900 Cr. 15,590 10,840 760 671 57 57 62,900 4-12 12,328 3,262 15,590 15,590 50,572 15,590 50,572 57 47,310 3,262 50,572 EXERCISE 4-3 GOODE COMPANY Income Statement For the Month Ended April 30, 2008 Revenues Service revenue.................................................................. Expenses Salaries expense................................................................ Rent expense ...................................................................... Depreciation expense....................................................... Interest expense................................................................. Total expenses........................................................... Net income .................................................................................... $15,590 $10,840 760 671 57 12,328 $ 3,262 GOODE COMPANY Owner’s Equity Statement For the Month Ended April 30, 2008 T. Goode, Capital, April 1 .................................................................... Add: Net income .................................................................................. Less: Drawings...................................................................................... T. Goode, Capital, April 30.................................................................. $30,960 3,262 34,222 3,650 $30,572 GOODE COMPANY Balance Sheet April 30, 2008 Assets Current assets Cash ....................................................................................... Accounts receivable ......................................................... Prepaid rent ......................................................................... Total current assets ................................................. Property, plant, and equipment Equipment ............................................................................ Less: Accumulated depreciation................................. Total assets................................................................. 4-13 $13,752 7,840 2,280 23,872 $23,050 4,921 18,129 $42,001 EXERCISE 4-3 (Continued) GOODE COMPANY Balance Sheet (Continued) April 30, 2008 Liabilities and Owner’s Equity Current liabilities Notes payable....................................................................................... Accounts payable ............................................................................... Interest payable ................................................................................... Total current liabilities.............................................................. Owner’s equity T. Goode, Capital................................................................................. Total liabilities and owner’s equity ...................................... $ 5,700 5,672 57 11,429 30,572 $42,001 EXERCISE 4-4 (a) Apr. 30 30 30 30 Service Revenue ............................................. Income Summary ................................... 15,590 Income Summary ............................................ Salaries Expense.................................... Rent Expense .......................................... Depreciation Expense .......................... Interest Expense..................................... 12,328 Income Summary ............................................ T. Goode, Capital.................................... 3,262 T. Goode, Capital............................................. T. Goode, Drawing ................................. 3,650 15,590 10,840 760 671 57 3,262 3,650 (b) (2) (3) Income Summary 12,328 (1) 15,590 3,262 15,590 15,590 4-14 (4) T. Goode, Capital 3,650 30,960 (3) 3,262 Bal. 30,572 EXERCISE 4-4 (Continued) (c) GOODE COMPANY Post-Closing Trial Balance April 30, 2008 Cash ................................................................................ Accounts Receivable................................................. Prepaid Rent................................................................. Equipment ..................................................................... Accumulated Depreciation ...................................... Notes Payable .............................................................. Accounts Payable....................................................... Interest Payable........................................................... T. Goode, Capital ........................................................ Debit $13,752 7,840 2,280 23,050 $46,922 Credit $ 4,921 5,700 5,672 57 30,572 $46,922 EXERCISE 4-5 (a) Accounts Receivable................................................. Service Revenue ................................................. 600 Insurance Expense..................................................... Prepaid Insurance.............................................. 400 Depreciation Expense ................................................ Accumulated Depreciation ............................. 900 Salaries Expense ......................................................... Salaries Payable.................................................. 500 4-15 600 400 900 500 EXERCISE 4-5 (Continued) (b) Income Statement Dr. Accounts Receivable Prepaid Insurance Accum. Depreciation Salaries Payable Service Revenue Salaries Expense Insurance Expense Depreciation Expense Cr. Balance Sheet Dr. X X Cr. X X X X X X EXERCISE 4-6 (a) Accounts Receivable—$25,000 ($34,000 – $9,000). Supplies—$2,000 ($7,000 – $5,000). Accumulated Depreciation—$22,000 ($12,000 + $10,000). Salaries Payable—$0 No liability recorded until adjustments are made. Insurance Expense—$6,000 ($26,000 – $20,000). Salaries Expense—$44,000 ($49,000 – $5,000). (b) Accounts Receivable ......................................................... Service Revenue......................................................... 9,000 Insurance Expense ............................................................. Prepaid Insurance ...................................................... 6,000 Supplies Expense ............................................................... Supplies......................................................................... 5,000 Depreciation Expense........................................................ Accumulated Depreciation...................................... 10,000 Salaries Expense................................................................. Salaries Payable ......................................................... 5,000 4-16 9,000 6,000 5,000 10,000 5,000 EXERCISE 4-7 (a) Service Revenue ............................................................. Income Summary..................................................... 4,064 Income Summary............................................................ Salaries Expense ..................................................... Miscellaneous Expense......................................... Supplies Expense.................................................... 3,828 Income Summary............................................................ Emil Skoda, Capital................................................. 236 Emil Skoda, Capital........................................................ Emil Skoda, Drawing .............................................. 300 (b) 4,064 1,344 256 2,228 236 300 EMIL SKODA COMPANY Post-Closing Trial Balance For the Month Ended June 30, 2008 Account Titles Cash .................................................................................... Accounts Receivable..................................................... Supplies ............................................................................. Accounts Payable........................................................... Salaries Payable.............................................................. Unearned Revenue......................................................... Emil Skoda, Capital........................................................ Debit $3,712 3,904 480 $8,096 4-17 Credit $1,792 448 160 5,696 $8,096 EXERCISE 4-8 (a) General Journal Date Account Titles Ref. July 31 Commission Revenue .............................. 404 Rent Revenue .............................................. 429 Income Summary ............................ 350 Debit 65,000 6,500 31 Income Summary ....................................... Salaries Expense............................. Utilities Expense.............................. Depreciation Expense.................... 350 720 732 711 74,600 31 B. J. Apachi, Capital.................................. Income Summary ............................ 301 350 3,100 31 B. J. Apachi, Capital.................................. B. J. Apachi, Drawing..................... 301 306 16,000 J15 Credit 71,500 55,700 14,900 4,000 3,100 16,000 (b) B. J. Apachi, Capital Date Explanation Ref. Debit July 31 Balance 31 Close net loss J15 3,100 31 Close drawing J15 16,000 Income Summary Date Explanation Ref. Debit July 31 Close revenue J15 31 Close expenses J15 74,600 31 Close net loss J15 4-18 Credit Credit 71,500 3,100 No. 301 Balance 45,200 42,100 26,100 No. 350 Balance 71,500 (3,100) 0 EXERCISE 4-8 (Continued) (c) APACHI COMPANY Post-Closing Trial Balance July 31, 2008 Cash ................................................................................ Accounts Receivable................................................. Equipment ..................................................................... Accumulated Depreciation ...................................... Accounts Payable....................................................... Unearned Rent Revenue........................................... B. J. Apachi, Capital................................................... Debit $14,840 8,780 15,900 $39,520 Credit $ 7,400 4,220 1,800 26,100 $39,520 EXERCISE 4-9 (a) APACHI COMPANY Income Statement For the Year Ended July 31, 2008 Revenues Commission revenue........................................ Rent revenue ....................................................... Total revenues ........................................... Expenses Salaries expense................................................ Utilities expense................................................. Depreciation expense....................................... Total expenses........................................... Net loss .......................................................................... $65,000 6,500 71,500 $55,700 14,900 4,000 74,600 ($ 3,100) APACHI COMPANY Owner’s Equity Statement For the Year Ended July 31, 2008 B. J. Apachi, Capital, August 1, 2007 ................... Less: Net loss ............................................................. Drawings........................................................... B. J. Apachi, Capital, July 31, 2008....................... 4-19 $45,200 $ 3,100 16,000 19,100 $26,100 EXERCISE 4-9 (Continued) (b) APACHI COMPANY Balance Sheet July 31, 2008 Assets Current assets Cash........................................................................... Accounts receivable............................................. Total current assets..................................... Property, plant, and equipment Equipment ............................................................... Less: Accumulated depreciation .................... Total assets .................................................... $14,840 8,780 23,620 $15,900 7,400 8,500 $32,120 Liabilities and Owner’s Equity Current liabilities Accounts payable ................................................. Unearned rent revenue........................................ Total current liabilities................................ Owner’s equity B. J. Apachi, Capital ............................................. Total liabilities and owner’s equity......... $ 4,220 1,800 6,020 26,100 $32,120 EXERCISE 4-10 1. False “Analyze business transactions” is the first step in the accounting cycle. 2. False. Reversing entries are an optional step in the accounting cycle. 3. True. 4. True. 5. True. 6. False. Steps 1–3 may occur daily in the accounting cycle. Steps 4–7 are performed on a periodic basis. Steps 8 and 9 are usually prepared only at the end of a company’s annual accounting period. 7. False. The step of “journalize the transactions” occurs before the step of “post to the ledger accounts.” 8. False. Closing entries are prepared after financial statements are prepared. 4-20 EXERCISE 4-11 (a) June 30 30 30 30 Service Revenue........................................... Income Summary ................................ 15,100 Income Summary ......................................... Salaries Expense................................. Supplies Expense ............................... Rent Expense ....................................... 13,100 Income Summary ......................................... Nina Cole, Capital................................ 2,000 Nina Cole, Capital ........................................ Nina Cole, Drawing ............................. 2,500 15,100 8,800 1,300 3,000 2,000 2,500 (b) Income Summary June 30 13,100 June 30 June 30 2,000 15,100 15,100 15,100 EXERCISE 4-12 (a) 1. 2. Cash ............................................................................. Equipment ........................................................ 600 Salaries Expense ..................................................... Cash ................................................................... 600 Service Revenue ...................................................... Cash ................................................................... 100 Cash ............................................................................. Accounts Receivable.................................... 1,000 4-21 600 600 100 1,000 EXERCISE 4-12 (Continued) 3. (b) 1. 2. 3. Accounts Payable.................................................... Equipment ........................................................ Equipment .................................................................. Accounts Payable .......................................... 890 Salaries Expense...................................................... Equipment ........................................................ 600 Service Revenue ...................................................... Cash ............................................................................. Accounts Receivable .................................... 100 900 Equipment .................................................................. Accounts Payable .......................................... 90 890 980 980 600 1,000 90 EXERCISE 4-13 1. 2. 3. Accounts Payable ($630 – $360) .................................. Cash.............................................................................. 270 Supplies................................................................................ Equipment .................................................................. Accounts Payable .................................................... 560 M. Mason, Drawing ........................................................... Salaries Expense...................................................... 400 4-22 270 56 504 400 EXERCISE 4-14 (a) KARR BOWLING ALLEY Balance Sheet December 31, 2008 Assets Current assets Cash ..................................................... Accounts receivable ....................... Prepaid insurance............................ Total current assets ............... Property, plant, and equipment Land...................................................... Building............................................... Less: Acc. depr.—building .......... Equipment .......................................... Less: Acc. depr.—equipment ..... Total assets............................... 4-23 $ 18,040 14,520 4,680 37,240 $64,000 $128,800 42,600 62,400 18,720 86,200 43,680 193,880 $231,120 EXERCISE 4-14 (Continued) KARR BOWLING ALLEY Balance Sheet (Continued) December 31, 2008 Liabilities and Owner’s Equity Current liabilities Current portion of note payable ........................................... Accounts payable ..................................................................... Interest payable ......................................................................... Total current liabilities.................................................... Long-term liabilities Note payable ............................................................................... Total liabilities ................................................................... Owner’s equity S. Karr, Capital ($115,000 + $3,440*) ................................... Total liabilities and owner’s equity............................. $ 13,900 12,300 2,600 28,800 83,880 112,680 118,440 $231,120 *Net income = $14,180 – $780 – $7,360 – $2,600 = $3,440 (b) Current assets exceed current liabilities by $8,440 ($37,240 – $28,800). In addition, approximately 50% of current assets are in the form of cash. In sum, the company’s liquidity appears to be reasonably good. EXERCISE 4-15 CL CA PPE PPE CA OE IA CL Accounts payable Accounts receivable Accumulated depreciation Buildings Cash Roberts, Capital Patents Salaries payable CA Inventories LTI Investments PPE Land LTL Long-term dept CA Supplies PPE Office equipment CA Prepaid expenses 4-24 EXERCISE 4-16 R. STEVENS COMPANY Balance Sheet December 31, 2008 (in thousands) Assets Current assets Cash ................................................................... Short-term investments ............................... Accounts receivable ..................................... Inventories ....................................................... Prepaid expenses .......................................... Total current assets ............................. Long-term investments......................................... Property, plant, and equipment Property, plant, and equipment ................ Less: Accumulated depreciation.............. Total assets .............................................................. $ 2,668 3,690 1,696 1,256 880 $10,190 264 11,500 (5,655) 5,845 $16,299 Liabilities and Owner’s Equity Current liabilities Notes payable in 2009 .................................. Accounts payable .......................................... Total current liabilities ........................ Long-term liabilities Long-term debt ............................................... Notes payable (after 2009) .......................... Total long-term liabilities ..................... Total liabilities.......................................................... Owner’s equity R. Stevens, Capital ........................................ Total owner’s equity............................. Total liabilities and owner’s equity................... 4-25 $ 481 1,444 $ 1,925 943 368 1,311 3,236 13,063 13,063 $16,299 EXERCISE 4-17 (a) B. SNYDER COMPANY Income Statement For the Year Ended July 31, 2008 Revenues Commission revenue .................................... Rent revenue.................................................... Total revenues........................................ Expenses Salaries expense ............................................ Utilities expense ............................................. Depreciation expense ................................... Total expense ......................................... Net loss ..................................................................... $61,100 8,500 $69,600 51,700 22,600 4,000 78,300 $ (8,700) B. SNYDER COMPANY Owner’s Equity Statement For the Year Ended July 31, 2008 Owner’s equity, August 1, 2007.......................... Less: Net loss.......................................................... Drawings ....................................................... Owner’s equity, July 31, 2008 ............................. 4-26 $51,200 $8,700 4,000 12,700 $38,500 EXERCISE 4-17 (Continued) (b) B. SNYDER COMPANY Balance Sheet July 31, 2008 Assets Current assets Cash ........................................................................... Accounts receivable ............................................. Total current assets ..................................... Property, plant, and equipment Equipment ................................................................ Less: Accumulated depreciation ..................... Total assets ................................................... $24,200 9,780 $33,980 18,500 6,000 12,500 $46,480 Liabilities and Owner’s Equity Current liabilities Accounts payable .................................................. Salaries payable ..................................................... Total current liabilities ................................ Long-term liabilities Note payable............................................................ Total liabilities................................................ Owner’s equity B. Snyder, Capital .................................................. Total owner’s equity ............................................. Total liabilities and owner’s equity .................. 4-27 $ 4,100 2,080 $ 6,180 1,800 7,980 38,500 38,500 $46,480 *EXERCISE 4-18 (a) Dec. 31 Jan. 6 (b) Dec. 31 Jan. 1 Jan. 6 Salaries Expense ($10,000 X 2/5) ............ Salaries Payable................................... 4,000 Salaries Payable............................................ Salaries Expense ($10,000 X 3/5) ............ Cash ......................................................... 4,000 6,000 Salaries Expense .......................................... Salaries Payable................................... 4,000 Salaries Payable............................................ Salaries Expense ................................. 4,000 Salaries Expense .......................................... Cash ......................................................... 10,000 4,000 10,000 4,000 4,000 10,000 *EXERCISE 4-19 (a) Dec. 31 31 (b) Jan. 1 1 Commission Revenue ................................. Income Summary................................. 92,000 Income Summary.......................................... Interest Expense .................................. 7,800 Commission Revenue ................................. Accounts Receivable.......................... 4,500 Interest Payable ............................................ Interest Expense .................................. 1,500 4-28 92,000 7,800 4,500 1,500 *EXERCISE 4-19 (Continued) (c) & (e) Accounts Receivable Dec. 31 Balance *19,500 31 Adjusting 4,500 24,000 Jan. 1 Reversing 4,500 *($24,000 – $4,500) Commission Revenue Dec. 31 Closing 92,000 Dec. 31 Balance 31 Adjusting 92,000 Jan. 1 Reversing 4,500 Jan. 10 87,500* 4,500 92,000 4,500 *($92,000 – $4,500) Jan. 1 Reversing Dec. 31 Balance 31 Adjusting Jan. 15 Interest Payable Dec. 31 Adjusting 1,500 Interest Expense *6,300 Dec. 31 Closing 1,500 7,800 2,500 Jan. 1 Reversing 1,500 7,800 7,800 1,500 *($7,800 – $1,500) (d) Jan. 10 15 (1) Cash.......................................................................... Commission Revenue................................ 4,500 (2) Interest Expense................................................... Cash................................................................. 2,500 4-29 4,500 2,500 (a) THOMAS MAGNUM P.I. Worksheet For the Quarter Ended March 31, 2008 Account Titles Trial Balance Dr. Cr. (e) Cr. 530 (a) (d) 670 600 Dr. Cr. Dr. Cr. 11,400 6,150 380 1,800 30,000 10,000 12,350 20,000 Balance Sheet Dr. 11,400 6,150 380 1,800 30,000 10,000 12,350 20,000 600 10,000 12,350 20,000 600 13,620 (e) 530 2,200 1,300 1,200 200 55,970 55,970 (a) 670 (b) 1,000 300 (d) 600 3,100 600 14,150 2,200 1,300 1,200 200 670 1,000 670 1,000 1,000 300 (c) 300 3,100 14,150 2,200 1,300 1,200 200 (b) 1,000 (c) Cr. 300 600 57,800 57,800 1,000 300 300 600 7,470 14,150 6,680 14,150 14,150 Key: (a) Supplies Used; (b) Depreciation Expensed; (c) Accrued Interest on note; (d) Insurance Expired; (e) Service Revenue Earned but unbilled. 50,330 43,650 6,680 50,330 50,330 SOLUTIONS TO PROBLEMS 11,400 5,620 1,050 2,400 30,000 Dr. Income Statement PROBLEM 4-1A 4-30 Cash Accounts Receivable Supplies Prepaid Insurance Equipment Notes Payable Accounts Payable T. Magnum, Capital T. Magnum, Drawing Service Revenue Salaries Expense Travel Expense Rent Expense Miscellaneous Expense Totals Supplies Expense Depreciation Expense Accumulated Depreciation Interest Expense Interest Payable Insurance Expense Totals Net Income Totals Adjusted Trial Balance Adjustments PROBLEM 4-1A (Continued) (b) THOMAS MAGNUM P.I. Income Statement For the Quarter Ended March 31, 2008 Revenues Service revenue....................................................... Expenses Salaries expense..................................................... Travel expense......................................................... Rent expense............................................................ Depreciation expense............................................ Supplies expense ................................................... Insurance expense ................................................. Interest expense...................................................... Miscellaneous expense ........................................ Total expenses................................................ Net income ......................................................................... $14,150 $2,200 1,300 1,200 1,000 670 600 300 200 7,470 $ 6,680 THOMAS MAGNUM P.I. Owner’s Equity Statement For the Quarter Ended March 31, 2008 T. Magnum, Capital, January 1..................................... Add: Investment by owner .......................................... Net income............................................................. Less: Drawings................................................................. T. Magnum, Capital, March 31 ...................................... 4-31 $ $20,000 6,680 0 26,680 600 $26,080 PROBLEM 4-1A (Continued) THOMAS MAGNUM P.I. Balance Sheet March 31, 2008 Assets Current assets Cash........................................................................... Accounts receivable............................................. Supplies.................................................................... Prepaid insurance ................................................. Total current assets..................................... Property, plant, and equipment Equipment ............................................................... Less: Accumulated depreciation .................... Total assets .................................................... $11,400 6,150 380 1,800 19,730 $30,000 1,000 29,000 $48,730 Liabilities and Owner’s Equity Current liabilities Notes payable......................................................... Accounts payable ................................................. Interest payable ..................................................... Total current liabilities................................ Owner’s equity T. Magnum, Capital............................................... Total liabilities and owner’s equity ........................................................... (c) Mar. 31 31 31 31 $10,000 12,350 300 22,650 26,080 $48,730 Supplies Expense ....................................... Supplies ................................................ 670 Depreciation Expense ............................... Accumulated Depreciation ............ 1,000 Interest Expense ......................................... Interest Payable.................................. 300 Insurance Expense..................................... Prepaid Insurance.............................. 600 4-32 670 1,000 300 600 PROBLEM 4-1A (Continued) Mar. 31 (d) Mar. 31 31 31 31 Accounts Receivable...................................... Service Revenue ..................................... 530 Service Revenue .............................................. Income Summary.................................... 14,150 Income Summary............................................. Travel Expense........................................ Salaries Expense .................................... Rent Expense........................................... Insurance Expense................................. Depreciation Expense ........................... Supplies Expense................................... Interest Expense ..................................... Miscellaneous Expense........................ 7,470 Income Summary............................................. T. Magnum, Capital ................................ 6,680 T. Magnum, Capital ......................................... T. Magnum, Drawing.............................. 600 4-33 530 14,150 1,300 2,200 1,200 600 1,000 670 300 200 6,680 600 PROBLEM 4-2A (a) PORTER COMPANY Partial Worksheet For the Year Ended December 31, 2008 Account No. Titles 101 112 126 130 151 152 200 201 212 230 301 306 400 610 631 711 722 726 905 Cash Accounts Receivable Supplies Prepaid Insurance Office Equipment Acc. Depr.—Off. Equip. Notes Payable Accounts Payable Salaries Payable Interest Payable B. Porter, Capital B. Porter, Drawing Service Revenue Advertising Expense Supplies Expense Depreciation Expense Insurance Expense Salaries Expense Interest Expense Totals Net Income Totals Adjusted Trial Balance Dr. Cr. Income Statement Dr. Cr. 18,800 16,200 2,300 4,400 44,000 Balance Sheet Dr. Cr. 18,800 16,200 2,300 4,400 44,000 20,000 20,000 8,000 2,600 1,000 36,000 20,000 20,000 8,000 2,600 1,000 36,000 12,000 12,000 77,800 12,000 3,700 8,000 4,000 39,000 1,000 165,400 165,400 4-34 77,800 12,000 3,700 8,000 4,000 39,000 1,000 67,700 10,100 77,800 77,800 97,700 77,800 97,700 87,600 10,100 97,700 PROBLEM 4-2A (Continued) (b) PORTER COMPANY Income Statement For the Year Ended December 31, 2008 Revenues Service revenue..................................................... Expenses Salaries expense................................................... Advertising expense ............................................ Depreciation expense.......................................... Insurance expense ............................................... Supplies expense ................................................. Interest expense.................................................... Total expenses.............................................. Net income ....................................................................... $77,800 $39,000 12,000 8,000 4,000 3,700 1,000 67,700 $10,100 PORTER COMPANY Owner’s Equity Statement For the Year Ended December 31, 2008 B. Porter, Capital, January 1 ............................................................ Add: Net income................................................................................ Less: Drawings.................................................................................... B. Porter, Capital, December 31...................................................... 4-35 $36,000 10,100 46,100 12,000 $34,100 PROBLEM 4-2A (Continued) PORTER COMPANY Balance Sheet December 31, 2008 Assets Current assets Cash........................................................................... Accounts receivable............................................. Supplies.................................................................... Prepaid insurance ................................................. Total current assets..................................... Property, plant, and equipment Office equipment ................................................... Less: Accumulated depreciation .................... Total assets .................................................... $18,800 16,200 2,300 4,400 41,700 $44,000 20,000 24,000 $65,700 Liabilities and Owner’s Equity Current liabilities Notes payable......................................................... Accounts payable ................................................. Salaries payable .................................................... Interest payable ..................................................... Total current liabilities................................ Long-term liabilities Notes payable......................................................... Total liabilities ............................................... Owner’s equity B. Porter, Capital ................................................... Total liabilities and owner’s equity ............................................................. 4-36 $10,000 8,000 2,600 1,000 21,600 10,000 31,600 34,100 $65,700 PROBLEM 4-2A (Continued) (c) General Journal Date Account Titles and Explanation Dec. 31 Service Revenue ........................................ Income Summary............................ Ref. 400 350 Debit 77,800 31 Income Summary....................................... Advertising Expense...................... Supplies Expense ........................... Depreciation Expense ................... Insurance Expense......................... Salaries Expense ............................ Interest Expense ............................. 350 610 631 711 722 726 905 67,700 31 Income Summary....................................... B. Porter, Capital............................. 350 301 10,100 31 B. Porter, Capital........................................ B. Porter, Drawing .......................... 301 306 12,000 J14 Credit 77,800 12,000 3,700 8,000 4,000 39,000 1,000 10,100 12,000 (d) Date Explanation Jan. 31 Balance Dec. 31 Closing entry 31 Closing entry B. Porter, Capital Ref. Debit
J14 J14 12,000 Date Explanation Dec. 31 Balance 31 Closing entry B. Porter, Drawing Ref. Debit
12,000 J14 4-37 Credit 36,000 10,100 Credit 12,000 No. 301 Balance 36,000 46,100 34,100 No. 306 Balance 12,000 0 PROBLEM 4-2A (Continued) Explanation Closing entry Closing entry Closing entry Income Summary Ref. Debit J14 J14 67,700 J14 10,100 Date Explanation Dec. 31 Balance 31 Closing entry Service Revenue Ref. Debit
J14 77,800 Date Explanation Dec. 31 Balance 31 Closing entry Advertising Expense Ref. Debit
12,000 J14 Date Explanation Dec. 31 Balance 31 Closing entry Supplies Expense Ref. Debit
3,700 J14 Date Explanation Dec. 31 Balance 31 Closing entry Depreciation Expense Ref. Debit
8,000 J14 Date Dec. 31 31 31 Date Dec. 31 31 Explanation Balance Closing entry Insurance Expense Ref. Debit
4,000 J14 4-38 Credit 77,800 Credit 77,800 Credit 12,000 Credit 3,700 Credit 8,000 Credit 4,000 No. 350 Balance 77,800 10,100 0 No. 400 Balance 77,800 0 No. 610 Balance 12,000 0 No. 631 Balance 3,700 0 No. 711 Balance 8,000 0 No. 722 Balance 4,000 0 PROBLEM 4-2A (Continued) Date Explanation Dec. 31 Balance 31 Closing entry Salaries Expense Ref. Debit
39,000 J14 Date Explanation Dec. 31 Balance 31 Closing entry Interest Expense Ref. Debit
1,000 J14 (e) Credit 39,000 Credit 1,000 No. 726 Balance 39,000 0 No. 905 Balance 1,000 0 PORTER COMPANY Post-Closing Trial Balance December 31, 2008 Cash ................................................................................ Accounts Receivable................................................. Supplies ......................................................................... Prepaid Insurance ...................................................... Office Equipment ........................................................ Accumulated Depreciation—Office Equipment ................................................................ Notes Payable .............................................................. Accounts Payable....................................................... Salaries Payable.......................................................... Interest Payable........................................................... B. Porter, Capital......................................................... Debit $18,800 16,200 2,300 4,400 44,000 $85,700 4-39 Credit $20,000 20,000 8,000 2,600 1,000 34,100 $85,700 PROBLEM 4-3A (a) WOODS COMPANY Income Statement For the Year Ended December 31, 2008 Revenues Service revenue .................................................. Expenses Salaries expense ................................................ Repair expense ................................................... Utilities expense ................................................. Depreciation expense ....................................... Insurance expense............................................. Total expenses ........................................... Net loss........................................................................... $44,000 $35,200 5,400 4,000 2,800 1,200 48,600 $ (4,600) WOODS COMPANY Owner’s Equity Statement For the Year Ended December 31, 2008 S. Woods, Capital, January 1 .................................. Add: Additional investment by owner ............... Less: Net loss.............................................................. Drawings ........................................................... S. Woods, Capital, December 31............................ $30,000 4,000 34,000 $4,600 7,200 11,800 $22,200 WOODS COMPANY Balance Sheet December 31, 2008 Assets Current assets Cash........................................................................ Accounts receivable.......................................... Prepaid insurance .............................................. Total current assets.................................. Property, plant, and equipment Equipment ............................................................ Less: Accumulated depreciation ................. Total assets ................................................. 4-40 $ 8,200 7,500 1,800 17,500 $28,000 8,600 19,400 $36,900 PROBLEM 4-3A (Continued) WOODS COMPANY Balance Sheet (Continued) December 31, 2008 Liabilities and Owner’s Equity Current liabilities Accounts payable ....................................................................... Salaries payable .......................................................................... Total current liabilities ..................................................... Owner’s equity S. Woods, Capital ....................................................................... Total liabilities and owner’s equity................................................................................. (b) $11,700 3,000 14,700 22,200 $36,900 General Journal Date Account Titles Dec. 31 Service Revenue ........................................ Income Summary ............................ Ref. 400 350 Debit 44,000 31 Income Summary....................................... Repair Expense................................ Depreciation Expense ................... Insurance Expense......................... Salaries Expense............................. Utilities Expense.............................. 350 622 711 722 726 732 48,600 31 S. Woods, Capital ...................................... Income Summary ............................ 301 350 4,600 S. Woods, Capital ...................................... S. Woods, Drawing ......................... 301 306 7,200 31 4-41 Credit 44,000 5,400 2,800 1,200 35,200 4,000 4,600 7,200 PROBLEM 4-3A (Continued) (c) 12/31 12/31 S. Woods, Capital No. 301 4,600 12/31 Bal. 34,000 7,200 12/31 Bal. 22,200 Repair Expense 5,400 12/31 12/31 Bal. No. 622 5,400 Depreciation Expense No. 711 12/31 Bal. 2,800 12/31 2,800 12/31 Bal. S. Woods, Drawing 7,200 12/31 No. 306 7,200 12/31 Bal. 12/31 12/31 (d) Income Summary 48,600 12/31 12/31 48,600 Insurance Expense 1,200 12/31 No. 722 1,200 No. 350 44,000 4,600 48,600 Salaries Expense 12/31 Bal. 35,200 12/31 No. 726 35,200 Service Revenue No. 400 44,000 12/31 Bal. 44,000 Utilities Expense 12/31 Bal. 4,000 12/31 No. 732 4,000 WOODS COMPANY Post-Closing Trial Balance December 31, 2008 Cash................................................................................. Accounts Receivable ................................................. Prepaid Insurance....................................................... Equipment ..................................................................... Accumulated Depreciation....................................... Accounts Payable ....................................................... Salaries Payable .......................................................... S. Woods, Capital........................................................ Totals 4-42 Debit $ 8,200 7,500 1,800 28,000 $45,500 Credit $ 8,600 11,700 3,000 22,200 $45,500 (a) DISNEY AMUSEMENT PARK Worksheet For the Year Ended September 30, 2008 Account Titles Trial Balance Dr. Cr. Dr. 41,400 18,600 31,900 80,000 120,000 Cr. (a) 17,400 (b) 23,000 36,200 14,600 3,700 50,000 109,700 (d) (c) 6,000 (d) 1,700 Adjusted Trial Balance Dr. Dr. Cr. 41,400 1,200 8,900 80,000 120,000 105,000 30,500 9,400 16,900 18,000 6,000 491,700 491,700 14,000 279,200 279,200 3,000 4,000 105,000 30,500 9,400 16,900 21,000 10,000 (b) 23,000 (a) 17,400 23,000 17,400 23,000 17,400 (f) (c) 6,000 (e) 55,100 3,000 55,100 4,000 4,000 4,000 6,000 Cr. 42,200 14,600 2,000 50,000 109,700 105,000 30,500 9,400 16,900 21,000 10,000 (e) (f) Dr. 41,400 1,200 8,900 80,000 120,000 14,000 277,500 Balance Sheet 42,200 14,600 2,000 50,000 109,700 1,700 14,000 Cr. Income Statement 3,000 504,700 504,700 6,000 239,200 279,200 40,000 279,200 279,200 265,500 265,500 3,000 225,500 40,000 265,500 Key: (a) Supplies Used; (b) Expired Insurance; (c) Depreciation Expensed; (d) Admissions Revenue Earned; (e) Accrued Property Taxes; (f) Accrued Interest Payable. PROBLEM 4-4A 4-43 Cash Supplies Prepaid Insurance Land Equipment Accumulated Depreciation Accounts Payable Unearned Admissions Revenue Mortgage Note Payable L. Disney, Capital L. Disney, Drawing Admissions Revenue Salaries Expense Repair Expense Advertising Expense Utilities Expense Property Taxes Expense Interest Expense Totals Insurance Expense Supplies Expense Interest Payable Depreciation Expense Property Taxes Payable Totals Net Income Totals Adjustments PROBLEM 4-4A (Continued) (b) DISNEY AMUSEMENT PARK Balance Sheet September 30, 2008 Assets Current assets Cash...................................................... Supplies .............................................. Prepaid insurance............................ Total current assets ............... Property, plant, and equipment Land...................................................... Equipment .......................................... Less: Accum. depreciation.......... Total assets............................... $ 41,400 1,200 8,900 51,500 $80,000 $120,000 42,200 77,800 157,800 $209,300 Liabilities and Owner’s Equity Current liabilities Current maturity of mortgage note payable.................................. Accounts payable ............................ Interest payable ................................ Property taxes payable .................. Unearned admissions revenue ........................................... Total current liabilities........... Long-term liabilities Mortgage note payable................... Total liabilities .......................... Owner’s equity L. Disney, Capital ($109,700 + $40,000 – $14,000) ........ Total liabilities and owner’s equity ..................... 4-44 $ 10,000 14,600 4,000 3,000 2,000 33,600 40,000 73,600 135,700 $209,300 PROBLEM 4-4A (Continued) (c) Sept. 30 30 30 30 30 30 (d) Sept. 30 30 30 30 Supplies Expense...................................... Supplies ............................................... 17,400 Insurance Expense ................................... Prepaid Insurance ............................ 23,000 Depreciation Expense.............................. Accumulated Depreciation ............ 6,000 Unearned Admissions Revenue ........... Admissions Revenue ...................... 1,700 Property Taxes Expense ......................... Property Taxes Payable.................. 3,000 Interest Expense ........................................ Interest Payable ................................ 4,000 Admissions Revenue ............................... Income Summary.............................. 279,200 Income Summary....................................... Salaries Expense .............................. Repair Expense ................................. Insurance Expense........................... Property Taxes Expense ................ Supplies Expense............................. Utilities Expense ............................... Interest Expense ............................... Advertising Expense ....................... Depreciation Expense ..................... 239,200 Income Summary....................................... L. Disney, Capital.............................. 40,000 L. Disney, Capital....................................... L. Disney, Drawing ........................... 14,000 4-45 17,400 23,000 6,000 1,700 3,000 4,000 279,200 105,000 30,500 23,000 21,000 17,400 16,900 10,000 9,400 6,000 40,000 14,000 PROBLEM 4-4A (Continued) (e) DISNEY AMUSEMENT PARK Post-Closing Trial Balance September 30, 2008 Cash ................................................................................ Supplies ......................................................................... Prepaid Insurance....................................................... Land................................................................................. Equipment ..................................................................... Accumulated Depreciation ...................................... Accounts Payable....................................................... Interest Payable........................................................... Property Taxes Payable............................................ Unearned Admissions Revenue ............................ Mortgage Note Payable............................................. L. Disney, Capital ........................................................ Debit $ 41,400 1,200 8,900 80,000 120,000 $251,500 4-46 Credit $ 42,200 14,600 4,000 3,000 2,000 50,000 135,700 $251,500 PROBLEM 4-5A (a) General Journal Date Mar. 1 1 3 5 14 18 20 21 28 31 31 Account Titles and Explanation Cash ............................................................. L. Eddy, Capital ............................. Ref. 101 301 Debit 10,000 Equipment.................................................. Cash .................................................. Accounts Payable......................... 157 101 201 6,000 Cleaning Supplies ................................... Accounts Payable......................... 128 201 1,200 Prepaid Insurance ................................... Cash .................................................. 130 101 1,200 Accounts Receivable ............................. Service Revenue ........................... 112 400 4,800 Accounts Payable ................................... Cash .................................................. 201 101 2,000 Salaries Expense ..................................... Cash .................................................. 726 101 1,800 Cash ............................................................. Accounts Receivable................... 101 112 1,400 Accounts Receivable ............................. Service Revenue ........................... 112 400 2,500 Gas & Oil Expense .................................. Cash .................................................. 633 101 200 L. Eddy, Drawing...................................... Cash .................................................. 306 101 700 4-47 J1 Credit 10,000 3,000 3,000 1,200 1,200 4,800 2,000 1,800 1,400 2,500 200 700 EDDY’S CARPET CLEANERS Worksheet For the Month Ended March 31, 2008 Account Titles Trial Balance Dr. 4-48 Cash Accounts Receivable Cleaning Supplies Prepaid Insurance Equipment Accounts Payable L. Eddy, Capital L. Eddy, Drawing Service Revenue Gas & Oil Expense Salaries Expense Totals Depreciation Expense Accum. Depr.—Equipment Insurance Expense Cleaning Supplies Expense Salaries Payable Totals Net Income Totals Adjustments Cr. 2,500 5,900 1,200 1,200 6,000 Dr. (a) Cr. 700 (d) (c) 800 100 Adjusted Trial Balance Income Statement Dr. Dr. Cr. 2,500 6,600 400 1,100 6,000 2,200 10,000 Dr. 2,200 10,000 700 7,300 (a) (e) 500 (b) 250 700 Cr. 2,500 6,600 400 1,100 6,000 2,200 10,000 700 200 1,800 19,500 Cr. Balance Sheet 700 8,000 8,000 200 2,300 200 2,300 19,500 (c) (d) 250 100 800 250 500 2,350 20,950 250 100 800 100 800 (e) 2,350 250 250 (b) 500 20,950 3,650 4,350 8,000 8,000 17,300 8,000 17,300 Key: (a) Service Revenue Earned; (b) Depreciation Expensed; (c) Insurance Expired; (d) Cleaning Supplies Used; (e) Unpaid Salaries. 500 12,950 4,350 17,300 PROBLEM 4-5A (Continued) (b) & (c) PROBLEM 4-5A (Continued) (a), (e) & (f) Date Mar. 1 1 5 18 20 21 31 31 Date Mar. 14 21 28 31 Date Mar. 3 31 Date Mar. 5 31 Date Mar. 1 Explanation Explanation Adjusting Explanation Adjusting Explanation Adjusting Explanation Cash Ref. J1 J1 J1 J1 J1 J1 J1 J1 Debit 10,000 3,000 1,200 2,000 1,800 1,400 200 700 Accounts Receivable Ref. Debit J1 4,800 J1 J1 2,500 J2 700 Cleaning Supplies Ref. Debit J1 1,200 J2 Prepaid Insurance Ref. Debit J1 1,200 J2 Equipment Ref. J1 4-49 Credit Debit 6,000 Credit 1,400 Credit 800 Credit 100 Credit No. 101 Balance 10,000 7,000 5,800 3,800 2,000 3,400 3,200 2,500 No. 112 Balance 4,800 3,400 5,900 6,600 No. 128 Balance 1,200 400 No. 130 Balance 1,200 1,100 No. 157 Balance 6,000 PROBLEM 4-5A (Continued) Date Mar. 31 Date Mar. 1 3 18 Date Mar. 31 Date Mar. 1 31 31 Date Mar. 31 31 Date Mar. 31 31 31 Accumulated Depreciation—Equipment Explanation Ref. Debit Credit Adjusting J2 250 Explanation Explanation Adjusting Explanation Closing Closing Accounts Payable Ref. Debit J1 J1 J1 2,000 Salaries Payable Ref. Debit J2 L. Eddy, Capital Ref. Debit J1 J3 J3 700 Closing L. Eddy, Drawing Ref. Debit J1 700 J3 Explanation Closing Closing Closing Income Summary Ref. Debit J3 J3 3,650 J3 4,350 Explanation 4-50 Credit 3,000 1,200 Credit 500 Credit 10,000 4,350 Credit 700 Credit 8,000 No. 158 Balance 250 No. 201 Balance 3,000 4,200 2,200 No. 212 Balance 500 No. 301 Balance 10,000 14,350 13,650 No. 306 Balance 700 0 No. 350 Balance 8,000 4,350 0 PROBLEM 4-5A (Continued) Date Mar. 14 28 31 31 Date Mar. 31 31 Explanation Adjusting Closing Explanation Closing Service Revenue Ref. Debit J1 J1 J2 J3 8,000 Gas & Oil Expense Ref. Debit J1 200 J3 Date Mar. 31 31 Cleaning Supplies Expense Explanation Ref. Debit Adjusting J2 800 Closing J3 Date Mar. 31 31 Explanation Adjusting Closing Depreciation Expense Ref. Debit J2 250 J3 Explanation Adjusting Closing Insurance Expense Ref. Debit J2 100 J3 Date Mar. 31 31 Date Mar. 20 31 31 Explanation Adjusting Closing Salaries Expense Ref. Debit J1 1,800 J2 500 J3 4-51 Credit 4,800 2,500 700 No. 400 Balance 4,800 7,300 8,000 0 Credit No. 633 Balance 200 0 200 Credit 800 Credit 250 Credit 100 Credit 2,300 No. 634 Balance 800 0 No. 711 Balance 250 0 No. 722 Balance 100 0 No. 726 Balance 1,800 2,300 0 PROBLEM 4-5A (Continued) (d) EDDY’S CARPET CLEANERS Income Statement For the Month Ended March 31, 2008 Revenues Service revenue..................................................... Expenses Salaries expense ................................................... Cleaning supplies expense................................ Depreciation expense.......................................... Gas & oil expense ................................................. Insurance expense ............................................... Total expenses.............................................. Net income ....................................................................... $8,000 $2,300 800 250 200 100 3,650 $4,350 EDDY’S CARPET CLEANERS Owner’s Equity Statement For the Month Ended March 31, 2008 L. Eddy, Capital, March 1............................................. Add: Investments......................................................... Net income .......................................................... Less: Drawings.............................................................. L. Eddy, Capital, March 31 .......................................... $ $10,000 4,350 0 14,350 14,350 700 $13,650 EDDY’S CARPET CLEANERS Balance Sheet March 31, 2008 Assets Current assets Cash........................................................................... Accounts receivable ............................................ Cleaning supplies ................................................. Prepaid insurance................................................. Total current assets .................................... 4-52 $ 2,500 6,600 400 1,100 10,600 PROBLEM 4-5A (Continued) EDDY’S CARPET CLEANERS Balance Sheet (Continued) March 31, 2008 Assets (Continued) Property, plant, and equipment Equipment................................................................. Less: Accumulated depreciation ..................... Total assets ..................................................... $6,000 250 5,750 $16,350 Liabilities and Owner’s Equity Current liabilities Accounts payable................................................... Salaries payable...................................................... Total current liabilities ................................. Owner’s equity L. Eddy, Capital ....................................................... Total liabilities and owner’s equity............................................................. (e) $ 2,200 500 2,700 13,650 $16,350 General Journal Date Mar. 31 31 31 31 31 Account Titles and Explanation Accounts Receivable ............................. Service Revenue ........................... Ref. 112 400 Debit 700 Depreciation Expense ........................... Accumulated Depreciation— Equipment .................................. 711 250 Insurance Expense................................. Prepaid Insurance ........................ 722 130 100 Cleaning Supplies Expense................. Cleaning Supplies ........................ 634 128 800 Salaries Expense..................................... Salaries Payable ........................... 726 212 500 4-53 J2 Credit 700 158 250 100 800 500 PROBLEM 4-5A (Continued) (f) General Journal Date Mar. 31 (g) Account Titles and Explanation Service Revenue ...................................... Income Summary........................... Ref. 400 350 Debit 8,000 31 Income Summary ..................................... Salaries Expense ........................... Depreciation Expense .................. Insurance Expense........................ Cleaning Supplies Expense ....... Gas & Oil Expense ........................ 350 726 711 722 634 633 3,650 31 Income Summary ..................................... L. Eddy, Capital .............................. 350 301 4,350 31 L. Eddy, Capital......................................... L. Eddy, Drawing............................ 301 306 700 J3 Credit 8,000 2,300 250 100 800 200 4,350 700 EDDY’S CARPET CLEANERS Post-Closing Trial Balance March 31, 2008 Cash ................................................................................ Accounts Receivable................................................. Cleaning Supplies....................................................... Prepaid Insurance....................................................... Equipment ..................................................................... Accumulated Depreciation—Equipment............. Accounts Payable....................................................... Salaries Payable.......................................................... L. Eddy, Capital............................................................ 000,000 4-54 Debit $ 2,500 6,600 400 1,100 6,000 Credit $ $16,600 250 2,200 500 13,650 $16,600 (a) (1) INCORRECT ENTRY 1. 4-55 3. 4. 5. Cash ...................................... Accts. Receivable ....... 960 Misc. Expense .................... Cash................................ 65 Salaries Expense............... Cash................................ 1,900 Supplies ............................... Accounts Payable....... 290 Equipment ........................... Cash................................ 59 (3) CORRECTING ENTRY Cash....................................... Accts. Receivable ....... 690 960 Advertising Expense ........ Cash ................................ 65 65 690 65 Accounts Receivable......... 270 Cash.................................. 270 Advertising Expense ......... Misc. Expense ............... 65 65 Salaries Expense............... 1,200 Salaries Payable ................ 700 Cash ................................ 1,900 Salaries Payable.................. 700 Salaries Expense .......... 700 Equipment ........................... Accounts Payable ....... 290 290 Equipment............................. 290 Supplies........................... 290 Repair Expense.................. Cash ................................ 95 59 1,900 290 95 Repair Expense ................... Cash.................................. Equipment....................... 95 36 59 PROBLEM 4-6A 2. (2) CORRECT ENTRY PROBLEM 4-6A (Continued) (b) FOX CABLE Trial Balance April 30, 2008 Cash ($4,100 – $270 – $36)....................................... Accounts Receivable ($3,200 + $270) .................. Supplies ($800 – $290) .............................................. Equipment ($10,600 + $290 – $59)......................... Accumulated Depreciation ...................................... Accounts Payable....................................................... Salaries Payable ($700 – $700) ............................... Unearned Revenue ..................................................... A. Manion, Capital....................................................... Service Revenue ......................................................... Salaries Expense ($3,300 – $700) .......................... Advertising Expense ($600 + $65)......................... Miscellaneous Expense ($290 – $65) ................... Repair Expense............................................................ Depreciation Expense ............................................... 4-56 Debit $ 3,794 3,470 510 10,831 Credit $ 1,350 2,100 0 890 12,900 5,450 2,600 665 225 95 500 $22,690 $22,690 (a) EVERLAST ROOFING Worksheet For the Month Ended March 31, 2008 Account Titles Trial Balance Dr. Dr. Cr. 2,500 1,800 1,100 6,000 700 1,400 300 7,000 (c) (a) 860 (b) 200 (c) 170 Income Statement Dr. Dr. Cr. Cr. 2,500 1,800 240 6,000 Dr. Cr. 2,500 1,800 240 6,000 900 1,400 130 7,000 600 3,500 Balance Sheet 900 1,400 130 7,000 170 600 700 200 12,900 Adjusted Trial Balance 600 3,670 3,670 (d) 350 1,050 200 1,050 200 (a) (b) 860 200 860 200 860 200 12,900 (d) 1,580 350 1,580 13,450 350 13,450 2,310 1,360 3,670 Key: (a) Supplies Used; (b) Depreciation Expensed; (c) Service Revenue Earned; (d) Salaries Accrued. 3,670 11,140 3,670 11,140 350 9,780 1,360 11,140 PROBLEM 4-1B 4-57 Cash Accounts Receivable Roofing Supplies Equipment Accumulated Depreciation Accounts Payable Unearned Revenue J. Watt, Capital J. Watt, Drawing Service Revenue Salaries Expense Miscellaneous Expense Totals Supplies Expense Depreciation Expense Salaries Payable Totals Net Income Totals Cr. Adjustments PROBLEM 4-1B (Continued) (b) EVERLAST ROOFING Income Statement For the Month Ended March 31, 2008 Revenues Service revenue.......................................................... Expenses Salaries expense ........................................................ Supplies expense....................................................... Depreciation expense............................................... Miscellaneous expense............................................ Total expenses................................................... Net income ............................................................................ $3,670 $1,050 860 200 200 2,310 $1,360 EVERLAST ROOFING Owner’s Equity Statement For the Month Ended March 31, 2008 J. Watt, Capital, March 1 ....................................................................... Add: Net income ................................................................................... Less: Drawings....................................................................................... J. Watt, Capital, March 31..................................................................... $7,000 1,360 8,360 600 $7,760 EVERLAST ROOFING Balance Sheet March 31, 2008 Assets Current assets Cash................................................................................ Accounts receivable ................................................. Roofing supplies ........................................................ Total current assets ......................................... Property, plant, and equipment Equipment .................................................................... Less: Accum. depreciation—equipment........... Total assets......................................................... 4-58 $2,500 1,800 240 4,540 $6,000 900 5,100 $9,640 PROBLEM 4-1B (Continued) EVERLAST ROOFING Balance Sheet (Continued) March 31, 2008 Liabilities and Owner’s Equity Current liabilities Accounts payable........................................................................... Salaries payable.............................................................................. Unearned revenue .......................................................................... Total current liabilities ......................................................... Owner’s equity J. Watt, Capital................................................................................. Total liabilities and owner’s equity.................................. (c) Mar. 31 31 31 31 (d) Mar. 31 31 31 31 Supplies Expense................................................. Roofing Supplies ......................................... 860 Depreciation Expense......................................... Accumulated Depreciation....................... 200 Unearned Revenue .............................................. Service Revenue.......................................... 170 Salaries Expense.................................................. Salaries Payable .......................................... 350 Service Revenue................................................... Income Summary......................................... 3,670 Income Summary ................................................. Salaries Expense ......................................... Supplies Expense........................................ Depreciation Expense................................ Miscellaneous Expense............................. 2,310 Income Summary ................................................. J. Watt, Capital ............................................. 1,360 J. Watt, Capital ...................................................... J. Watt, Drawing........................................... 600 4-59 $1,400 350 130 1,880 7,760 $9,640 860 200 170 350 3,670 1,050 860 200 200 1,360 600 PROBLEM 4-2B (a) SPARKS COMPANY Partial Worksheet For the Year Ended December 31, 2008 Account No. 101 112 126 130 151 152 200 201 212 230 301 306 400 610 631 711 722 726 905 Titles Cash Accounts Receivable Supplies Prepaid Insurance Office Equipment Acc. Depr.—Off. Equip. Notes Payable Accounts Payable Salaries Payable Interest Payable B. Sparks, Capital B. Sparks, Drawing Service Revenue Advertising Expense Supplies Expense Depreciation Expense Insurance Expense Salaries Expense Interest Expense Totals Net Income Totals Adjusted Trial Balance Dr. 11,600 15,400 2,000 2,800 34,000 Cr. Income Statement Dr. Cr. Balance Sheet Dr. 11,600 15,400 2,000 2,800 34,000 8,000 20,000 9,000 3,500 800 25,000 8,000 20,000 9,000 3,500 800 25,000 10,000 10,000 85,000 12,000 5,700 8,000 5,000 44,000 800 151,300 Cr. 151,300 4-60 85,000 12,000 5,700 8,000 5,000 44,000 800 75,500 9,500 85,000 85,000 75,800 85,000 75,800 66,300 9,500 75,800 PROBLEM 4-2B (Continued) (b) SPARKS COMPANY Income Statement For the Year Ended December 31, 2008 Revenues Service revenue ..................................................... Expenses Salaries expense.................................................... Advertising expense............................................. Depreciation expense .......................................... Supplies expense .................................................. Insurance expense ................................................ Interest expense..................................................... Total expenses .............................................. Net income........................................................................ $85,000 $44,000 12,000 8,000 5,700 5,000 800 75,500 $ 9,500 SPARKS COMPANY Owner’s Equity Statement For the Year Ended December 31, 2008 B. Sparks, Capital, January 1 .......................................................... Add: Net income................................................................................ Less: Drawings ................................................................................... B. Sparks, Capital, December 31.................................................... 4-61 $25,000 9,500 34,500 10,000 $24,500 PROBLEM 4-2B (Continued) SPARKS COMPANY Balance Sheet December 31, 2008 Assets Current assets Cash........................................................................... Accounts receivable ............................................ Supplies ................................................................... Prepaid insurance................................................. Total current assets .................................... Property, plant, and equipment Office equipment................................................... Less: Accumulated depreciation.................... Total assets.................................................... $11,600 15,400 2,000 2,800 31,800 $34,000 8,000 26,000 $57,800 Liabilities and Owner’s Equity Current liabilities Notes payable......................................................... Accounts payable ................................................. Salaries payable .................................................... Interest payable ..................................................... Total current liabilities................................ Long-term liabilities Notes payable......................................................... Total liabilities ............................................... Owner’s equity B. Sparks, Capital ................................................. Total liabilities and owner’s equity ........................................................... 4-62 $10,000 9,000 3,500 800 23,300 10,000 33,300 24,500 $57,800 PROBLEM 4-2B (Continued) (c) General Journal Date Account Titles and Explanation Ref. Dec. 31 Service Revenue......................................... 400 Income Summary............................. 350 Debit 85,000 31 Income Summary ....................................... Advertising Expense ...................... Supplies Expense............................ Depreciation Expense .................... Insurance Expense.......................... Salaries Expense ............................. Interest Expense .............................. 350 610 631 711 722 726 905 75,500 31 Income Summary ....................................... B. Sparks, Capital ............................ 350 301 9,500 31 B. Sparks, Capital....................................... B. Sparks, Drawing.......................... 301 306 10,000 J14 Credit 85,000 12,000 5,700 8,000 5,000 44,000 800 9,500 10,000 (d) Date Jan. 1 Dec. 31 31 Date Explanation Balance Closing entry Closing entry B. Sparks, Capital Ref. Debit
J14 J14 10,000 Explanation B. Sparks, Drawing Ref. Debit Dec. 31 Balance 31 Closing entry
J14 4-63 Credit 25,000 9,500 No. 301 Balance 25,000 34,500 24,500 Credit No. 306 Balance 10,000 10,000 0 10,000 PROBLEM 4-2B (Continued) Explanation Closing entry Closing entry Closing entry Income Summary Ref. Debit J14 J14 75,500 J14 9,500 Explanation Balance Closing entry Service Revenue Ref. Debit
J14 85,000 Explanation Balance Closing entry Advertising Expense Ref. Debit
12,000 J14 Date Dec. 31 31 Explanation Balance Closing entry Supplies Expense Ref. Debit
5,700 J14 Date Dec. 31 31 Depreciation Expense Explanation Ref. Debit Balance
8,000 Closing entry J14 Date Dec. Date Dec. Date Dec. Date Dec. 31 31 31 31 31 31 31 31 31 Explanation Balance Closing entry Insurance Expense Ref. Debit
5,000 J14 4-64 Credit 85,000 No. 350 Balance 85,000 9,500 0 Credit 85,000 No. 400 Balance 85,000 0 Credit 12,000 Credit 5,700 Credit 8,000 Credit 5,000 No. 610 Balance 12,000 0 No. 631 Balance 5,700 0 No. 711 Balance 8,000 0 No. 722 Balance 5,000 0 PROBLEM 4-2B (Continued) Date Dec. 31 31 Date Dec. 31 31 (e) Explanation Balance Closing entry Salaries Expense Ref. Debit
44,000 J14 Explanation Balance Closing entry Interest Expense Ref. Debit
800 J14 Credit 44,000 Credit 800 No. 726 Balance 44,000 0 No. 905 Balance 800 0 SPARKS COMPANY Post-Closing Trial Balance December 31, 2008 Cash ................................................................................. Accounts Receivable.................................................. Supplies.......................................................................... Prepaid Insurance ....................................................... Office Equipment......................................................... Accumulated Depreciation—Office Equipment ................................................................. Notes Payable............................................................... Accounts Payable........................................................ Salaries Payable .......................................................... Interest Payable ........................................................... B. Sparks, Capital ........................................................ Totals 4-65 Debit $11,600 15,400 2,000 2,800 34,000 $65,800 Credit $ 8,000 20,000 9,000 3,500 800 24,500 $65,800 PROBLEM 4-3B (a) MOLINDA COMPANY Income Statement For the Year Ended December 31, 2008 Revenues Service revenue..................................................... Expenses Salaries expense ................................................... Depreciation expense.......................................... Insurance expense ............................................... Repair expense ...................................................... Utilities expense .................................................... Total expenses.............................................. Net income ....................................................................... $69,000 $37,000 2,600 2,200 2,000 1,700 45,500 $23,500 MOLINDA COMPANY Owner’s Equity Statement For the Year Ended December 31, 2008 Ann Molinda, Capital, January 1 ............................................. Add: Net income ........................................................................ Less: Drawings............................................................................ Ann Molinda, Capital, December 31....................................... $36,000 23,500 59,500 14,000 $45,500 MOLINDA COMPANY Balance Sheet December 31, 2008 Assets Current assets Cash........................................................................... Accounts receivable ............................................ Prepaid insurance................................................. Total current assets .................................... Property, plant, and equipment Equipment ............................................................... Less: Accumulated depreciation.................... Total assets.................................................... 4-66 $22,400 13,500 3,500 39,400 $26,000 5,600 20,400 $59,800 PROBLEM 4-3B (Continued) MOLINDA COMPANY Balance Sheet (Continued) December 31, 2008 Liabilities and Owner’s Equity Current liabilities Accounts payable....................................................................... Salaries payable.......................................................................... Total current liabilities ..................................................... Owner’s equity Ann Molinda, Capital ................................................................. Total liabilities and owner’s equity................................................................................. (b) $11,300 3,000 14,300 45,500 $59,800 General Journal Date Dec. 31 31 31 31 Account Titles and Explanation Service Revenue......................................... Income Summary............................. Ref. 400 350 Debit 69,000 Income Summary........................................ Repair Expense ................................ Depreciation Expense .................... Insurance Expense.......................... Salaries Expense ............................. Utilities Expense .............................. 350 622 711 722 726 732 45,500 Income Summary........................................ Ann Molinda, Capital....................... 350 301 23,500 Ann Molinda, Capital ................................. Ann Molinda, Drawing .................... 301 306 14,000 4-67 Credit 69,000 2,000 2,600 2,200 37,000 1,700 23,500 14,000 PROBLEM 4-3B (Continued) (c) 12/31 Ann Molinda, Capital No. 301 14,000 1/1 Bal. 36,000 12/31 23,500 12/31 Bal. 45,500 Repair Expense 2,000 12/31 12/31 Bal. No. 622 2,000 Depreciation Expense No. 711 12/31 Bal. 2,600 12/31 2,600 Ann Molinda, Drawing No. 306 12/31 Bal. 14,000 12/31 14,000 12/31 12/31 12/31 (d) Income Summary 45,500 12/31 23,500 69,000 Insurance Expense 12/31 Bal. 2,200 12/31 No. 722 2,200 Salaries Expense 12/31 Bal. 37,000 12/31 No. 726 37,000 Utilities Expense 1,700 12/31 No. 732 1,700 No. 350 69,000 69,000 Service Revenue No. 400 69,000 12/31 Bal. 69,000 12/31 Bal. MOLINDA COMPANY Post-Closing Trial Balance December 31, 2008 Cash ................................................................................ Accounts Receivable................................................. Prepaid Insurance....................................................... Equipment ..................................................................... Accumulated Depreciation ...................................... Accounts Payable....................................................... Salaries Payable.......................................................... Ann Molinda, Capital.................................................. Totals 4-68 Debit $22,400 13,500 3,500 26,000 $65,400 Credit $ 5,600 11,300 3,000 45,500 $65,400 (a) PETTENGILL MANAGEMENT SERVICES Worksheet For the Year Ended December 31, 2008 Account Titles Trial Balance Dr. Cr. Dr. 11,500 23,600 3,100 56,000 106,000 49,000 Cr. (a) 1,700 10,400 5,000 100,000 120,000 (d) Dr. Cr. Income Statement Dr. Cr. 11,500 23,600 1,400 56,000 106,000 49,000 10,400 2,800 100,000 120,000 18,000 75,600 26,200 (d) 2,200 Cr. 11,500 23,600 1,400 56,000 106,000 49,000 18,000 75,600 24,000 Balance Sheet Dr. 10,400 2,800 100,000 120,000 2,200 18,000 35,000 17,000 15,800 335,000 Adjusted Trial Balance 75,600 26,200 35,000 17,000 15,800 35,000 17,000 15,800 1,700 2,500 1,700 2,500 335,000 (a) (b) 1,700 2,500 (c) 3,900 (e) 9,000 2,500 (b) 2,500 3,900 (c) 3,900 3,900 9,000 (e) 19,300 2,500 3,900 9,000 19,300 350,400 3,900 9,000 9,000 350,400 84,900 16,900 101,800 101,800 265,500 101,800 265,500 Key: (a) Expired Insurance; (b) Depreciation Expense—Building; (c) Depreciation Expense—Equipment; (d) Rent Revenue Earned; (e) Accrued Interest Payable. 9,000 248,600 16,900 265,500 PROBLEM 4-4B 4-69 Cash Accounts Receivable Prepaid Insurance Land Building Equipment Accounts Payable Unearned Rent Revenue Mortgage Note Payable G. Pettengill, Capital G. Pettengill, Drawing Service Revenue Rent Revenue Salaries Expense Advertising Expense Utilities Expense Totals Insurance Expense Depr. Expense—Building Accum. Depr.—Building Depr. Expense—Equipment Accum. Depr.—Equipment Interest Expense Interest Payable Totals Net Income Totals Adjustments PROBLEM 4-4B (Continued) (b) PETTENGILL MANAGEMENT SERVICES Balance Sheet December 31, 2008 Assets Current assets Cash ................................................... Accounts receivable ..................... Prepaid insurance ......................... Total current assets ............. Property, plant, and equipment Land ................................................... Building............................................. Less: Accumulated depreciation—building............ Equipment........................................ Less: Accumulated depreciation—equipment ....... Total assets ............................ $ 11,500 23,600 1,400 36,500 $ 56,000 $106,000 2,500 49,000 103,500 3,900 45,100 204,600 $241,100 Liabilities and Owner’s Equity Current liabilities Current maturity of mortgage note payable ...................... Accounts payable....................................................................... Interest payable........................................................................... Unearned rent revenue ............................................................. Total current liabilities ..................................................... Long-term liabilities Mortgage note payable ............................................................. Total liabilities..................................................................... Owner’s equity G. Pettengill, Capital ($120,000 – $18,000 + $16,900)........... Total liabilities and owner’s equity.............................. 4-70 $ 10,000 10,400 9,000 2,800 32,200 90,000 122,200 118,900 $241,100 PROBLEM 4-4B (Continued) (c) Dec. 31 31 31 31 31 (d) Dec. 31 31 31 31 Insurance Expense...................................... Prepaid Insurance .............................. 1,700 Depreciation Expense—Building ........... Accumulated Depreciation— Building ............................................. 2,500 Depreciation Expense—Equipment ...... Accumulated Depreciation— Equipment ........................................ 3,900 Unearned Rent Revenue ........................... Rent Revenue....................................... 2,200 Interest Expense .......................................... Interest Payable................................... 9,000 Service Revenue .......................................... Rent Revenue................................................ Income Summary................................ 75,600 26,200 Income Summary......................................... Salaries Expense ................................ Advertising Expense ......................... Interest Expense ................................. Utilities Expense ................................. Depreciation Expense— Equipment ........................................ Depreciation Expense— Building ............................................. Insurance Expense............................. 84,900 Income Summary......................................... G. Pettengill, Capital .......................... 16,900 G. Pettengill, Capital ................................... G. Pettengill, Drawing........................ 18,000 4-71 1,700 2,500 3,900 2,200 9,000 101,800 35,000 17,000 9,000 15,800 3,900 2,500 1,700 16,900 18,000 PROBLEM 4-4B (Continued) (e) PETTENGILL MANAGEMENT SERVICES Post-Closing Trial Balance December 31, 2008 Cash ............................................................................ Accounts Receivable............................................. Prepaid Insurance .................................................. Land ............................................................................ Building...................................................................... Accumulated Depreciation—Building ............. Equipment................................................................. Accumulated Depreciation—Equipment ........ Accounts Payable................................................... Interest Payable ...................................................... Unearned Rent Revenue ...................................... Mortgage Note Payable ........................................ G. Pettengill, Capital .............................................. Debit $ 11,500 23,600 1,400 56,000 106,000 $ 2,500 49,000 $247,500 4-72 Credit 3,900 10,400 9,000 2,800 100,000 118,900 $247,500 PROBLEM 4-5B (a) General Journal Date July 1 1 3 5 12 18 20 21 25 31 31 Account Titles and Explanation Cash .............................................................. Lee Choi, Capital ............................ Ref. 101 301 Debit 12,000 Equipment................................................... Cash.................................................... Accounts Payable .......................... 157 101 201 6,000 Cleaning Supplies .................................... Accounts Payable .......................... 128 201 1,300 Prepaid Insurance .................................... Cash.................................................... 130 101 2,400 Accounts Receivable............................... Service Revenue............................. 112 400 2,500 Accounts Payable..................................... Cash.................................................... 201 101 1,800 Salaries Expense ...................................... Cash.................................................... 726 101 1,200 Cash .............................................................. Accounts Receivable .................... 101 112 1,400 Accounts Receivable............................... Service Revenue............................. 112 400 5,000 Gas & Oil Expense ................................... Cash.................................................... 633 101 200 Lee Choi, Drawing .................................... Cash.................................................... 306 101 900 4-73 J1 Credit 12,000 3,000 3,000 1,300 2,400 2,500 1,800 1,200 1,400 5,000 200 900 Account Titles CHOI’S WINDOW WASHING Worksheet For the Month Ended July 31, 2008 Trial Balance Dr. 4-74 Cash Accounts Receivable Cleaning Supplies Prepaid Insurance Equipment Accounts Payable Lee Choi, Capital Lee Choi, Drawing Service Revenue Gas & Oil Expense Salaries Expense Totals Depreciation Expense Accum. Depr.—Equipment Insurance Expense Cleaning Supplies Expense Salaries Payable Totals Net Income Totals Cr. 3,900 6,100 1,300 2,400 6,000 Adjusted Trial Balance Adjustments Dr. Cr. (a) 1,500 (d) (c) 900 200 Dr. Dr. Cr. 3,900 7,600 400 2,200 6,000 2,500 12,000 Balance Sheet Dr. 2,500 12,000 900 7,500 (a) 1,500 (e) 600 (b) 300 Cr. 3,900 7,600 400 2,200 6,000 2,500 12,000 900 200 1,200 22,000 Cr. Income Statement 900 9,000 200 1,800 9,000 200 1,800 22,000 300 (b) (c) (d) 300 200 900 200 900 (e) 3,500 300 300 600 3,500 24,400 300 200 900 600 24,400 3,400 5,600 9,000 9,000 21,000 9,000 21,000 Key: (a) Service Revenue Earned; (b) Depreciation Expense; (c) Insurance Expired; (d) Cleaning Supplies Used; (e) Unpaid Salaries. 600 15,400 5,600 21,000 PROBLEM 4-5B (Continued) (b) & (c) PROBLEM 4-5B (Continued) (a), (e) & (f) Date Explanation July 1 1 5 18 20 21 31 31 Date Explanation July 12 21 25 31 Adjusting Date July 3 31 Explanation Adjusting Date Explanation July 5 31 Adjusting Date July 1 Explanation Cash Ref. J1 J1 J1 J1 J1 J1 J1 J1 Debit 12,000 3,000 2,400 1,800 1,200 1,400 200 900 Accounts Receivable Ref. Debit J1 2,500 J1 J1 5,000 J2 1,500 Cleaning Supplies Ref. Debit J1 1,300 J2 Prepaid Insurance Ref. Debit J1 2,400 J2 Equipment Ref. J1 4-75 Credit Debit 6,000 Credit 1,400 Credit 900 Credit 200 Credit No. 101 Balance 12,000 9,000 6,600 4,800 3,600 5,000 4,800 3,900 No. 112 Balance 2,500 1,100 6,100 7,600 No. 128 Balance 1,300 400 No. 130 Balance 2,400 2,200 No. 157 Balance 6,000 PROBLEM 4-5B (Continued) Date July 31 Date July 1 3 18 Date July 31 Date July 1 31 31 Date July 31 31 Date July 31 31 31 Accumulated Depreciation—Equipment Explanation Ref. Debit Credit Adjusting J2 300 Explanation Explanation Adjusting Explanation Closing Closing Accounts Payable Ref. Debit J1 J1 J1 1,800 Salaries Payable Ref. Debit J2 Lee Choi, Capital Ref. Debit J1 J3 J3 900 Closing Lee Choi, Drawing Ref. Debit J1 900 J3 Explanation Closing Closing Closing Income Summary Ref. Debit J3 J3 3,400 J3 5,600 Explanation 4-76 Credit 3,000 1,300 Credit 600 Credit 12,000 5,600 Credit 900 Credit 9,000 No. 158 Balance 300 No. 201 Balance 3,000 4,300 2,500 No. 212 Balance 600 No. 301 Balance 12,000 17,600 16,700 No. 306 Balance 900 0 No. 350 Balance 9,000 5,600 0 PROBLEM 4-5B (Continued) Date July 12 25 31 31 Date July 31 31 Explanation Adjusting Closing Explanation Closing Service Revenue Ref. Debit J1 J1 J2 J3 9,000 Gas & Oil Expense Ref. Debit J1 200 J3 Date July 31 31 Cleaning Supplies Expense Explanation Ref. Debit Adjusting J2 900 Closing J3 Date July 31 31 Explanation Adjusting Closing Depreciation Expense Ref. Debit J2 300 J3 Explanation Adjusting Closing Insurance Expense Ref. Debit J2 200 J3 Date July 31 31 Date July 20 31 31 Explanation Adjusting Closing Salaries Expense Ref. Debit J1 1,200 J2 600 J3 4-77 Credit 2,500 5,000 1,500 No. 400 Balance 2,500 7,500 9,000 0 Credit No. 633 Balance 200 0 200 Credit 900 Credit 300 Credit 200 Credit 1,800 No. 634 Balance 900 0 No. 711 Balance 300 0 No. 722 Balance 200 0 No. 726 Balance 1,200 1,800 0 PROBLEM 4-5B (Continued) (d) CHOI’S WINDOW WASHING Income Statement For the Month Ended July 31, 2008 Revenues Service revenue....................................................... Expenses Salaries expense..................................................... Cleaning supplies expense ................................. Depreciation expense............................................ Gas & oil expense................................................... Insurance expense ................................................. Total expenses ............................................... Net income......................................................................... $9,000 $1,800 900 300 200 200 3,400 $5,600 CHOI’S WINDOW WASHING Owner’s Equity Statement For the Month Ended July 31, 2008 Lee Choi, Capital, July 1................................................ Add: Investments .......................................................... Net income............................................................ $ $12,000 5,600 Less: Drawings ............................................................... Lee Choi, Capital, July 31 ............................................. 0 17,600 17,600 900 $16,700 CHOI’S WINDOW WASHING Balance Sheet July 31, 2008 Assets Current assets Cash ................................................................................................... Accounts receivable ..................................................................... Cleaning supplies.......................................................................... Prepaid insurance ......................................................................... Total current assets ............................................................. 4-78 $3,900 7,600 400 2,200 14,100 PROBLEM 4-5B (Continued) CHOI’S WINDOW WASHING Balance Sheet (Continued) July 31, 2008 Assets (Continued) Property, plant, and equipment Equipment ................................................................. Less: Accumulated depreciation ...................... Total assets ...................................................... $6,000 300 5,700 $19,800 Liabilities and Owner’s Equity Current liabilities Accounts payable ....................................................................... Salaries payable .......................................................................... Total current liabilities...................................................... Owner’s equity Lee Choi, Capital ......................................................................... Total liabilities and owner’s equity............................... (e) $ 2,500 600 3,100 16,700 $19,800 General Journal Date July 31 31 31 31 31 Account Titles and Explanation Accounts Receivable.............................. Service Revenue............................ Ref. 112 400 Debit 1,500 Depreciation Expense ............................ Accumulated Depreciation— Equipment................................... 711 300 Insurance Expense.................................. Prepaid Insurance......................... 722 130 200 Cleaning Supplies Expense ................. Cleaning Supplies......................... 634 128 900 Salaries Expense ..................................... Salaries Payable ............................ 726 212 600 4-79 J2 Credit 1,500 158 300 200 900 600 PROBLEM 4-5B (Continued) (f) General Journal Date July 31 31 31 31 (g) Account Titles and Explanation Service Revenue ....................................... Income Summary ........................... Ref. 400 350 Debit 9,000 Income Summary...................................... Salaries Expense ........................... Depreciation Expense .................. Insurance Expense........................ Cleaning Supplies Expense ....... Gas & Oil Expense......................... 350 726 711 722 634 633 3,400 Income Summary...................................... Lee Choi, Capital............................ 350 301 5,600 Lee Choi, Capital....................................... Lee Choi, Drawing ......................... 301 306 900 J3 Credit 9,000 1,800 300 200 900 200 5,600 900 CHOI’S WINDOW WASHING Post-Closing Trial Balance July 31, 2008 Cash ................................................................................ Accounts Receivable................................................. Cleaning Supplies ...................................................... Prepaid Insurance ...................................................... Equipment..................................................................... Accumulated Depreciation—Equipment ............ Accounts Payable....................................................... Salaries Payable.......................................................... Lee Choi, Capital......................................................... Debit $ 3,900 7,600 400 2,200 6,000 $ $20,100 4-80 Credit 300 2,500 600 16,700 $20,100 COMPREHENSIVE PROBLEM: CHAPTERS 2 TO 4 (a) General Journal Date July 1 1 3 5 12 18 20 21 25 31 31 Account Titles and Explanation Cash .............................................................. Julie Molony, Capital ................... Ref. 101 301 Debit 14,000 Equipment................................................... Cash .................................................. Accounts Payable......................... 157 101 201 10,000 Cleaning Supplies .................................... Accounts Payable......................... 128 201 800 Prepaid Insurance .................................... Cash .................................................. 130 101 1,800 Accounts Receivable............................... Service Revenue ........................... 112 400 3,800 Accounts Payable..................................... Cash .................................................. 201 101 1,400 Salaries Expense ...................................... Cash .................................................. 726 101 1,600 Cash .............................................................. Accounts Receivable................... 101 112 1,400 Accounts Receivable............................... Service Revenue ........................... 112 400 1,500 Gas & Oil Expense ................................... Cash .................................................. 633 101 400 Julie Molony, Drawing............................. Cash .................................................. 306 101 600 4-81 J1 Credit 14,000 3,000 7,000 800 1,800 3,800 1,400 1,600 1,400 1,500 400 600 Account Titles JULIE’S MAIDS CLEANING SERVICE Worksheet For the Month Ended July 31, 2008 Trial Balance Dr. 4-82 Cash Accounts Receivable Cleaning Supplies Prepaid Insurance Equipment Accounts Payable Julie Molony, Capital Julie Molony, Drawing Service Revenue Gas & Oil Expense Salaries Expense Total Depreciation Expense Accum. Depr.—Equipment Insurance Expense Cleaning Supplies Expense Salaries Payable Totals Net Income Totals Cr. 6,600 3,900 800 1,800 10,000 Adjusted Trial Balance Adjustments Dr. Cr. (a) 1,300 (d) (c) 700 150 Dr. Dr. Cr. 6,600 5,200 100 1,650 10,000 6,400 14,000 Balance Sheet Dr. 6,400 14,000 600 5,300 (a) 1,300 (e) 500 (b) 200 Cr. 6,600 5,200 100 1,650 10,000 6,400 14,000 600 400 1,600 25,700 Cr. Income Statement 600 6,600 6,600 400 2,100 400 2,100 25,700 (c) (d) 200 150 700 200 500 2,850 27,700 200 150 700 150 700 (e) 2,850 200 200 (b) 500 27,700 3,550 3,050 6,600 6,600 24,150 6,600 24,150 500 21,100 3,050 24,150 Key: (a) Service Revenue; (b) Depreciation Expense; (c) Insurance Expired; (d) Cleaning Supplies Used; (e) Unpaid Salaries. COMPREHENSIVE PROBLEM (Continued) (b) & (c) COMPREHENSIVE PROBLEM (Continued) (a), (e) & (f) Date July 1 1 5 18 20 21 31 31 Date July 12 21 25 31 Date July 3 31 Date July 5 31 Date July 1 Explanation Explanation Adjusting Explanation Adjusting Explanation Adjusting Explanation Cash Ref. J1 J1 J1 J1 J1 J1 J1 J1 Debit 14,000 3,000 1,800 1,400 1,600 1,400 400 600 Accounts Receivable Ref. Debit J1 3,800 J1 J1 1,500 J2 1,300 Cleaning Supplies Ref. Debit J1 800 J2 Prepaid Insurance Ref. Debit J1 1,800 J2 Equipment Ref. J1 4-83 Credit Debit 10,000 Credit 1,400 Credit 700 Credit 150 Credit No. 101 Balance 14,000 11,000 9,200 7,800 6,200 7,600 7,200 6,600 No. 112 Balance 3,800 2,400 3,900 5,200 No. 128 Balance 800 100 No. 130 Balance 1,800 1,650 No. 157 Balance 10,000 COMPREHENSIVE PROBLEM (Continued) Date July 31 Date July 1 3 18 Date July 31 Date July 1 31 31 Date July 31 31 Date July 31 31 31 Accumulated Depreciation—Equipment Explanation Ref. Debit Credit Adjusting J2 200 Explanation Explanation Adjusting Explanation Closing Closing Explanation Closing Explanation Closing Closing Closing Accounts Payable Ref. Debit J1 J1 J1 1,400 Salaries Payable Ref. Debit J2 Julie Molony, Capital Ref. Debit J1 J3 J3 600 Julie Molony, Drawing Ref. Debit J1 600 J3 Income Summary Ref. Debit J3 J3 3,550 J3 3,050 4-84 Credit 7,000 800 Credit 500 Credit 14,000 3,050 Credit 600 Credit 6,600 No. 158 Balance 200 No. 201 Balance 7,000 7,800 6,400 No. 212 Balance 500 No. 301 Balance 14,000 17,050 16,450 No. 306 Balance 600 0 No. 350 Balance 6,600 3,050 0 COMPREHENSIVE PROBLEM (Continued) Date July 12 25 31 31 Date July 31 31 Explanation Adjusting Closing Explanation Closing Service Revenue Ref. Debit J1 J1 J2 J3 6,600 Gas & Oil Expense Ref. Debit J1 400 J3 Date July 31 31 Cleaning Supplies Expense Explanation Ref. Debit Adjusting J2 700 Closing J3 Date July 31 31 Explanation Adjusting Closing Depreciation Expense Ref. Debit J2 200 J3 Explanation Adjusting Closing Insurance Expense Ref. Debit J2 150 J3 Date July 31 31 Date July 20 31 31 Explanation Adjusting Closing Salaries Expense Ref. Debit J1 1,600 J2 500 J3 4-85 Credit 3,800 1,500 1,300 No. 400 Balance 3,800 5,300 6,600 0 Credit No. 633 Balance 400 0 400 Credit 700 Credit 200 Credit 150 Credit 2,100 No. 634 Balance 700 0 No. 711 Balance 200 0 No. 722 Balance 150 0 No. 726 Balance 1,600 2,100 0 COMPREHENSIVE PROBLEM (Continued) (d) JULIE’S MAIDS CLEANING SERVICE Income Statement For the Month Ended July 31, 2008 Revenues Service revenue....................................................... Expenses Salaries expense..................................................... Cleaning supplies expense ................................. Gas & oil expense................................................... Depreciation expense............................................ Insurance expense ................................................. Total expenses ............................................... Net income......................................................................... $6,600 $2,100 700 400 200 150 3,550 $3,050 JULIE’S MAIDS CLEANING SERVICE Statement of Owner’s Equity For the Month Ended July 31, 2008 Julie Molony, Capital, July 1 ........................................ Add: Investments .......................................................... Net income............................................................ Less: Drawings ............................................................... Julie Molony, Capital, July 31...................................... 4-86 $ $14,000 3,050 0 17,050 17,050 600 $16,450 COMPREHENSIVE PROBLEM (Continued) JULIE’S MAIDS CLEANING SERVICE Balance Sheet July 31, 2008 Assets Current assets Cash............................................................................. Accounts receivable............................................... Cleaning supplies ................................................... Prepaid insurance ................................................... Total current assets....................................... Capital assets Equipment ................................................................. Less: Accumulated depreciation ...................... Total assets ...................................................... $ 6,600 5,200 100 1,650 13,550 $10,000 200 9,800 $23,350 Liabilities and Owner’s Equity Current liabilities Accounts payable ................................................... Salaries payable ...................................................... Total current liabilities.................................. Owner’s equity Julie Molony, Capital.............................................. Total liabilities and owner’s equity ............................................................. 4-87 $ 6,400 500 6,900 16,450 $23,350 COMPREHENSIVE PROBLEM (Continued) (e) General Journal Date July 31 31 31 31 31 (f) Account Titles and Explanation Accounts Receivable ............................. Service Revenue ........................... Ref. 112 400 Debit 1,300 Depreciation Expense ........................... Accumulated Depreciation— Equipment .................................. 711 200 Insurance Expense................................. Prepaid Insurance ........................ 722 130 150 Cleaning Supplies Expense................. Cleaning Supplies ........................ 634 128 700 Salaries Expense..................................... Salaries Payable............................ 726 212 500 J2 Credit 1,300 158 200 150 700 500 General Journal Date July 31 31 31 31 Account Titles and Explanation Service Revenue...................................... Income Summary.......................... Ref. 400 350 Debit 6,600 Income Summary .................................... Salaries Expense .......................... Depreciation Expense ................. Insurance Expense....................... Cleaning Supplies Expense ...... Gas & Oil Expense ....................... 350 726 711 722 634 633 3,550 Income Summary .................................... Julie Molony, Capital ................... 350 301 3,050 Julie Molony, Capital.............................. Julie Molony, Drawing................. 301 306 600 4-88 J3 Credit 6,600 2,100 200 150 700 400 3,050 600 COMPREHENSIVE PROBLEM (Continued) (g) JULIE’S MAIDS CLEANING SERVICE Post-Closing Trial Balance July 31, 2008 Cash................................................................................. Accounts Receivable ................................................. Cleaning Supplies....................................................... Prepaid Insurance....................................................... Equipment ..................................................................... Accumulated Depreciation—Equipment ............. Accounts Payable ....................................................... Salaries Payable .......................................................... Julie Molony, Capital.................................................. Debit $ 6,600 5,200 100 1,650 10,000 $ $23,550 4-89 Credit 200 6,400 500 16,450 $23,550 BYP 4-1 FINANCIAL REPORTING PROBLEM (a) Total current assets were $10,454 million at December 31, 2005, and $8,639 million at December 25, 2004. (b) Current assets are properly listed in the order of liquidity. As you will learn in the next chapter, inventory is considered to be less liquid than receivables. Thus, it is listed below receivables and before prepaid expenses and other current assets. (c) The asset classifications are similar to the text: (1) current assets, (2) property, plant, and equipment, (3) intangible assets, and (4) investments. (d) Cash equivalents are investments with original maturities of 3 months or less that PepsiCo does not intend to rollover beyond three months. (e) Total current liabilities were $9,406 million at December 31, 2005, and $6,752 million at December 25, 2004. 4-90 BYP 4-2 (a) 1. 2. 3. 4. COMPARATIVE ANALYSIS PROBLEM (in millions) PepsiCo Total current assets Net property, plant & equipment Total current liabilities Total stockholders’ (shareholders’) equity 10,454 8,681 9,406 14,251* Coca-Cola 10,250 5,786 9,836 16,355 *($31,727 – $17,476) (b) Current assets are cash and other resources that are reasonably expected to be realized in cash or sold or consumed within one year or the company’s operating cycle, whichever is longer. Current liabilities are obligations that are reasonably expected to be paid from existing current assets or through the creation of other current liabilities. In both PepsiCo and Coca-Cola’s case, current assets were slightly greater than current liabilities. From this information, it appears that both are in approximately the same liquidity position. Coca-Cola’s stockholders’ equity represents a larger percentage of     total assets 55.6%  $16,355  than PepsiCo’s 44.9%  $14,251 . As a result,  $31,727   $29,427  Coca-Cola has less debt relative to its total assets than PepsiCo. It therefore appears that Coca-Cola is less likely to default on a debt obligation. 4-91 BYP 4-3 EXPLORING THE WEB The solution is dependent upon the companies chosen by the student. 4-92 BYP 4-4 (a) DECISION MAKING ACROSS THE ORGANIZATION WHITEGLOVES JANITORIAL SERVICE Balance Sheet December 31, 2008 Assets Current assets Cash......................................................... Accounts receivable ($9,000 + $3,700) .............................. Janitorial supplies ($5,200 – $2,700) .............................. Prepaid insurance ($4,800 X 2/3)......... Total current assets................... Property, plant, and equipment Cleaning equipment ($22,000 + $4,000)............................ Less: Accum. depreciation— cleaning equipment ($4,000 + $2,000) ................ Delivery trucks ($34,000 + $5,000)............................ Less: Accum. depreciation— delivery trucks ($5,000 + $5,000) ................ Total assets .................................. $ 6,500 12,700 2,500 3,200 24,900 $26,000 6,000 $20,000 39,000 10,000 29,000 49,000 $73,900 Liabilities and Owner’s Equity Current liabilities Notes payable due within one year ....................................... Accounts payable ($2,500 + $500)......................................... Interest payable ($25,000 X 10% X 6/12) .............................. Total current liabilities...................................................... Long-term liabilities Notes payable, due July 1, 2010............................................. Total liabilities ..................................................................... Owner’s equity Nancy Kohl, Capital .................................................................... Total liabilities and owner’s equity............................... 4-93 $10,000 3,000 1,250 14,250 15,000 29,250 44,650* $73,900 BYP 4-4 (Continued) WHITEGLOVES JANITORIAL SERVICE Balance Sheet (Continued) December 31, 2008 *Capital balance as reported........................................ Add: Earned but unbilled fees................................. Less: Janitorial supplies used ................................. Insurance expired ($4,800 X 1/3).................. Depreciation ($2,000 + $5,000)...................... Expenses incurred but unpaid ..................... Interest accrued................................................. Total.............................................................. Capital balance as adjusted ....................................... $54,000 3,700 57,700 $2,700 1,600 7,000 500 1,250 13,050 $44,650 (b) Whitegloves Janitorial Service met the terms of the bank loan because current assets exceed current liabilities by $10,650 ($24,900 – $14,250) at December 31, 2008. 4-94 BYP 4-5 COMMUNICATION ACTIVITY MEMO To: Accounting Instructor From: Student Re: Accounting Cycle The required steps in the accounting cycle, in the order in which they should be completed, are: 1. 2. 3. 4. 5. 6. 7. 8. 9. Analyze business transactions. Journalize the transactions. Post to ledger accounts. Prepare a trial balance. Journalize and post adjusting entries. Prepare an adjusted trial balance. Prepare financial statements. Journalize and post closing entries. Prepare a post-closing trial balance. The optional steps in the accounting cycle include preparing a worksheet and preparing reversing entries. If a worksheet is prepared, it is done after step 3 above, and it includes steps 4 and 6. The worksheet is a form used to make it easier to prepare adjusting entries and financial statements. If reversing entries are prepared, they are journalized and posted after step 9, at the beginning of the next accounting period. A reversing entry is the exact opposite of a previously recorded adjusting entry and simplifies the recording of subsequent transactions. 4-95 BYP 4-6 ETHICS CASE (a) The stakeholders in this case are:
You, as controller.
Jerry McNabb, president.
Users of the company’s financial statements. (b) The ethical issue is the continued circulation of significantly misstated financial statements. As controller, you have just issued misleading financial statements. You have acted ethically by telling the company’s president. The president has reacted unethically by allowing the misleading financial statements to continue to circulate. (c) As controller, you should impress upon the president the consequences of having those misleading financial statements be detected by some user or the SEC (if you are a public company). Also stress upon him that you have a professional obligation to correct the statements or to resign. 4-96 BYP 4-7 ALL ABOUT YOU ACTIVITY The following is a personal balance sheet using the classified presentation. Note that the earnings from the part-time job as well as the tuition costs are not listed since neither of those items is an asset, liability, or equity item. Assets Current assets Cash.............................................................................. Money market account ........................................... Certificate of deposit............................................... Accounts receivable from brother...................... Total current assets........................................ $1,200 1,800 3,000 300 Property, plant, and equipment Automobile ................................................................. Video and stereo equipment ................................ Home computer ........................................................ Total assets ....................................................... 7,000 1,250 800 $ 6,300 9,050 $15,350 Liabilities and Owner’s Equity Current liabilities Current portion of automobile loan ................... Current portion of credit card payable.............. Total current liabilities................................... Long-term liabilities Automobile loan ....................................................... Student loan............................................................... Credit card payable ................................................. Total long-term liabilities.............................. Total liabilities ........................................... Owner’s equity M. Y. Own, Capital ($15,350 – $12,300) ............. Total liabilities and owner’s equity ........ 4-97 $1,500 150 $ 1,650 4,000 5,000 1,650 10,650 12,300 3,050 $15,350 CHAPTER 5 Accounting for Merchandising Operations ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises Exercises A Problems B Problems *1. Identify the differences between service and merchandising companies. 2, 3, 4 1 1 *2. Explain the recording of purchases under a perpetual inventory system. 5, 6, 7, 8 2, 4 2, 3, 4, 10 1A, 2A, 4A 1B, 2B, 4B *3. Explain the recording of sales revenues under a perpetual inventory system. 9, 10, 11 2, 3 3, 4, 5, 10 1A, 2A, 4A 1B, 2B, 4B *4. Explain the steps in the accounting cycle for a merchandising company. 1, 12, 13, 14 5, 6 6, 7, 8 3A, 4A, 8A 3B, 4B, 8B *5. Distinguish between a multiple-step and a singlestep income statement. 18, 19, 20 7, 8, 9 6, 9, 11, 12 2A, 3A, 8A 2B, 3B, 8B *6. Explain the computation and importance of gross profit. 15, 16, 17 9, 11 11, 12 2A, 5A, 6A, 8A 2B, 5B, 6B, 8B 7. Determine cost of goods sold under a periodic system. 21 10, 11 13, 14, 15 5A, 6A, 7A 5B, 6B, 7B *8. Explain the recording of purchases and sales under a periodic inventory system. 22 12 16, 17 7A 7B *9. Prepare a worksheet for a merchandising company. 23 13 18, 19 8A *Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendices to the chapter. 5-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Journalize purchase and sales transactions under a perpetual inventory system. Simple 20–30 2A Journalize, post, and prepare a partial income statement. Simple 30–40 3A Prepare financial statements and adjusting and closing entries. Moderate 40–50 4A Journalize, post, and prepare a trial balance. Simple 30–40 5A Determine cost of goods sold and gross profit under periodic approach. Moderate 40–50 6A Calculate missing amounts and assess profitability. Moderate 20–30 Simple 30–40 Moderate 50–60 *7A Journalize, post, and prepare trial balance and partial income statement using periodic approach. *8A Complete accounting cycle beginning with a worksheet. 1B Journalize purchase and sales transactions under a perpetual inventory system. Simple 20–30 2B Journalize, post, and prepare a partial income statement. Simple 30–40 3B Prepare financial statements and adjusting and closing entries. Moderate 40–50 4B Journalize, post, and prepare a trial balance. Simple 30–40 5B Determine cost of goods sold and gross profit under periodic approach. Moderate 40–50 6B Calculate missing amounts and assess profitability. Moderate 20–30 Simple 30–40 *7B Journalize, post, and prepare trial balance and partial income statement using periodic approach. 5-2 Study Objective Knowledge Comprehension Application Analysis Identify the differences between service and merchandising companies. Q5-2 Q5-3 Q5-4 E5-1 BE5-1 *2. Explain the recording of purchases under a perpetual inventory system. Q5-5 Q5-6 Q5-7 Q5-8 BE5-2 BE5-4 E5-2 E5-3 E5-4 P5-1A P5-2A P5-1B E5-10 P5-2B P5-4A P5-4B *3. Explain the recording of sales revenues under a perpetual inventory system. Q5-10 Q5-11 BE5-2 BE5-3 E5-3 E5-4 E5-5 P5-1A P5-2A P5-4A Q5-9 P5-1B E5-10 P5-2B P5-4B *4. Explain the steps in the accounting cycle for a merchandising company. Q5-1 Q5-12 Q5-14 Q5-13 BE5-5 BE5-6 E5-6 E5-7 E5-8 P5-4A P5-3A P5-8A P5-3B P5-4B *5. Distinguish between a multiple-step and a singlestep income statement. Q5-20 BE5-8 BE5-7 BE5-9 E5-6 E5-9 E5-11 E5-12 P5-2A P5-3A P5-2B P5-3B P5-8A *6. Explain the computation and importance of gross profit. Q5-17 Q5-15 Q5-16 BE5-9 BE5-11 E5-11 E5-12 P5-2A P5-2B P5-5A P5-6A P5-5B P5-6B P5-8A *7. Determine cost of goods sold Q5-21 under a periodic system. BE5-10 BE5-11 E5-13 E5-15 P5-5A P5-5B P5-7A E5-14 P5-7B P5-6A P5-6B *8. Explain the recording of purchases and sales under a periodic inventory system. Q5-22 BE5-12 E5-16 E5-17 P5-7A P5-7B *9. Prepare a worksheet for a merchandising company. E5-18 E5-19 P5-8A 5-3 *1. Broadening Your Perspective Q5-18 Q5-19 Q5-23 BE5-13 Communication Exploring the Web Synthesis Decision Making Financial Reporting Across the Comparative Analysis Decision Making Across Organization the Organization Evaluation All About You Comparative Analysis Financial Reporting Decision Making Across the Organization Ethics Case BLOOM'S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. (a) Disagree. The steps in the accounting cycle are the same for both a merchandising company and a service company. (b) The measurement of income is conceptually the same. In both types of companies, net income (or loss) results from the matching of expenses with revenues. 2. The normal operating cycle for a merchandising company is likely to be longer than in a service company because inventory must first be purchased and sold, and then the receivables must be collected. 3. (a) The components of revenues and expenses differ as follows: Merchandising Revenues Expenses (b) Service Fees, Rents, etc. Operating (only) Sales Cost of Goods Sold and Operating The income measurement process is as follows: Sales Revenue Less Cost of Goods Sold Gross Profit Equals Less Operating Expenses Equals Net Income 4. Income measurement for a merchandising company differs from a service company as follows: (a) sales are the primary source of revenue and (b) expenses are divided into two main categories: cost of goods sold and operating expenses. 5. In a perpetual inventory system, cost of goods sold is determined each time a sale occurs. 6. The letters FOB mean Free on Board. FOB shipping point means that goods are placed free on board the carrier by the seller. The buyer then pays the freight and debits Merchandise Inventory. FOB destination means that the goods are placed free on board to the buyer’s place of business. Thus, the seller pays the freight and debits Freight-out. 7. Credit terms of 2/10, n/30 mean that a 2% cash discount may be taken if payment is made within 10 days of the invoice date; otherwise, the invoice price, less any returns, is due 30 days from the invoice date. 8. July 24 Accounts Payable ($2,000 – $200) ......................................................... Merchandise Inventory ($1,800 X 2%) .......................................... Cash ($1,800 – $36).......................................................................... 1,800 36 1,764 9. Agree. In accordance with the revenue recognition principle, sales revenues are generally considered to be earned when the goods are transferred from the seller to the buyer; that is, when the exchange transaction occurs. The earning of revenue is not dependent on the collection of credit sales. 10. (a) The primary source documents are: (1) cash sales—cash register tapes and (2) credit sales— sales invoice. 5-4 Questions Chapter 5 (Continued) (b) The entries are: Debit Cash sales— Credit sales— 11. July 19 Cash.......................................................................... Sales ................................................................ Cost of Goods Sold ................................................ Merchandise Inventory ................................. XX Accounts Receivable ............................................. Sales ................................................................ Cost of Goods Sold ................................................ Merchandise Inventory ................................. XX Cash ($800 – $16)............................................................................ Sales Discounts ($800 X 2%) ........................................................ Accounts Receivable ($900 – $100).................................... Credit XX XX XX XX XX XX 784 16 800 12. The perpetual inventory records for merchandise inventory may be incorrect due to a variety of causes such as recording errors, theft, or waste. 13. Two closing entries are required: (1) (2) Sales .............................................................................................................. Income Summary ............................................................................... 200,000 Income Summary ........................................................................................ Cost of Goods Sold............................................................................ 145,000 200,000 145,000 14. Of the merchandising accounts, only Merchandise Inventory will appear in the post-closing trial balance. 15. Sales revenues ......................................................................................................................... Cost of goods sold ................................................................................................................... Gross profit ................................................................................................................................ $105,000 70,000 $ 35,000 Gross profit rate: $35,000 ÷ $105,000 = 33.3% 16. Gross profit ................................................................................................................................ Less: Net income..................................................................................................................... Operating expenses................................................................................................................. 17. There are three distinguishing features in the income statement of a merchandising company: (1) a sales revenues section, (2) a cost of goods sold section, and (3) gross profit. 5-5 $370,000 240,000 $130,000 Questions Chapter 5 (Continued) *18. (a) The operating activities part of the income statement has three sections: sales revenues, cost of goods sold, and operating expenses. (b) The nonoperating activities part consists of two sections: other revenues and gains, and other expenses and losses. *19. The functional groupings are selling and administrative. The problem with functional groupings is that some expenses may have to be allocated between the groups. *20. The single-step income statement differs from the multiple-step income statement in that: (1) all data are classified into two categories: revenues and expenses, and (2) only one step, subtracting total expenses from total revenues, is required in determining net income (or net loss). *21. Accounts Added/Deducted Purchase Returns and Allowances Purchase Discounts Freight-in Deducted Deducted Added *22. July 24 *23. Accounts Payable ($3,000 – $200) .............................................................. Purchase Discounts ($2,800 X 2%) .................................................... Cash ($2,800 – $56)............................................................................... 2,800 56 2,744 The columns are: (a) Merchandise Inventory—Trial Balance (Dr.), Adjusted Trial Balance (Dr.), and Balance Sheet (Dr.). (b) Cost of Goods Sold—Trial Balance (Dr.), Adjusted Trial Balance (Dr.), and Income Statement (Dr.). 5-6 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 5-1 (a) Cost of goods sold = $45,000 ($75,000 – $30,000). Operating expenses = $19,200 ($30,000 – $10,800). (b) Gross profit = $38,000 ($108,000 – $70,000). Operating expenses = $8,500 ($38,000 – $29,500). (c) Sales = $151,500 ($71,900 + $79,600). Net income = $40,100 ($79,600 – $39,500). BRIEF EXERCISE 5-2 Hollins Company Merchandise Inventory .............................................. Accounts Payable............................................... Gordon Company Accounts Receivable.................................................. Sales ....................................................................... Cost of Goods Sold..................................................... Merchandise Inventory ..................................... 780 780 780 780 520 520 BRIEF EXERCISE 5-3 (a) Accounts Receivable.................................................. Sales ....................................................................... Cost of Goods Sold..................................................... Merchandise Inventory ..................................... 900,000 (b) Sales Returns and Allowances ............................... Accounts Receivable......................................... Merchandise Inventory .............................................. Cost of Goods Sold............................................ 120,000 5-7 900,000 620,000 620,000 120,000 90,000 90,000 BRIEF EXERCISE 5-3 (Continued) (c) Cash ($780,000 – $15,600)........................................ Sales Discounts ($780,000 X 2%) .......................... Accounts Receivable ........................................ ($900,000 – $120,000) 764,400 15,600 780,000 BRIEF EXERCISE 5-4 (a) Merchandise Inventory.............................................. Accounts Payable .............................................. 900,000 (b) Accounts Payable....................................................... Merchandise Inventory..................................... 120,000 (c) Accounts Payable ($900,000 – $120,000)............ Merchandise Inventory..................................... ($780,000 X 2%) Cash ($780,000 – $15,600)............................... 780,000 900,000 120,000 15,600 764,400 BRIEF EXERCISE 5-5 Cost of Goods Sold............................................................. Merchandise Inventory.............................................. 1,500 1,500 BRIEF EXERCISE 5-6 Sales......................................................................................... Income Summary ........................................................ 195,000 Income Summary ................................................................. Cost of Goods Sold .................................................... Sales Discounts........................................................... 107,000 5-8 195,000 105,000 2,000 BRIEF EXERCISE 5-7 MAULDER COMPANY Income Statement (Partial) For the Month Ended October 31, 2008 Sales revenues Sales ($280,000 + $100,000) ..................................... Less: Sales returns and allowances .................... Sales discounts............................................... Net sales ......................................................................... $380,000 $11,000 13,000 24,000 $356,000 BRIEF EXERCISE 5-8 As the name suggests, numerous steps are required in determining net income in a multiple-step income statement. In contrast, only one step is required to compute net income in a single-step income statement. A multiplestep statement has five sections whereas a single-step statement has only two sections. The multiple-step statement provides more detail than a singlestep statement, but net income is the same under both statements. Some of the differences in presentation can be seen from the comparative information presented below. (1) Multiple-Step Income Statement a. b. c. Item Gain on sale of equipment Casualty loss from vandalism Cost of goods sold Section Other revenues and gains Other expenses and losses Cost of goods sold (2) Single-Step Income Statement Item a. b. c. Section Gain on sale of equipment Casualty loss from vandalism Cost of goods sold Revenues Expenses Expenses BRIEF EXERCISE 5-9 (a) Net sales = $510,000 – $15,000 = $495,000. (b) Gross profit = $495,000 – $350,000 = $145,000. 5-9 BRIEF EXERCISE 5-9 (Continued) (c) Income from operations = $145,000 – $70,000 – $40,000 = $35,000. (d) Gross profit rate = $145,000 ÷ $495,000 = 29.3%. BRIEF EXERCISE 5-10 Purchases................................................................................... Less: Purchase returns and allowances ........................ Purchase discounts................................................... Net purchases ........................................................................... $450,000 $11,000 8,000 Net purchases ........................................................................... Add: Freight-in ........................................................................ Cost of goods purchased...................................................... 19,000 $431,000 $431,000 16,000 $447,000 BRIEF EXERCISE 5-11 Net sales ..................................................................................... Beginning inventory................................................................ Add: Cost of goods purchased*........................................ Cost of goods available for sale ......................................... Ending inventory...................................................................... Cost of goods sold .................................................................. Gross profit................................................................................ $630,000 $ 60,000 447,000 507,000 90,000 417,000 $213,000 *Information taken from Brief Exercise 5-10. *BRIEF EXERCISE 5-12 (a) (b) (c) Purchases........................................................................ 1,000,000 Accounts Payable ................................................. Accounts Payable ......................................................... Purchase Returns and Allowances................. 130,000 Accounts Payable ($1,000,000 – $130,000)........... Purchase Discounts ($870,000 X 2%)............. Cash ($870,000 – $17,400).................................. 870,000 5-10 1,000,000 130,000 17,400 852,600 *BRIEF EXERCISE 5-13 (a) Cash: Trial balance debit column; Adjusted trial balance debit column; Balance sheet debit column. (b) Merchandise inventory: Trial balance debit column; Adjusted trial balance debit column; Balance sheet debit column. (c) Sales: Trial balance credit column; Adjusted trial balance credit column, Income statement credit column. (d) Cost of goods sold: Trial balance debit column, Adjusted trial balance debit column, Income statement debit column. 5-11 SOLUTIONS TO EXERCISES EXERCISE 5-1 1. True. 2. False. For merchandising company, sales less cost of goods sold is called gross profit. 3. True. 4. True. 5. False. The operating cycle of a merchandising company differs from that that of a service company. The operating cycle of a merchandising company is ordinarily longer. False. In a periodic inventory system, no detailed inventory records of goods on hand are maintained. 6. 7. True. 8. False. A perpetual inventory system provides better control over inventories than a periodic system. EXERCISE 5-2 (a) (1) April 5 Merchandise Inventory........................ Accounts Payable........................ 25,000 Merchandise Inventory........................ Cash ................................................. 900 Equipment ............................................... Accounts Payable........................ 26,000 Accounts Payable................................. Merchandise Inventory............... 4,000 Accounts Payable................................. ($25,000 – $4,000) Merchandise Inventory............... [($25,000 – $4,000) X 2%] Cash ($21,000 – $420)................. 21,000 Accounts Payable ........................................... Cash............................................................ 21,000 (2) April 6 (3) April 7 (4) April 8 (5) April 15 (b) May 4 5-12 25,000 900 26,000 4,000 420 20,580 21,000 EXERCISE 5-3 Sept. 6 9 10 12 14 20 Merchandise Inventory (80 X $20)..................... Cash ................................................................... 1,600 Merchandise Inventory ......................................... Cash ................................................................... 80 Accounts Payable (2 X $21)................................. Merchandise Inventory ................................ 42 Accounts Receivable (26 X $31) ........................ Sales................................................................... Cost of Goods Sold (26 X $21) ........................... Merchandise Inventory ................................ 806 Sales Returns and Allowances ......................... Accounts Receivable................................... Merchandise Inventory ........................................ Cost of Goods Sold...................................... 31 Accounts Receivable (30 X $31) ....................... Sales.................................................................. Cost of Goods Sold (30 X $21) .......................... Merchandise Inventory ............................... 1,600 80 42 806 546 546 31 21 21 930 930 630 630 EXERCISE 5-4 (a) June 10 11 12 19 Merchandise Inventory................................ Accounts Payable ................................ 8,000 Merchandise Inventory................................ Cash.......................................................... 400 Accounts Payable ......................................... Merchandise Inventory....................... 300 Accounts Payable ($8,000 – $300)........... Merchandise Inventory....................... ($7,700 X 2%) Cash ($7,700 – $154) ........................... 7,700 5-13 8,000 400 300 154 7,546 EXERCISE 5-4 (Continued) (b) June 10 12 19 Accounts Receivable................................... Sales ........................................................ Cost of Goods Sold...................................... Merchandise Inventory ...................... 8,000 Sales Returns and Allowances ................ Accounts Receivable.......................... Merchandise Inventory ............................... Cost of Goods Sold............................. 300 Cash ($7,700 – $154).................................... Sales Discounts ($7,700 X 2%)................. Accounts Receivable.......................... ($8,000 – $300) 7,546 154 8,000 5,000 5,000 300 150 150 7,700 EXERCISE 5-5 (a) 1. Accounts Receivable........................... Sales................................................. Cost of Goods Sold.............................. Merchandise Inventory .............. 500,000 Sales Returns and Allowances ........ Accounts Receivable.................. 27,000 Cash ($473,000 – $9,460).................... Sales Discounts .................................... [($500,000 – $27,000) X 2%] Accounts Receivable.................. ($500,000 – $27,000) 463,540 9,460 (b) Cash ....................................................................................... Accounts Receivable ............................................... ($500,000 – $27,000) 473,000 2. 3. Dec. 3 Dec. 8 Dec. 13 5-14 500,000 350,000 350,000 27,000 473,000 473,000 EXERCISE 5-6 (a) ZAMBRANA COMPANY Income Statement (Partial) For the Year Ended October 31, 2008 Sales revenues Sales .......................................................................... Less: Sales returns and allowances .............. Sales discounts......................................... Net sales ................................................................... $800,000 $25,000 15,000 40,000 $760,000 Note: Freight-out is a selling expense. (b) (1) Oct. 31 Sales ...................................................... Income Summary...................... 800,000 Income Summary............................... Sales Returns and Allowances............................. Sales Discounts ........................ 40,000 (a) Cost of Goods Sold........................................................ Merchandise Inventory ........................................ 900 (b) Sales ................................................................................... Income Summary................................................... 108,000 Income Summary............................................................ Cost of Goods Sold............................................... Operating Expenses ............................................. Sales Returns and Allowances ......................... Sales Discounts ..................................................... 92,800 Income Summary ($108,000 – $92,800)................... Peter Kalle, Capital................................................ 15,200 (2) 31 800,000 25,000 15,000 EXERCISE 5-7 5-15 900 108,000 60,900 29,000 1,700 1,200 15,200 EXERCISE 5-8 (a) Cost of Goods Sold ....................................................... Merchandise Inventory........................................ 600 (b) Sales................................................................................... Income Summary .................................................. 350,000 Income Summary ........................................................... Cost of goods sold ($218,000 + $600) ............ Freight-out............................................................... Insurance expense ............................................... Rent expense.......................................................... Salary expense....................................................... Sales discounts ..................................................... Sales returns and allowances........................... 341,600 Income Summary ($350,000 – $341,600) ................ Rogers, Capital ...................................................... 8,400 5-16 600 350,000 218,600 7,000 12,000 20,000 61,000 10,000 13,000 8,400 EXERCISE 5-9 (a) PELE COMPANY Income Statement For the Year Ended December 31, 2008 Net sales ...................................................... Cost of goods sold................................... Gross profit ................................................ Operating expenses Selling expenses.............................. Administrative expenses .............. Total operating expenses .... Income from operations ......................... Other revenues and gains Interest revenue ............................... Other expenses and losses Interest expense............................... Loss on sale of equipment ........... Net income.................................................. (b) $2,312,000 1,289,000 1,023,000 $490,000 435,000 925,000 98,000 28,000 $70,000 10,000 80,000 $ 52,000 46,000 PELE COMPANY Income Statement For the Year Ended December 31, 2008 Revenues Net sales ...................................................... Interest revenue ........................................ Total revenues .................................. Expenses Cost of goods sold................................... Selling expenses....................................... Administrative expenses ....................... Interest expense........................................ Loss on sale of equipment .................... Total expenses ................................. Net income........................................................... 5-17 $2,312,000 28,000 2,340,000 $1,289,000 490,000 435,000 70,000 10,000 2,294,000 $ 46,000 EXERCISE 5-10 1. 2. 3. 4. Sales Returns and Allowances................................................ Sales........................................................................................ 175 Supplies .......................................................................................... Cash ................................................................................................. Accounts Payable ............................................................... Merchandise Inventory...................................................... 180 180 Sales Discounts............................................................................ Sales........................................................................................ 110 Merchandise Inventory............................................................... Cash ................................................................................................. Freight-out............................................................................. 20 180 175 180 180 110 200 EXERCISE 5-11 (a) $900,000 – $540,000 = $360,000. (b) $360,000/$900,000 = 40%. The gross profit rate is generally considered to be more useful than the gross profit amount. The rate expresses a more meaningful (qualitative) relationship between net sales and gross profit. The gross profit rate tells how many cents of each sales dollar go to gross profit. The trend of the gross profit rate is closely watched by financial statement users, and is compared with rates of competitors and with industry averages. Such comparisons provide information about the effectiveness of a company’s purchasing function and the soundness of its pricing policies. (c) Income from operations is $130,000 ($360,000 – $230,000), and net income is $119,000 ($130,000 – $11,000). (d) The amount shown for net income is the same in a multiple-step income statement and a single-step income statement. Both income statements report the same revenues and expenses, but in different order. Therefore, net income in Payton’s single-step income statement is also $119,000. (e) Merchandise inventory is reported as a current asset immediately below accounts receivable. 5-18 EXERCISE 5-12 (a) (*missing amount) a. Sales........................................................................................... *Sales returns........................................................................... Net sales ................................................................................... $ 90,000) (6,000) $ 84,000) b. Net sales ................................................................................... Cost of goods sold................................................................ *Gross profit ............................................................................. $ 84,000) (56,000) $ 28,000) c. Gross profit.............................................................................. Operating expenses.............................................................. *Net income............................................................................... $ 28,000) (15,000) $ 13,000) d. *Sales .......................................................................................... Sales returns ........................................................................... Net sales ................................................................................... $105,000) (5,000) $100,000) e. Net sales ................................................................................... *Cost of goods sold................................................................ Gross profit.............................................................................. $100,000) 58,500) $ 41,500) f. Gross profit.............................................................................. *Operating expenses ............................................................. Net income ............................................................................... $ 41,500) 26,500) $ 15,000) ) (b) Nam Company Gross profit ÷ Net sales = $28,000 ÷ $84,000 = 33.33% Mayo Company Gross profit ÷ Net sales = $41,500 ÷ $100,000 = 41.5% 5-19 EXERCISE 5-13 Inventory, September 1, 2007 .............................................. Purchases................................................................................... Less: Purchase returns and allowances......................... Net Purchases........................................................................... Add: Freight-in......................................................................... Cost of goods purchased...................................................... Cost of goods available for sale ......................................... Inventory, August 31, 2008 ................................................... Cost of goods sold......................................................... $ 17,200 $149,000 2,000 147,000 4,000 151,000 168,200 25,000 $143,200 EXERCISE 5-14 (a) (b) Sales ............................................................... Less: Sales returns and allowances....... Sales discounts .............................. Net sales........................................................ Cost of goods sold Inventory, January 1........................... Purchases .............................................. Less: Purch. rets. and alls. .............. Purch. discounts ..................... Add: Freight-in ..................................... Cost of goods available for sale..... Inventory, December 31 .................... Cost of goods sold...................... Gross profit ........................................... $800,000 $ 10,000 5,000 15,000 785,000 50,000 $500,000 (2,000) (6,000) 492,000 4,000 546,000 (60,000) 486,000 $299,000 Gross profit $299,000 – Operating expenses = Net income $130,000. Operating expenses = $169,000. EXERCISE 5-15 (a) (b) (c) (d) (e) (f) $1,560 $1,670 $1,510 $50 $250 $120 ($1,600 – $40) ($1,560 + $110) ($1,820 – $310) ($1,080 – $1,030) ($1,280 – $1,030) ($1,350 – $1,230) (g) (h) (i) (j) (k) (l) $6,500 $1,730 $8,940 $6,200 $2,500 $43,330 5-20 ($290 + $6,210) ($7,940 – $6,210) ($1,000 + $7,940) ($49,530 – $43,330 from (I)) ($43,590 – $41,090) ($41,090 + $2,240) *EXERCISE 5-16 (a) 1. 2. 3. 4. 5. (b) April 5 April 6 April 7 April 8 April 15 May 4 Purchases .............................................. Accounts Payable......................... 20,000 Freight-in ................................................ Cash .................................................. 900 Equipment.............................................. Accounts Payable......................... 26,000 Accounts Payable................................ Purchase Returns and Allowances.................................. 2,800 Accounts Payable................................ ($20,000 – $2,800) Purchase Discounts..................... [($20,000 – $2,800) X 2%)] Cash ($17,200 – $344).................. 17,200 Accounts Payable................................ ($20,000 – $2,800) Cash .................................................. 17,200 Purchases .............................................. Accounts Payable......................... 22,000 Freight-in ................................................ Cash .................................................. 800 Equipment.............................................. Accounts Payable......................... 26,000 Accounts Payable................................ Purchase Returns and Allowances.................................. 4,000 20,000 900 26,000 2,800 344 16,856 17,200 *EXERCISE 5-17 (a) 1. 2. 3. 4. April 5 April 5 April 7 April 8 5-21 22,000 800 26,000 4,000 *EXERCISE 5-17 (Continued) 5. (b) April 15 May 4 Accounts Payable ................................ ($22,000 – $4,000) Purchase Discounts ..................... [($22,000 – $4,000) X 2%)] Cash ($18,000 – $360) .................. 18,000 Accounts Payable ................................ ($22,000 – $4,000) Cash................................................... 18,000 360 17,640 18,000 *EXERCISE 5-18 Adjusted Trial Balance Accounts Debit Cash Merchandise Inventory Sales Sales Returns and Allowances Sales Discounts Cost of Goods Sold Credit Income Statement Debit Balance Sheet Credit Debit Credit 9,000 76,000 9,000 76,000 450,000 450,000 10,000 9,000 300,000 10,000 9,000 300,000 *EXERCISE 5-19 GREEN COMPANY Worksheet For the Month Ended June 30, 2008 Account Titles Cash Accounts Receivable Merchandise Inventory Accounts Payable Ed Green, Capital Sales Cost of Goods Sold Operating Expenses Totals Net Income Totals Trial Balance Dr. Cr. 2,320 2,440 Adjustments Dr. Cr. 11,640 Income Statement Dr. Cr. 11,640 1,120 3,600 42,400 20,560 10,160 47,120 Adj. Trial Balance Dr. Cr. 2,320 2,440 47,120 1,500 1,500 1,500 1,500 5-22 11,640 2,620 3,600 42,400 20,560 11,660 48,620 Balance Sheet Dr. Cr. 2,320 2,440 48,620 2,620 3,600 42,400 20,560 11,660 32,220 10,180 42,400 42,400 16,400 42,400 16,400 6,220 10,180 16,400 SOLUTIONS TO PROBLEMS PROBLEM 5-1A (a) July 1 3 9 12 17 18 20 21 Merchandise Inventory (60 X $30) .................. Accounts Payable ....................................... 1,800 Accounts Receivable (40 X $50)...................... Sales ................................................................ 2,000 Cost of Goods Sold (40 X $30)......................... Merchandise Inventory.............................. 1,200 Accounts Payable ................................................ Merchandise Inventory.............................. ($1,800 X .02) Cash................................................................. 1,800 Cash.......................................................................... Sales Discounts .................................................... Accounts Receivable ................................. 1,980 20 Accounts Receivable (30 X $50)...................... Sales ................................................................ 1,500 Cost of Goods Sold (30 X $30)......................... Merchandise Inventory.............................. 900 Merchandise Inventory....................................... Accounts Payable ....................................... 1,700 Merchandise Inventory....................................... Cash................................................................. 100 Accounts Payable ................................................ Merchandise Inventory.............................. 300 Cash.......................................................................... Sales Discounts .................................................... Accounts Receivable ................................. 1,485 15 5-23 1,800 2,000 1,200 36 1,764 2,000 1,500 900 1,700 100 300 1,500 PROBLEM 5-1A (Continued) July 22 30 31 Accounts Receivable (45 X $50) ...................... Sales................................................................. 2,250 Cost of Goods Sold (45 X $30) ......................... Merchandise Inventory .............................. 1,350 Accounts Payable ($1,700 – $300) .................. Cash ................................................................. 1,400 Sales Returns and Allowances (4 X $50)......... Accounts Receivable.................................. 200 Merchandise Inventory (4 X $30) ..................... Cost of Goods Sold..................................... 120 5-24 2,250 1,350 1,400 200 120 PROBLEM 5-2A (a) General Journal Date Apr. 2 4 5 6 11 13 14 16 18 20 Account Titles and Explanation Merchandise Inventory........................... Accounts Payable ........................... Ref. 120 201 Debit 6,900 Accounts Receivable ............................. Sales ................................................... Cost of Goods Sold ................................ Merchandise Inventory................. 112 401 505 120 5,500 Freight-out ................................................. Cash.................................................... 644 101 240 Accounts Payable ................................... Merchandise Inventory................. 201 120 500 Accounts Payable ($6,900 – $500)........ Merchandise Inventory................. ($6,400 X 1%) Cash.................................................... 201 120 6,400 Cash............................................................. Sales Discounts ($5,500 X 1%) ........... Accounts Receivable .................... 101 414 112 5,445 55 Merchandise Inventory.......................... Cash.................................................... 120 101 3,800 Cash............................................................. Merchandise Inventory................. 101 120 500 Merchandise Inventory.......................... Accounts Payable .......................... 120 201 4,500 Merchandise Inventory.......................... Cash.................................................... 120 101 100 5-25 J1 Credit 6,900 5,500 4,100 4,100 240 500 64 101 6,336 5,500 3,800 500 4,500 100 PROBLEM 5-2A (Continued) General Journal Date Apr. 23 26 27 29 30 Account Titles and Explanation Cash ............................................................. Sales.................................................... Cost of Goods Sold................................. Merchandise Inventory ................. Ref. 101 401 505 120 Debit 6,400 Merchandise Inventory .......................... Cash .................................................... 120 101 2,300 Accounts Payable.................................... Merchandise Inventory ................. ($4,500 X 2%) Cash .................................................... 201 120 4,500 Sales Returns and Allowances ........... Cash .................................................... Merchandise Inventory .......................... Cost of Goods Sold........................ 412 101 120 505 90 Accounts Receivable.............................. Sales.................................................... Cost of Goods Sold................................. Merchandise Inventory ................. 112 401 505 120 3,700 5-26 J1 Credit 6,400 5,120 5,120 2,300 90 101 4,410 90 30 30 3,700 2,800 2,800 PROBLEM 5-2A (Continued) (b) Cash Date Apr. No. 101 1 5 11 13 14 16 20 23 26 27 29 Explanation Balance Ref.
J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 Debit Credit 240 6,336 5,445 3,800 500 100 6,400 2,300 4,410 90 Accounts Receivable Date Apr. Explanation 4 13 30 Merchandise Inventory Date Explanation Apr. 2 4 6 11 14 16 18 20 23 26 27 29 30 Balance 9,000 8,760 2,424 7,869 4,069 4,569 4,469 10,869 8,569 4,159 4,069 No. 112 Ref. J1 J1 J1 Ref. J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 5-27 Debit 5,500 Credit 5,500 3,700 Debit 6,900 Credit 4,100 500 64 3,800 500 4,500 100 5,120 2,300 90 30 2,800 Balance 5,500 0 3,700 No. 120 Balance 6,900 2,800 2,300 2,236 6,036 5,536 10,036 10,136 5,016 7,316 7,226 7,256 4,456 PROBLEM 5-2A (Continued) Accounts Payable Date Apr. Explanation 2 6 11 18 27 M. Olaf, Capital Date Explanation Apr. 1 Balance No. 201 Ref. J1 J1 J1 J1 J1 Ref.
Debit Credit 6,900 500 6,400 4,500 4,500 Debit Credit Sales Date Apr. Balance 6,900 6,400 0 4,500 0 No. 301 Balance 9,000 No. 401 Explanation 4 23 30 Sales Returns and Allowances Date Explanation Apr. 29 Ref. J1 J1 J1 Ref. J1 Debit Debit 90 Credit 5,500 6,400 3,700 Balance 5,500 11,900 15,600 Credit No. 412 Balance 90 Sales Discounts Date Apr. 13 Explanation Cost of Goods Sold Date Explanation Apr. 4 23 29 30 No. 414 Ref. J1 Ref. J1 J1 J1 J1 5-28 Debit 55 Debit 4,100 5,120 Credit Credit 30 2,800 Balance 55 No. 505 Balance 4,100 9,220 9,190 11,990 PROBLEM 5-2A (Continued) Freight-out Date Apr. (c) No. 644 Explanation 5 Ref. J1 Debit 240 Credit Balance 240 OLAF DISTRIBUTING COMPANY Income Statement (Partial) For the Month Ended April 30, 2008 Sales revenues Sales ............................................................................... Less: Sales returns and allowances ................... Sales discounts.............................................. Net sales ........................................................................ Cost of goods sold.............................................................. Gross profit ........................................................................... 5-29 $15,600 $90 55 145 15,455 11,990 $ 3,465 PROBLEM 5-3A (a) MAINE DEPARTMENT STORE Income Statement For the Year Ended December 31, 2008 Sales revenues Sales ............................................................. Less: Sales returns and allowances ................................. Net sales...................................................... Cost of goods sold ........................................... Gross profit......................................................... Operating expenses Selling expenses Sales salaries expense.................... Sales commissions expense ......... Depr. expense—equipment............ Utilities expense ($12,000 X 60%) ............................. Insurance expense ($7,200 X 60%) ............................... Total selling expenses............. Administrative expenses Office salaries expense................... Depr. expense—building................. Property tax expense ....................... Utilities expense ($12,000 X 40%) ............................. Insurance expense ($7,200 X 40%) ............................... Total administrative expenses................................. Total operating expenses ..................... Income from operations .................................. Other revenues and gains Interest revenue......................................... Other expenses and losses Interest expense........................................ Net income .......................................................... 5-30 $628,000 8,000 620,000 412,700 207,300 $76,000 14,500 13,300 7,200 4,320 $115,320 32,000 10,400 4,800 4,800 2,880 54,880 170,200 37,100 4,000 11,000 7,000 $ 30,100 PROBLEM 5-3A (Continued) MAINE DEPARTMENT STORE Owner’s Equity Statement For the Year Ended December 31, 2008 B. Maine, Capital, January 1 ................................................................... Add: Net income....................................................................................... Less: Drawings .......................................................................................... B. Maine, Capital, December 31............................................................. $176,600 30,100 206,700 28,000 $178,700 MAINE DEPARTMENT STORE Balance Sheet December 31, 2008 Assets Current assets Cash ............................................................ Accounts receivable.............................. Merchandise inventory ......................... Prepaid insurance .................................. Total current assets...................... Property, plant, and equipment Building...................................................... Less: Accumulated depreciation— building .................................... Equipment................................................. Less: Accumulated depreciation— equipment................................ Total assets ..................................... 5-31 $ 23,800 50,300 75,000 2,400 $151,500 $190,000 52,500 110,000 137,500 42,900 67,100 204,600 $356,100 PROBLEM 5-3A (Continued) MAINE DEPARTMENT STORE Balance Sheet (Continued) December 31, 2008 Liabilities and Owner’s Equity Current liabilities Accounts payable .............................................................. $ 79,300 Mortgage payable due next year................................... 20,000 Interest payable .................................................................. 8,000 Property taxes payable .................................................... 4,800 Sales commissions payable........................................... 4,300 Utilities expense payable ................................................ 1,000 Total current liabilities............................................. $117,400 Long-term liabilities Mortgage payable .............................................................. 60,000 Total liabilities............................................................ 177,400 Owner’s equity B. Maine, Capital ................................................................ 178,700 Total liabilities and owner’s equity ..................... $356,100 (b) Dec. 31 31 31 31 31 Depreciation Expense—Building ............. Accumulated Depreciation— Building ............................................... 10,400 Depreciation Expense—Equipment......... Accumulated Depreciation— Equipment .......................................... 13,300 Insurance Expense........................................ Prepaid Insurance................................. 7,200 Interest Expense ............................................ Interest Payable..................................... 8,000 Property Tax Expense.................................. Property Taxes Payable...................... 4,800 5-32 10,400 13,300 7,200 8,000 4,800 PROBLEM 5-3A (Continued) 31 31 (c) Dec. 31 31 31 31 Sales Commissions Expense................... Sales Commissions Payable ........... 4,300 Utilities Expense........................................... Utilities Expense Payable ................. 1,000 Sales ................................................................ Interest Revenue.......................................... Income Summary................................ 628,000 4,000 Income Summary ........................................ Sales Returns and Allowances........ Cost of Goods Sold ........................... Office Salaries Expense ................... Sales Salaries Expense .................... Sales Commissions Expense......... Property Tax Expense....................... Utilities Expense................................. Depreciation Expense— Building............................................. Depreciation Expense— Equipment ........................................ Insurance Expense ............................ Interest Expense................................. 601,900 Income Summary ........................................ B. Maine, Capital................................. 30,100 B. Maine, Capital.......................................... B. Maine, Drawing .............................. 28,000 5-33 4,300 1,000 632,000 8,000 412,700 32,000 76,000 14,500 4,800 12,000 10,400 13,300 7,200 11,000 30,100 28,000 PROBLEM 5-4A (a) General Journal Date Apr. 4 6 8 10 11 13 14 15 17 18 Account Titles and Explanation Merchandise Inventory ............................ Accounts Payable............................. Ref. 120 201 Debit 840 Merchandise Inventory ............................ Cash ...................................................... 120 101 40 Accounts Receivable................................ Sales...................................................... 112 401 1,150 Cost of Goods Sold................................... Merchandise Inventory ................... 505 120 790 Accounts Payable...................................... Merchandise Inventory ................... 201 120 40 Merchandise Inventory ............................ Cash ...................................................... 120 101 420 Accounts Payable ($840 – $40) ............. Merchandise Inventory ................... ($800 X 2%) Cash ...................................................... 201 120 800 Merchandise Inventory ............................ Accounts Payable............................. 120 201 900 Cash ............................................................... Merchandise Inventory ................... 101 120 50 Merchandise Inventory ............................ Cash ...................................................... 120 101 30 Accounts Receivable................................ Sales...................................................... 112 401 810 Cost of Goods Sold................................... Merchandise Inventory ................... 505 120 530 5-34 J1 Credit 840 40 1,150 790 40 420 16 101 784 900 50 30 810 530 PROBLEM 5-4A (Continued) General Journal Date Apr. 20 21 27 30 Account Titles and Explanation Cash ............................................................... Accounts Receivable....................... Ref. 101 112 Debit 500 Accounts Payable...................................... Merchandise Inventory ................... ($900 X 3%) Cash ...................................................... 201 120 900 Sales Returns and Allowances ............. Accounts Receivable....................... 412 112 30 Cash ............................................................... Accounts Receivable....................... 101 112 660 J1 Credit 500 27 873 101 30 660 (b) Cash Date Apr. 1 6 11 13 15 17 20 21 30 No. 101 Explanation Balance Ref.
J1 J1 J1 J1 J1 J1 J1 J1 Debit Credit 40 420 784 50 30 500 873 660 Accounts Receivable Date Apr. 8 18 20 27 30 Explanation Balance 2,500 2,460 2,040 1,256 1,306 1,276 1,776 903 1,563 No. 112 Ref. J1 J1 J1 J1 J1 5-35 Debit 1,150 810 Credit 500 30 660 Balance 1,150 1,960 1,460 1,430 770 PROBLEM 5-4A (Continued) Merchandise Inventory Date Apr. 1 4 6 8 10 11 13 14 15 17 18 21 Explanation Balance No. 120 Ref.
J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 Debit Credit 840 40 790 40 420 16 900 50 30 530 27 Accounts Payable Date Apr. Explanation 4 10 13 14 21 No. 201 Ref. J1 J1 J1 J1 J1 Debit Credit 840 40 800 900 900 J. Hafner, Capital Date Apr. 1 Explanation Balance Balance 840 800 0 900 0 No. 301 Ref.
Debit Credit Sales Date Apr. 8 18 Balance 1,700 2,540 2,580 1,790 1,750 2,170 2,154 3,054 3,004 3,034 2,504 2,477 Balance 4,200 No. 401 Explanation Ref. J1 J1 5-36 Debit Credit 1,150 810 Balance 1,150 1,960 PROBLEM 5-4A (Continued) Sales Returns and Allowances Date Apr. 27 Explanation No. 412 Ref. J1 Debit 30 Credit Cost of Goods Sold Date Apr. (c) Explanation 8 18 Balance 30 No. 505 Ref. J1 J1 Debit 790 530 Credit Balance 790 1,320 HAFNER’S TENNIS SHOP Trial Balance April 30, 2008 Cash...................................................................................... Accounts Receivable ...................................................... Merchandise Inventory................................................... J. Hafner, Capital .............................................................. Sales ..................................................................................... Sales Returns and Allowances.................................... Cost of Goods Sold ......................................................... 5-37 Debit $1,563 770 2,477 Credit $4,200 1,960 30 1,320 $6,160 $6,160 PROBLEM 5-5A GORDMAN DEPARTMENT STORE Income Statement (Partial) For the Year Ended December 31, 2008 Sales revenues Sales................................................. $718,000 Less: Sales returns and allowances .................... 8,000 Net sales ......................................... 710,000 Cost of goods sold Inventory, January 1 ................... $ 40,500 Purchases....................................... $447,000 Less: Purchase returns and allowances $ 6,400 Purchase discounts....... 12,000 18,400 Net purchases............................... 428,600 Add: Freight-in............................. 5,600 Cost of goods purchased ........... 434,200 Cost of goods available for sale..................................... 474,700 Inventory, December 31............. 75,000 Cost of goods sold .............. 399,700 Gross profit............................................ $310,300 5-38 PROBLEM 5-6A (a) Cost of goods sold: Beginning inventory Plus: Purchases Cost of goods available Less: Ending inventory Cost of goods sold 2006 2007 2008 $ 13,000 146,000 159,000 (11,300) $147,700 $ 11,300 145,000 156,300 (14,700) $141,600 $ 14,700 129,000 143,700 (12,200) $131,500 2006 $225,700 147,700 $ 78,000 2007 $227,600 141,600 $ 86,000 2008 $219,500 131,500 $ 88,000 2006 $ 20,000 146,000 135,000 $ 31,000 2007 $ 31,000 145,000 161,000 $ 15,000 2008 $ 15,000 129,000 127,000 $ 17,000 (b) Sales Less: CGS Gross profit (c) Beginning accounts payable Plus: Purchases Less: Payments to suppliers Ending accounts payable 1 (d) Gross profit rate 34.6% 1 $78,000 ÷ $225,700 2 3 $86,000 ÷ $227,600 3 37.8% 2 40.1% $88,000 ÷ $219,500 No. Even though sales declined in 2008 from each of the two prior years, the gross profit rate increased. This means that cost of goods sold declined more than sales did, reflecting better purchasing power or control of costs. Therefore, in spite of declining sales, profitability, as measured by the gross profit rate, actually improved. 5-39 *PROBLEM 5-7A (a) General Journal Date Account Titles and Explanation Apr. 4 Purchases ................................................................... Accounts Payable ........................................... Debit 740 740 6 Freight-in..................................................................... Cash ..................................................................... 60 8 Accounts Receivable .............................................. Sales .................................................................... 900 10 Accounts Payable .................................................... Purchase Returns and Allowances ........... 40 11 Purchases ................................................................... Cash ..................................................................... 300 13 Accounts Payable ($740 – $40)............................ Purchase Discount ($700 X 3%) ................. Cash ..................................................................... 700 14 Purchases ................................................................... Accounts Payable ........................................... 600 15 Cash.............................................................................. Purchase Returns and Allowances ........... 50 17 Freight-in..................................................................... Cash ..................................................................... 30 18 Accounts Receivable .............................................. Sales .................................................................... 1,000 20 Cash.............................................................................. Accounts Receivable ..................................... 500 21 Accounts Payable .................................................... Purchase Discounts ($600 X 2%) ............... Cash ..................................................................... 600 5-40 Credit 60 900 40 300 21 679 600 50 30 1,000 500 12 588 *PROBLEM 5-7A (Continued) Date Account Titles and Explanation Apr. 27 Sales Returns and Allowances....................... Accounts Receivable ................................ Debit 30 30 Cash......................................................................... Accounts Receivable ................................ 500 Credit 30 500 (b) Cash 4/1 Bal. 2,500 4/6 4/15 50 4/11 4/20 500 4/13 4/30 500 4/17 4/21 4/30 Bal. 1,893 60 300 679 30 588 4/10 4/13 4/21 740 600 0 Angie Wilbert, Capital 4/1 Bal. 4,200 4/30 Bal. 4,200 Accounts Receivable 4/8 900 4/20 500 4/18 1,000 4/27 30 4/30 500 4/30 Bal. 870 Sales 4/8 4/18 4/30 Bal. Merchandise Inventory 4/1 Bal. 1,700 4/30 Bal. 1,700 Purchase Discounts 4/13 4/21 4/30 Bal. Sales Returns and Allowances 4/27 30 4/30 Bal. 30 Purchases 4/4 740 4/11 300 4/14 600 4/30 Bal. 1,640 Accounts Payable 40 4/4 700 4/14 600 4/30 Bal. 4/6 4/17 4/30 Bal. Purchase Returns and Allowances 4/10 40 4/15 50 4/30 Bal. 90 5-41 Freight-in 60 30 90 900 1,000 1,900 21 12 33 *PROBLEM 5-7A (Continued) (c) VILLAGE TENNIS SHOP Trial Balance April 30, 2008 Cash ................................................................................... Accounts Receivable.................................................... Merchandise Inventory ................................................ Angie Wilbert, Capital................................................... Sales................................................................................... Sales Returns and Allowances ................................. Purchases......................................................................... Purchase Returns and Allowances.......................... Purchase Discounts...................................................... Freight-in .......................................................................... Debit $1,893 870 1,700 Credit $4,200 1,900 30 1,640 90 33 90 $6,223 $6,223 VILLAGE TENNIS SHOP Income Statement (Partial) For the Month Ended April 30, 2008 Sales revenues Sales..................................................... Less: Sales returns and allowances ........................ Net sales ............................................. Cost of goods sold Inventory, April 1.............................. Purchases........................................... Less: Purchase returns ................ and allowances ............... Purchase discounts........... Net purchases................................... Add: Freight-in................................. Cost of goods purchased.............. Cost of goods available for sale......................................... Inventory, April 30 ........................... Cost of goods sold .................. Gross profit................................................ 5-42 $1,900 30 1,870 $1,700 $1,640 $90 33 123 1,517 90 1,607 3,307 2,296 1,011 $ 859 (a) TERRY MANNING FASHION CENTER Worksheet For the Year Ended November 30, 2008 Account Titles Trial Balance Dr. Cr. Dr. Cr. 28,700 30,700 44,700 6,200 85,000 22,000 (e) (a) 300 3,700 (b) 9,000 48,000 Adjusted Trial Balance Dr. Dr. Cr. 28,700 30,700 44,400 2,500 85,000 (c) 31,000 11,000 51,000 48,500 110,000 12,000 12,000 755,200 755,200 8,800 497,700 140,000 24,400 14,000 12,100 16,700 24,000 8,800 497,700 140,000 24,400 14,000 12,100 16,700 24,000 3,700 3,700 3,700 (b) 9,000 9,000 9,000 (c) (d) 5,000 4,080 5,000 4,080 5,000 4,080 300 (a) Cr. 48,000 11,000 51,000 48,500 110,000 755,200 (e) Dr. 31,000 5,000 12,000 Balance Sheet 28,700 30,700 44,400 2,500 85,000 48,000 6,000 51,000 48,500 110,000 8,800 497,400 140,000 24,400 14,000 12,100 16,700 24,000 992,700 Cr. Income Statement 992,700 (d) 22,080 4,080 22,080 1,010,780 4,080 1,010,780 759,480 759,480 755,200 4,280 759,480 251,300 4,280 255,580 4,080 255,580 255,580 Key: (a) Store supplies used, (b) Depreciation expense—store equipment, (c) Depreciation expense—delivery equipment, (d) Accrued interest payable, (e) Adjustment of inventory. *PROBLEM 5-8A 5-43 Cash Accounts Receivable Merchandise Inventory Store Supplies Store Equipment Accum. Depreciation— Store Equipment Delivery Equipment Accum. Depreciation— Delivery Equipment Notes Payable Accounts Payable T. Manning, Capital T. Manning, Drawing Sales Sales Returns and Allowances Cost of Goods Sold Salaries Expense Advertising Expense Utilities Expense Repair Expense Delivery Expense Rent Expense Totals Store Supplies Expense Depreciation Expense— Store Equipment Depreciation Expense— Delivery Equipment Interest Expense Interest Payable Totals Net Loss Totals Adjustments *PROBLEM 5-8A (Continued) (b) TERRY MANNING FASHION CENTER Income Statement For the Year Ended November 30, 2008 Sales revenues Sales ............................................................. Less: Sales returns and allowances ................................. Net sales...................................................... Cost of goods sold ........................................... Gross profit......................................................... Operating expenses Selling expenses Salaries expense ............................... ($140,000 X 70%) Advertising expense ........................ Rent expense ($24,000 X 80%) ...... Delivery expense............................... Utilities expense................................ ($14,000 X 80%) Depreciation expense— store equipment............................ Depreciation expense— delivery equipment....................... Store supplies expense................... Total selling expenses............. Administrative expenses Salaries expense ............................... ($140,000 X 30%) Repair expense.................................. Rent expense ($24,000 X 20%) ...... Utilities expense ($14,000 X 20%) ............................. Total administrative expenses................................. Total operating expenses ..................... Loss from operations....................................... Other expenses and losses Interest expense........................................ Net loss ................................................................ 5-44 $755,200 8,800 746,400 497,700 248,700 $98,000 24,400 19,200 16,700 11,200 9,000 5,000 3,700 $187,200 42,000 12,100 4,800 2,800 61,700 248,900 (200) $ 4,080 (4,280) *PROBLEM 5-8A (Continued) TERRY MANNING FASHION CENTER Owner’s Equity Statement For the Year Ended November 30, 2008 T. Manning, Capital, December 1, 2007......................... Less: Net loss....................................................................... Drawings .................................................................... T. Manning, Capital, November 30, 2008 ...................... $110,000 $ 4,280 12,000 16,280 $ 93,720 TERRY MANNING FASHION CENTER Balance Sheet November 30, 2008 Assets Current assets Cash ........................................................... Accounts receivable............................. Merchandise inventory ........................ Store supplies......................................... Total current assets..................... Property, plant, and equipment Store equipment..................................... Accumulated depreciation— store equipment ................................ Delivery equipment ............................... Accumulated depreciation— delivery equipment........................... Total assets .................................... 5-45 $28,700 30,700 44,400 2,500 $106,300 $85,000 31,000 48,000 54,000 11,000 37,000 91,000 $197,300 *PROBLEM 5-8A (Continued) TERRY MANNING FASHION CENTER Balance Sheet (Continued) November 30, 2008 Liabilities and Owner’s Equity Current liabilities Notes payable due next year........................................... Accounts payable ............................................................... Interest payable ................................................................... Total current liabilities.............................................. Long-term liabilities Notes payable....................................................................... Total liabilities............................................................. Owner’s equity T. Manning, Capital............................................................. Total liabilities and owner’s equity ...................... (c) Nov. 30 30 30 30 30 Store Supplies Expense............................... Store Supplies ........................................ Depreciation Expense—Store Equipment .................................................... Accumulated Depreciation— Store Equipment ............................... Depreciation Expense—Delivery Equipment .................................................... Accumulated Depreciation— Delivery Equipment.......................... $30,000 48,500 4,080 $ 82,580 21,000 103,580 93,720 $197,300 3,700 3,700 9,000 9,000 5,000 5,000 Interest Expense............................................. Interest Payable ..................................... 4,080 Cost of Goods Sold ....................................... Merchandise Inventory ........................ 300 5-46 4,080 300 *PROBLEM 5-8A (Continued) (d) Nov. 30 30 30 30 Sales................................................................ Income Summary ............................... 755,200 Income Summary ........................................ Sales Returns and Allowances ...................................... Cost of Goods Sold ........................... Salaries Expense................................ Advertising Expense......................... Utilities Expense................................. Repair Expense................................... Delivery Expense ............................... Rent Expense ...................................... Store Supplies Expense................... Depreciation Expense—Store Equipment........................................ Depreciation Expense—Delivery Equipment........................................ Interest Expense................................. 759,480 T. Manning, Capital..................................... Income Summary ............................... 4,280 T. Manning, Capital..................................... T. Manning, Drawing ......................... 12,000 5-47 755,200 8,800 497,700 140,000 24,400 14,000 12,100 16,700 24,000 3,700 9,000 5,000 4,080 4,280 12,000 *PROBLEM 5-8A (Continued) (e) TERRY MANNING FASHION CENTER Post-Closing Trial Balance November 30, 2008 Cash ............................................................................ Accounts Receivable............................................. Merchandise Inventory ......................................... Store Supplies.......................................................... Store Equipment ..................................................... Accumulated Depreciation—Store Equipment............................................................. Delivery Equipment................................................ Accumulated Depreciation—Delivery Equipment............................................................. Notes Payable .......................................................... Accounts Payable................................................... Interest Payable....................................................... T. Manning, Capital................................................. Debit $ 28,700 30,700 44,400 2,500 85,000 $ 31,000 48,000 $239,300 5-48 Credit 11,000 51,000 48,500 4,080 93,720 $239,300 PROBLEM 5-1B (a) June 1 3 6 9 15 17 20 24 26 Merchandise Inventory (180 X $5)................. Accounts Payable...................................... 900 Accounts Receivable (120 X $10).................. Sales .............................................................. 1,200 Cost of Goods Sold (120 X $5) ....................... Merchandise Inventory ............................ 600 Accounts Payable (10 X $5) ............................ Merchandise Inventory ............................ 50 Accounts Payable ($900 – $50)...................... Merchandise Inventory ............................ ($850 X .02) Cash ............................................................... 850 Cash ........................................................................ Accounts Receivable................................ 1,200 Accounts Receivable (150 X $10).................. Sales .............................................................. 1,500 Cost of Goods Sold (150 X $5) ....................... Merchandise Inventory ............................ 750 Merchandise Inventory (120 X $5)................. Accounts Payable...................................... 600 Cash ........................................................................ Sales Discounts ($1,500 X .02)....................... Accounts Receivable................................ 1,470 30 Accounts Payable............................................... Merchandise Inventory ............................ ($600 X .02) Cash ............................................................... 600 5-49 900 1,200 600 50 17 833 1,200 1,500 750 600 1,500 12 588 PROBLEM 5-1B (Continued) June 28 30 Accounts Receivable (110 X $10) .................. Sales............................................................... 1,100 Cost of Goods Sold (110 X $5) ....................... Merchandise Inventory............................. 550 Sales Returns and Allowances....................... (15 X $10) Accounts Receivable ................................ 150 Merchandise Inventory (15 X $5) ................... Cost of Goods Sold ................................... 75 5-50 1,100 550 150 75 PROBLEM 5-2B (a) General Journal Date May 1 2 5 9 10 11 12 15 17 19 Account Titles and Explanation Merchandise Inventory......................... Accounts Payable ......................... Ref. 120 201 Debit 8,000 Accounts Receivable ............................ Sales .................................................. 112 401 4,000 Cost of Goods Sold ............................... Merchandise Inventory................ 505 120 3,100 Accounts Payable .................................. Merchandise Inventory................ 201 120 600 Cash ($4,000 – $40)................................ Sales Discounts ($4,000 X 1%) .......... Accounts Receivable ................... 101 414 112 3,960 40 Accounts Payable ($8,000 – $600).......... Merchandise Inventory................ ($7,400 X 2%) Cash................................................... 201 120 7,400 Supplies .................................................... Cash................................................... 126 101 900 Merchandise Inventory......................... Cash................................................... 120 101 2,700 Cash............................................................ Merchandise Inventory................ 101 120 230 Merchandise Inventory......................... Accounts Payable ......................... 120 201 2,500 Merchandise Inventory......................... Cash................................................... 120 101 250 5-51 J1 Credit 8,000 4,000 3,100 600 4,000 148 101 7,252 900 2,700 230 2,500 250 PROBLEM 5-2B (Continued) General Journal Date May 24 25 27 29 31 Account Titles and Explanation Cash .............................................................. Sales..................................................... Ref. 101 401 Debit 6,200 Cost of Goods Sold.................................. Merchandise Inventory .................. 505 120 4,600 Merchandise Inventory ........................... Accounts Payable............................ 120 201 1,000 Accounts Payable..................................... Merchandise Inventory .................. ($2,500 X 2%) Cash ..................................................... 201 120 2,500 Sales Returns and Allowances ............ Cash ..................................................... 412 101 100 Merchandise Inventory ........................... Cost of Goods Sold......................... 120 505 20 Accounts Receivable............................... Sales..................................................... 112 401 1,600 Cost of Goods Sold.................................. Merchandise Inventory .................. 505 120 1,120 5-52 J1 Credit 6,200 4,600 1,000 50 101 2,450 100 20 1,600 1,120 PROBLEM 5-2B (Continued) (b) Cash Date May No. 101 1 9 10 11 12 15 19 24 27 29 Explanation Balance Accounts Receivable Date Explanation May 2 9 31 Ref.
J1 J1 J1 J1 J1 J1 J1 J1 J1 Ref. J1 J1 J1 Debit Credit 3,960 7,252 900 2,700 230 250 6,200 2,450 100 Debit 4,000 Credit 4,000 1,600 Merchandise Inventory Date May Explanation 1 2 5 10 12 15 17 19 24 25 27 29 31 Balance 10,000 13,960 6,708 5,808 3,108 3,338 3,088 9,288 6,838 6,738 No. 112 Balance 4,000 0 1,600 No. 120 Ref. J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 J1 5-53 Debit 8,000 Credit 3,100 600 148 2,700 230 2,500 250 4,600 1,000 50 20 1,120 Balance 8,000 4,900 4,300 4,152 6,852 6,622 9,122 9,372 4,772 5,772 5,722 5,742 4,622 PROBLEM 5-2B (Continued) Supplies No. 126 Date Explanation May 11 Accounts Payable Date Explanation May 1 5 10 17 25 27 J. Newson, Capital Date Explanation May 1 Balance Ref. J1 Ref. J1 J1 J1 J1 J1 J1 Ref.
Debit 900 Debit Credit Credit 8,000 600 7,400 2,500 1,000 2,500 Debit Credit Sales Date May No. 201 Balance 8,000 7,400 0 2,500 3,500 1,000 No. 301 Balance 10,000 No. 401 Explanation 2 24 31 Ref. J1 J1 J1 Debit Credit 4,000 6,200 1,600 Sales Returns and Allowances Date May 29 Explanation Explanation 9 Balance 4,000 10,200 11,800 No. 412 Ref. J1 Debit 100 Credit Sales Discounts Date May Balance 900 Balance 100 No. 414 Ref. J1 5-54 Debit 40 Credit Balance 40 PROBLEM 5-2B (Continued) Cost of Goods Sold Date May (c) No. 505 Explanation 2 24 29 31 Ref. J1 J1 J1 J1 Debit 3,100 4,600 Credit 20 1,120 Balance 3,100 7,700 7,680 8,800 NEWSON HARDWARE STORE Income Statement (Partial) For the Month Ended May 31, 2008 Sales revenues Sales ............................................................................... Less: Sales returns and allowances ................... Sales discounts.............................................. Net sales ........................................................................ Cost of goods sold.............................................................. Gross profit ........................................................................... 5-55 $11,800 $100 40 140 11,660 8,800 $ 2,860 PROBLEM 5-3B (a) HUFFMAN DEPARTMENT STORE Income Statement For the Year Ended November 30, 2008 Sales revenues Sales ............................................................. Less: Sales returns & allowances....... Net sales...................................................... Cost of goods sold ........................................... Gross profit......................................................... Operating expenses Selling expenses Salaries expense ............................... ($120,000 X 75%) Sales commissions expense ......... Depreciation expense—store equipment....................................... Delivery expense............................... Insurance expense ........................... ($9,000 X 50%) Depreciation expense—delivery equipment....................................... Total selling expenses............. Administrative expenses Salaries expense ............................... ($120,000 X 25%) Rent expense ..................................... Utilities expense................................ Insurance expense ........................... ($9,000 X 50%) Property tax expense ....................... Total admin. expenses ............ Total oper. expenses........ Income from operations .................................. Other revenues and gains Interest revenue......................................... Other expenses and losses Interest expense........................................ Net income .......................................................... 5-56 $850,000 10,000 840,000 633,220 206,780 $90,000 14,000 9,500 8,200 4,500 4,000 $130,200 30,000 19,000 10,600 4,500 3,500 67,600 197,800 8,980 5,000 8,000 $ 3,000 5,980 PROBLEM 5-3B (Continued) HUFFMAN DEPARTMENT STORE Owner’s Equity Statement For the Year Ended November 30, 2008 M. Huffman, Capital, December 1, 2007 ................................................. Add: Net income.......................................................................................... Less: Drawings ............................................................................................. M. Huffman, Capital, November 30, 2008............................................... $84,200 5,980 90,180 12,000 $78,180 HUFFMAN DEPARTMENT STORE Balance Sheet November 30, 2008 Assets Current assets Cash ............................................................ Accounts receivable.............................. Merchandise inventory ......................... Prepaid insurance .................................. Total current assets...................... Property, plant, and equipment Store equipment...................................... Less: Accumulated depreciation— store equipment .................... Delivery equipment ................................ Less: Accumulated depreciation— delivery equipment............... Total assets ..................................... 5-57 $ 8,000 11,770 36,200 4,500 $ 60,470 $125,000 41,800 57,000 83,200 19,680 37,320 120,520 $180,990 PROBLEM 5-3B (Continued) HUFFMAN DEPARTMENT STORE Balance Sheet (Continued) November 30, 2008 Liabilities and Owner’s Equity Current liabilities Accounts payable ................................................................ Sales commissions payable............................................. Property taxes payable ...................................................... Total current liabilities............................................... Long-term liabilities Notes payable due 2011..................................................... Total liabilities.............................................................. Owner’s equity M. Huffman, Capital ............................................................. Total liabilities and owner’s equity ....................... (b) Nov. 30 $47,310 6,000 3,500 $ 56,810 46,000 102,810 78,180 $180,990 Depr. Expense—Delivery Equip. ................ Accumulated Depreciation— Delivery Equipment........................... 4,000 Depr. Expense—Store Equip. ..................... Accumulated Depreciation— Store Equipment ................................ 9,500 Insurance Expense ......................................... Prepaid Insurance .................................. 9,000 Property Tax Expense.................................... Property Taxes Payable ....................... 3,500 Sales Commissions Expense...................... Sales Commissions Payable .............. 6,000 5-58 4,000 9,500 9,000 3,500 6,000 PROBLEM 5-3B (Continued) (c) Nov. 30 30 30 30 Sales.................................................................. Interest Revenue ........................................... Income Summary ................................. 850,000 5,000 Income Summary .......................................... Sales Returns and Allowances ........................................ Cost of Goods Sold ............................. Salaries Expense.................................. Depreciation Expense— Delivery Equipment ........................ Delivery Expense ................................. Sales Commissions Expense .......... Depreciation Expense— Store Equipment .............................. Insurance Expense.............................. Rent Expense ........................................ Property Tax Expense ........................ Utilities Expense................................... Interest Expense................................... 849,020 Income Summary .......................................... M. Huffman, Capital ............................. 5,980 M. Huffman, Capital...................................... M. Huffman, Drawing........................... 12,000 5-59 855,000 10,000 633,220 120,000 4,000 8,200 14,000 9,500 9,000 19,000 3,500 10,600 8,000 5,980 12,000 PROBLEM 5-4B (a) General Journal Date Apr. 5 7 9 10 12 14 17 20 21 Account Titles and Explanation Merchandise Inventory ........................... Accounts Payable............................ Ref. 120 201 Debit 1,500 Merchandise Inventory ........................... Cash ..................................................... 120 101 80 Accounts Payable..................................... Merchandise Inventory .................. 201 120 100 Accounts Receivable............................... Sales..................................................... 112 401 1,100 Cost of Goods Sold.................................. Merchandise Inventory .................. 505 120 810 Merchandise Inventory ........................... Accounts Payable............................ 120 201 860 Accounts Payable ($1,500 – $100) ...... Merchandise Inventory .................. ($1,400 X 2%) Cash ..................................................... 201 120 1,400 Accounts Payable..................................... Merchandise Inventory .................. 201 120 60 Accounts Receivable............................... Sales..................................................... 112 401 700 Cost of Goods Sold.................................. Merchandise Inventory .................. 505 120 490 Accounts Payable ($860 – $60) ............ Merchandise Inventory .................. ($800 X 1%) Cash ..................................................... 201 120 800 5-60 1,500 80 100 1,100 810 860 28 101 101 J1 Credit 1,372 60 700 490 8 792 PROBLEM 5-4B (Continued) Date Apr. 27 30 Account Titles and Explanation Sales Returns and Allowances........ Accounts Receivable ................. Ref. 412 112 Debit 40 Cash ......................................................... Accounts Receivable ................. 101 112 1,000 J1 Credit 40 1,000 (b) Cash Date Apr. No. 101 1 7 14 21 30 Explanation Balance Ref.
J1 J1 J1 J1 Debit Credit 80 1,372 792 1,000 Accounts Receivable Date Apr. 10 20 27 30 Explanation No. 112 Ref. J1 J1 J1 J1 Debit 1,100 700 Credit 40 1,000 Merchandise Inventory Date Apr. 1 5 7 9 10 12 14 17 20 21 Explanation Balance Balance 2,500 2,420 1,048 256 1,256 Balance 1,100 1,800 1,760 760 No. 120 Ref.
J1 J1 J1 J1 J1 J1 J1 J1 J1 5-61 Debit Credit 1,500 80 100 810 860 28 60 490 8 Balance 3,500 5,000 5,080 4,980 4,170 5,030 5,002 4,942 4,452 4,444 PROBLEM 5-4B (Continued) Accounts Payable Date Explanation Apr. 5 9 12 14 17 21 No. 201 Ref. J1 J1 J1 J1 J1 J1 Debit Credit 1,500 100 860 1,400 60 800 M. Palmer, Capital Date Apr. Explanation 1 Balance No. 301 Ref.
Debit Credit Sales Date Explanation Apr. 10 20 Ref. J1 J1 Debit Credit 1,100 700 Balance 1,100 1,800 No. 412 Ref. J1 Debit 40 Credit Cost of Goods Sold Date Explanation Apr. 10 20 Balance 6,000 No. 401 Sales Returns and Allowances Date Explanation Apr. 27 Balance 1,500 1,400 2,260 860 800 0 Balance 40 No. 505 Ref. J1 J1 5-62 Debit 810 490 Credit Balance 810 1,300 PROBLEM 5-4B (Continued) (c) MIKE’S PRO SHOP Trial Balance April 30, 2008 Cash ..................................................................................... Accounts Receivable ..................................................... Merchandise Inventory .................................................. M. Palmer, Capital ........................................................... Sales .................................................................................... Sales Returns and Allowances ................................... Cost of Goods Sold ........................................................ 5-63 Debit $1,256 760 4,444 Credit $6,000 1,800 40 1,300 $7,800 $7,800 PROBLEM 5-5B DUCKWALL DEPARTMENT STORE Income Statement (Partial) For the Year Ended November 30, 2008 Sales revenues Sales.................................................. Less: Sales returns and allowances..................... Net sales .......................................... Cost of goods sold Inventory, Dec. 1, 2007................ Purchases........................................ Less: Purchase returns and allowances.............. Purchase discounts ......... Net purchases................................ Add: Freight-in.............................. Cost of goods purchased........... Cost of goods available for sale ................................... Inventory, Nov. 30, 2008 ............. Cost of goods sold ............ Gross profit............................................. $900,000 20,000 880,000 $ 44,360 $650,000 $3,000 7,000 10,000 640,000 5,060 645,060 689,420 36,200 653,220 $226,780 5-64 PROBLEM 5-6B (1) (a) Cost of goods sold = Sales – Gross profit = $96,850 – $69,640 = $27,210 (b) Net income = Gross profit – Operating expenses = $69,640 – $63,500 = $6,140 (c) Merchandise inventory = 2005 Inventory + Purchases – CGS = $13,000 + $25,890 – $27,210 = $11,680 (d) Cash payments to suppliers = 2005 Accounts payable + Purchases – 2006 Accounts payable = $5,800 + $25,890 – $6,500 = $25,190 (e) Sales = Cost of goods sold + Gross profit = $25,140 + $61,540 = $86,680 (f) Operating expenses = Gross profit – Net income = $61,540 – $4,570 = $56,970 (g) 2006 Inventory + Purchases – 2007 Inventory = CGS Purchases = CGS – 2006 Inventory + 2007 Inventory = $25,140 – $11,680 [from (c)] + $14,700 = $28,160 (h) Cash payments to suppliers = 2006 Accounts payable + Purchases – 2007 Accounts Payable = $6,500 + $28,160 [from (g)] – $4,600 = $30,060 (i) Gross profit = Sales – CGS = $82,220 – $25,990 = $56,230 (j) Net income = Gross profit – Operating expenses = $56,230 [from (i)] – $52,060 = $4,170 (k) 2007 Inventory + Purchases – 2008 Inventory = CGS Merchandise inventory = 2007 Inventory + Purchases – CGS = $14,700 + $24,050 – $25,990 = $12,760 (I) Accounts payable = 2007 Accounts payable + Purchases – Cash payments = $4,600 + $24,050 – $24,650 = $4,000 5-65 PROBLEM 5-6B (Continued) (2) A decline in sales does not necessarily mean that profitability declined. Profitability is affected by sales, cost of goods sold, and operating expenses. If cost of goods sold or operating expenses decline more than sales, profitability can increase even when sales decline. However, in this particular case, sales declined with insufficient offsetting cost savings to improve profitability. Therefore, profitability declined for Howit Inc. 2006 Gross profit rate 2007 2008 $69,640 ÷ $96,850 $61,540 ÷ $86,680 $56,230 ÷ $82,220 = 72% = 71% = 68% Profit margin ratio $6,140 ÷ $96,850 = 6.3% 5-66 $4,570 ÷ $86,680 = 5.3% $4,170 ÷ $82,220 = 5.1% *PROBLEM 5-7B (a) Date Apr. 5 7 9 10 12 14 17 20 21 27 30 General Journal Account Titles and Explanation Purchases ............................................................... Accounts Payable ....................................... Debit 2,200 2,200 Freight-in................................................................. Cash................................................................. 80 Accounts Payable ................................................ Purchase Returns and Allowances ....... 200 Accounts Receivable .......................................... Sales ................................................................ 950 Purchases ............................................................... Accounts Payable ....................................... 460 Accounts Payable ($2,200 – $200) ................... Purchase Discounts ($2,000 X 2%)........... Cash ($2,000 – $40)..................................... 2,000 Accounts Payable ................................................ Purchase Returns and Allowances .......... 60 Accounts Receivable .......................................... Sales ................................................................ 1,000 Accounts Payable ($460 – $60)........................ Purchase Discounts ................................... ($400 X 1%) Cash ($400 – $4)........................................... 400 Sales Returns and Allowances........................ Accounts Receivable ................................. 75 Cash.......................................................................... Accounts Receivable ................................. 1,100 5-67 Credit 80 200 950 460 40 1,960 60 1,000 4 396 75 1,100 *PROBLEM 5-7B (Continued) (b) 4/1 Bal. 4/30 4/30 Bal. Cash 2,500 4/7 1,100 4/14 4/21 1,164 80 1,960 396 Accounts Receivable 4/10 950 4/27 75 4/20 1,000 4/30 1,100 4/30 Bal. 775 Merchandise Inventory 4/1 Bal. 3,500 4/30 Bal. 3,500 4/9 4/14 4/17 4/21 Accounts Payable 200 4/5 2,000 4/12 60 400 4/30 Bal. Phil Mickel, Capital 4/1 Bal. 6,000 4/30 Bal. 6,000 2,200 460 0 Sales 4/10 4/20 4/30 Bal. Sales Returns and Allowances 4/27 75 4/30 Bal. 75 4/5 4/12 4/30 Bal. Purchases 2,200 460 2,660 4/7 4/30 Bal. Freight-in 80 80 Purchase Returns and Allowances 4/9 200 4/17 60 4/30 Bal. 260 Purchase Discounts 4/14 4/21 4/30 Bal. 950 1,000 1,950 40 4 44 5-68 *PROBLEM 5-7B (Continued) (c) FOUR OAKS PRO SHOP Trial Balance April 30, 2008 Cash................................................................................... Accounts Receivable ................................................... Merchandise Inventory................................................ Phil Mickel, Capital ....................................................... Sales .................................................................................. Sales Returns and Allowances................................. Purchases........................................................................ Purchase Returns and Allowances......................... Purchase Discounts ..................................................... Freight-in.......................................................................... Debit $1,164 775 3,500 Credit $6,000 1,950 75 2,660 260 44 80 $8,254 $8,254 FOUR OAKS PRO SHOP Income Statement (Partial) For the Month Ended April 30, 2008 Sales revenues Sales ....................................................... Less: Sales returns and allowances........................... Net sales................................................ Cost of goods sold Inventory, April 1 ................................ Purchases ............................................. Less: Purchase returns and allowances ................... Purchase discounts ............. Net purchases...................................... Add: Freight-in ................................... Cost of goods purchased................... Cost of goods available for sale ............................................... Inventory, April 30.............................. Cost of goods sold..................... Gross profit .................................................. 5-69 $1,950 75 1,875 $3,500 $2,660 $260 44 304 2,356 80 2,436 5,936 4,524 1,412 $ 463 BYP 5-1 FINANCIAL REPORTING PROBLEM 2004 (a) (1) (2) Percentage change in sales: ($29,261 – $26,971) ÷ $26,971 ($32,562 – $29,261) ÷ $29,261 8.5% increase 11.3% increase Percentage change in net income: ($4,212 – $3,568) ÷ $3,568 ($4,078 – $4,212) ÷ $4,212 18.0% increase 3.2% decrease (b) Gross profit rate: 2003 ($26,971 – $11,691) ÷ $26,971 2004 ($29,261 – $12,674) ÷ $29,261 2005 ($32,562 – $14,176) ÷ $32,562 (c) 2005 Percentage of net income to sales: 2003 ($3,568 ÷ $26,971) 2004 ($4,212 ÷ $29,261) 2005 ($4,078 ÷ $32,562) 56.7% 56.7% 56.5% 13.2% 14.4% 12.5% Comment The percentage of net income to sales increased 9% from 2003 to 2004 (13.2% to 14.4%) but declined 13% from 2004 to 2005 (14.4% to 12.5%). The gross profit rate has remained steady during this time. The primary reason for the decrease in 2005 income was the increase in income tax expense. Note 5 explains that the company’s 2005 tax expense includes a one-time tax that resulted from including “repatriated” earnings from international transactions. 5-70 BYP 5-2 (a) (1) COMPARATIVE ANALYSIS PROBLEM 2005 Gross profit PepsiCo Coca-Cola $18,3861 $14,909 (2) 2005 Gross profit rate 56.5%2 64.5%3 (3) 2005 Operating income $5,922 $6,085 (4) Percent change in operating income, 2004 to 2005 12.6%4 increase 6.8%5 increase 1 $32,562 – $14,176 2 4 ($5,922 – $5,259) ÷ $5,259 $18,386 ÷ $32,562 5 3 $14,909 ÷ $23,104 ($6,085 – $5,698) ÷ $5,698 (b) PepsiCo has a higher gross profit but a lower gross profit rate than Coca-Cola. This difference can be explained by PepsiCo’s higher sales level and a higher cost of goods sold. Coca-Cola had a larger operating income because its cost of goods sold was smaller than PepsiCo’s and it reported no amortization of intangible assets. 5-71 BYP 5-3 EXPLORING THE WEB The answers to this assignment will be dependent upon the articles selected from the Internet by the student. 5-72 BYP 5-4 (a) (1) GROUP DECISION CASE FEDCO DEPARTMENT STORE Income Statement For the Year Ended December 31, 2008 Net sales [$700,000 + ($700,000 X 6%)] ........ Cost of goods sold ($742,000 X 76%)*.......... Gross profit ($742,000 X 24%) ......................... Operating expenses Selling expenses......................................... Administrative expenses.......................... Total operating expenses ............... Net income............................................................. $742,000 563,920 178,080 $100,000 20,000 120,000 $ 58,080 **Alternatively: Net sales, $742,000 – gross profit, $178,080. (2) FEDCO DEPARTMENT STORE Income Statement For the Year Ended December 31, 2008 Net sales ................................................................. Cost of goods sold.............................................. Gross profit............................................................ Operating expenses Selling expenses......................................... Administrative expenses.......................... Net income............................................................. $700,000 553,000 147,000 $72,000* 20,000* 92,000 $ 55,000 *$100,000 – $30,000 – ($30,000 X 40%) + ($700,000 X 2%) = $72,000. (b) Carrie’s proposed changes will increase net income by $31,080. Luke’s proposed changes will reduce operating expenses by $28,000 and result in a corresponding increase in net income. Thus, if the choice is between Carrie’s plan and Luke’s plan, Carrie’s plan should be adopted. While Luke’s plan will increase net income, it may also have an adverse effect on sales personnel. Under Luke’s plan, sales personnel will be taking a cut of $16,000 in compensation [$60,000 – ($30,000 + $14,000)]. 5-73 BYP 5-4 (Continued) (c) FEDCO DEPARTMENT STORE Income Statement For the Year Ended December 31, 2008 Net sales ........................................................................ Cost of goods sold ..................................................... Gross profit................................................................... Operating expenses Selling expenses ................................................ Administrative expenses................................. Total operating expenses....................... Net income .................................................................... $742,000 563,920 178,080 $72,840* 20,000* 92,840 $ 85,240 *$72,000 + [2% X ($742,000 – $700,000)] = $72,840. If both plans are implemented, net income will be $58,240 ($85,240 – $27,000) higher than the 2007 results. This is an increase of over 200%. Given the size of the increase, Luke’s plan to compensate sales personnel might be modified so that they would not have to take a pay cut. For example, if sales commissions were 3%, the compensation cut would be reduced to $8,580 [$16,000 (from (b)) – $742,000 X (3% – 2%)]. 5-74 BYP 5-5 COMMUNICATION ACTIVITY (a), (b) President Surfing USA Co. Dear Sir: As you know, the financial statements for Surfing USA Co. are prepared in accordance with generally accepted accounting principles. One of these principles is the revenue recognition principle, which provides that revenues should be recognized when they are earned. Typically, sales revenues are earned when the goods are transferred to the buyer from the seller. At this point, the sales transaction is completed and the sales price is established. Thus, in the typical situation, revenue on the surfboard ordered by Flutie is earned at event No. 8, when Flutie picks up the surfboard. The circumstances pertaining to this sale may seem to you to be atypical because Flutie has ordered a specific kind of surfboard. From an accounting standpoint, this would be true only if you could not reasonably expect to sell this surfboard to another customer. In such case, it would be proper under generally accepted accounting principles to recognize sales revenue when you have completed the surfboard for Flutie. Whether Flutie makes a down payment with the purchase order is irrelevant in recognizing sales revenue because at this time, you have not done anything to earn the revenue. A down payment may be an indication of Flutie’s “good faith.” However, its effect on your financial statements is limited entirely to recognizing the down payment as unearned revenue. If you have further questions about the accounting for this sale, please let me know. Sincerely, 5-75 BYP 5-6 ETHICS CASE (a) Laura McAntee, as a new employee, is placed in a position of responsibility and is pressured by her supervisor to continue an unethical practice previously performed by him. The unethical practice is taking undeserved cash discounts. Her dilemma is either follow her boss’s unethical instructions or offend her boss and maybe lose the job she just assumed. (b) The stakeholders (affected parties) are:
Laura McAntee, the assistant treasurer.
Danny Feeney, the treasurer.
Dorchester Stores, the company.
Creditors of Dorchester Stores (suppliers).
Mail room employees (those assigned the blame). (c) Laura’s alternatives: 1. Tell the treasurer (her boss) that she will attempt to take every allowable cash discount by preparing and mailing checks within the discount period—the ethical thing to do. This will offend her boss and may jeopardize her continued employment. 2. Join the team and continue the unethical practice of taking undeserved cash discounts. 3. Go over her boss’s head and take the chance of receiving just and reasonable treatment from an officer superior to Danny. The company may not condone this practice. Laura definitely has a choice, but probably not without consequence. To continue the practice is definitely unethical. If Laura submits to this request, she may be asked to perform other unethical tasks. If Laura stands her ground and refuses to participate in this unethical practice, she probably won’t be asked to do other unethical things—if she isn’t fired. Maybe nobody has ever challenged Danny’s unethical behavior and his reaction may be one of respect rather than anger and retribution. Being ethically compromised is no way to start a new job. 5-76 BYP 5-7 ALL ABOUT YOU ACTIVITY (a) In a cash transaction the value of the item being exchanged is determined by the cash exchanged. In a barter transaction it is important that the value of the item being given up be objectively determined. To do this, Atlantis must demonstrate that it has sold similar space for cash to other parties. If it cannot demonstrate this, then it should not recognize revenue. In the late 1990’s it was quite common for Internet companies to engage in transactions in which they essentially swapped advertisements on each other’s web sites. At the time this was being done many of these companies were reporting net losses. It was believed by many that their high share prices were being driven instead by increasing revenues. Many observers were concerned that these swap transactions were simply a means to artificially boost reported revenue. (b) In order for revenue to be recognized it must be earned. In this case Atlantis has an obligation to provide goods with a value equal to the gift card. That obligation is not fulfilled until one of two things happens: Either the customer redeems the card for goods, or the card expires. Until either of those events occurs Atlantis cannot record revenue. (C) In this case Atlantis has sold two separate products. First, it has sold a stereo. Revenue from the sale of the stereo would be recorded upon delivery of the product. Second, it has sold an extended warranty. Under the warranty, it has an obligation to fix or replace the product for a three year period. Therefore, it has not fully earned the warranty revenue of $150 until the three years have passed. Rather than waiting until the end of the warranty period, it should instead recognize some revenue during each of the three years. It might do this evenly, or it might do it proportional to the related expenses it expects. 5-77 CHAPTER 6 Inventories ASSIGNMENT CLASSIFICATION TABLE Brief Exercises Exercises A Problems B Problems 1, 2, 3, 4, 5 1 1, 2 1A 1B Explain the accounting for inventories and apply the inventory cost flow methods. 5, 7, 8, 9, 10, 2, 3, 4 3, 4, 5, 6, 7, 8 2A, 3A, 4A, 5A, 6A, 7A 2B, 3B, 4B, 5B, 6B, 7B 3. Explain the financial effects of the inventory cost flow assumptions. 6, 11, 12 5, 6 3, 6, 7, 8 2A, 3A, 4A, 5A, 6A, 7A 2B, 3B, 4B, 5B, 6B, 7B 4. Explain the lower-ofcost-or-market basis of accounting for inventories. 13, 14, 15 7 9, 10 5. Indicate the effects of inventory errors on the financial statements. 16 8 11, 12 6. Compute and interpret the inventory turnover ratio. 17, 18 9 13, 14 *7. Apply the inventory cost flow methods to perpetual inventory records. 19, 20 10 15, 16, 17 8A, 9A 8B, 9B *8. Describe the two methods of estimating inventories. 21, 22, 23, 24 11, 12 18, 19, 20 10A, 11A 10B, 11B Study Objectives Questions 1. Describe the steps in determining inventory quantities. 2. *Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendices to the chapter. 6-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Determine items and amounts to be recorded in inventory. Moderate 15–20 2A Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost with analysis. Simple 30–40 3A Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost with analysis. Simple 30–40 4A Compute ending inventory, prepare income statements, and answer questions using FIFO and LIFO. Moderate 30–40 5A Calculate ending inventory, cost of goods sold, gross profit, and gross profit rate under periodic method; compare results. Moderate 30–40 6A Compare specific identification, FIFO, and LIFO under periodic method; use cost flow assumption to influence earnings. Moderate 20–30 7A Compute ending inventory, prepare income statements, and answer questions using FIFO and LIFO. Moderate 30–40 *8A Calculate cost of goods sold and ending inventory for FIFO, average-cost, and LIFO, under the perpetual system; compare gross profit under each assumption. Moderate 30–40 *9A Determine ending inventory under a perpetual inventory system. Moderate 40–50 *10A Estimate inventory loss using gross profit method. Moderate 30–40 *11A Compute ending inventory using retail method. Moderate 20–30 1B Determine items and amounts to be recorded in inventory. Moderate 15–20 2B Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost with analysis. Simple 30–40 3B Determine cost of goods sold and ending inventory using FIFO, LIFO, and average-cost with analysis. Simple 30–40 4B Compute ending inventory, prepare income statements, and answer questions using FIFO and LIFO. Moderate 30–40 5B Calculate ending inventory, cost of goods sold, gross profit, and gross profit rate under periodic method; compare results. Moderate 30–40 6B Compare specific identification, FIFO, and LIFO under periodic method; use cost flow assumption to justify price increase. Moderate 20–30 6-2 ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number Difficulty Level Time Allotted (min.) Compute ending inventory, prepare income statements, and answer questions using FIFO and LIFO. Moderate 30–40 *8B Calculate cost of goods sold and ending inventory under LIFO, FIFO, and average-cost, under the perpetual system; compare gross profit under each assumption. Moderate 30–40 *9B Determine ending inventory under a perpetual inventory system. Moderate 40–50 *10B Compute gross profit rate and inventory loss using gross profit method. Moderate 30–40 *11B Compute ending inventory using retail method. Moderate 20–30 7B Description 6-3 Study Objective Knowledge Comprehension Application Analysis Synthesis Evaluation Describe the steps in determining inventory quantities. Q6-2 Q6-1 Q6-3 2. Explain the accounting for inventories and apply the inventory cost flow methods. Q6-8 Q6-10 BE6-5 Q6-7 Q6-9 Q6-5 BE6-2 BE6-3 BE6-4 E6-5 E6-6 E6-7 E6-8 P6-2A P6-3A P6-2B P6-3B P6-5A P6-5B P6-6A P6-6B E6-3 E6-4 P6-4A P6-4B P6-7A P6-7B E6-3 E6-4 P6-5A P6-5B 3. Explain the financial effects of the inventory cost flow assumptions. Q6-6 Q6-11 Q6-12 BE6-5 BE6-6 E6-6 E6-7 E6-8 P6-2A P6-2B P6-3A P6-3B P6-5A P6-5B E6-3 P6-6A P6-4A P6-6B P6-4B P6-7A P6-7B E6-3 P6-5A P6-5B P6-6A P6-6B 4. Explain the lower-of-cost-or-market basis of accounting for inventories. Q6-13 BE6-7 E6-9 E6-10 5. Indicate the effects of inventory errors on the financial statements. 6. Compute and interpret the inventory turnover ratio. Q6-17 BE6-9 E6-13 E6-14 Q6-18 BE6-9 *7. Apply the inventory cost flow methods to perpetual inventory records. Q6-19 Q6-20 BE6-10 E6-15 E6-16 E6-17 P6-8A P6-9A P6-8B P6-9B *8. Describe the two methods of estimating inventories. Q6-21 Q6-22 Q6-23 Q6-24 BE6-11 BE6-12 E6-18 P6-11A E6-19 P6-10B E6-20 P6-11B P6-10A 6-4 1. Broadening Your Perspective Q6-4 Q6-5 BE6-1 E6-1 E6-1 E6-2 P6-1A P6-1B Q6-14 Q6-15 Q6-16 BE6-8 Financial Reporting Decision Making Across the Organization E6-11 E6-12 E6-16 E6-17 P6-8A P6-8B Communication Exploring the Web All About You Ethics Case Comp. Analysis BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. Agree. Effective inventory management is frequently the key to successful business operations. Management attempts to maintain sufficient quantities and types of goods to meet expected customer demand. It also seeks to avoid the cost of carrying inventories that are clearly in excess of anticipated sales. 2. Inventory items have two common characteristics: (1) they are owned by the company and (2) they are in a form ready for sale in the ordinary course of business. 3. Taking a physical inventory involves actually counting, weighing or measuring each kind of inventory on hand. Retailers, such as a hardware store, generally have thousands of different items to count. This is normally done when the store is closed. 4. (a) (1) 5. Inventoriable costs are $3,020 (invoice cost $3,000 + freight charges $50 – purchase discounts $30). The amount paid to negotiate the purchase is a buying cost that normally is not included in the cost of inventory because of the difficulty of allocating these costs. Buying costs are expensed in the year incurred. 6. There are three distinguishing features in the income statement of a merchandising company: (1) a sales revenues section, (2) a cost of goods sold section, and (3) gross profit. 7. Actual physical flow may be impractical because many items are indistinguishable from one another. Actual physical flow may be inappropriate because management may be able to manipulate net income through specific identification of items sold. 8. The major advantage of the specific identification method is that it tracks the actual physical flow of the goods available for sale. The major disadvantage is that management could manipulate net income. 9. No. Selection of an inventory costing method is a management decision. However, once a method has been chosen, it should be consistently applied. The goods will be included in Reeves Company’s inventory if the terms of sale are FOB destination. (2) They will be included in Cox Company’s inventory if the terms of sale are FOB shipping point. (b) Reeves Company should include goods shipped to a consignee in its inventory. Goods held by Reeves Company on consignment should not be included in inventory. 10. (a) FIFO. (b) Average-cost. (c) LIFO. 11. Plato Company is using the FIFO method of inventory costing, and Cecil Company is using the LIFO method. Under FIFO, the latest goods purchased remain in inventory. Thus, the inventory on the balance sheet should be close to current costs. The reverse is true of the LIFO method. Plato Company will have the higher gross profit because cost of goods sold will include a higher proportion of goods purchased at earlier (lower) costs. 6-5 Questions Chapter 6 (Continued) 12. Casey Company may experience severe cash shortages if this policy continues. All of its net income is being paid out as dividends, yet some of the earnings must be reinvested in inventory to maintain inventory levels. Some earnings must be reinvested because net income is computed with cost of goods sold based on older, lower costs while the inventory must be replaced at current, higher costs. Because of this factor, net income under FIFO is sometimes referred to as “phantom profits.” 13. Peter should know the following: (a) A departure from the cost basis of accounting for inventories is justified when the value of the goods is lower than its cost. The writedown to market should be recognized in the period in which the price decline occurs. (b) Market means current replacement cost, not selling price. For a merchandising company, market is the cost at the present time from the usual suppliers in the usual quantities. 14. Garitson Music Center should report the CD players at $380 each for a total of $1,900. $380 is the current replacement cost under the lower-of-cost-or-market basis of accounting for inventories. A decline in replacement cost usually leads to a decline in the selling price of the item. Valuation at LCM is conservative. 15. Ruthie Stores should report the toasters at $27 each for a total of $540. The $27 is the lower of cost or market. It is used because it is the lower of the inventory’s cost and current replacement cost. 16. (a) Mintz Company’s 2007 net income will be understated $7,000; (b) 2008 net income will be overstated $7,000; and (c) the combined net income for the two years will be correct. 17. Willingham Company should disclose: (1) the major inventory classifications, (2) the basis of accounting (cost or lower of cost or market), and (3) the costing method (FIFO, LIFO, or average). 18. An inventory turnover that is too high may indicate that the company is losing sales opportunities because of inventory shortages. Inventory outages may also cause customer ill will and result in lost future sales. *19. Disagree. The results under the FIFO method are the same but the results under the LIFO method are different. The reason is that the pool of inventoriable costs (cost of goods available for sale) is not the same. Under a periodic system, the pool of costs is the goods available for sale for the entire period, whereas under a perpetual system, the pool is the goods available for sale up to the date of sale. *20. In a periodic system, the average is a weighted average based on total goods available for sale for the period. In a perpetual system, the average is a moving average of goods available for sale after each purchase. *21. Inventories must be estimated when: (1) management wants monthly or quarterly financial statements but a physical inventory is only taken annually and (2) a fire or other type of casualty makes it impossible to take a physical inventory. 6-6 Questions Chapter 6 (Continued) *22. In the gross profit method, the average is the gross profit rate, which is gross profit divided by net sales. The rate is often based on last year’s actual rate. The gross profit rate is applied to net sales in using the gross profit method. In the retail inventory method, the average is the cost-to-retail ratio, which is the goods available for sale at cost divided by the goods available for sale at retail. The ratio is based on current year data and is applied to the ending inventory at retail. *23. The estimated cost of the ending inventory is $40,000: Net sales ...................................................................................................................................... Less: Gross profit ($400,000 X 35%) .................................................................................... Estimated cost of goods sold ................................................................................................... $400,000 140,000 $260,000 Cost of goods available for sale .............................................................................................. Less: Cost of goods sold.......................................................................................................... Estimated cost of ending inventory......................................................................................... $300,000 260,000 $ 40,000 *24. The estimated cost of the ending inventory is $28,000:  $84,000   $120,000  Cost-to-retail ratio: 70% = Ending inventory at retail: $40,000 = ($120,000 – $80,000) Ending inventory at cost: $28,000 = ($40,000 X 70%) 6-7 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 6-1 (a) Ownership of the goods belongs to the consignor (Smart). Thus, these goods should be included in Smart’s inventory. (b) The goods in transit should not be included in the inventory count because ownership by Smart does not occur until the goods reach the buyer. (c) The goods being held belong to the customer. They should not be included in Smart’s inventory. (d) Ownership of these goods rests with the other company (the consignor). Thus, these goods should not be included in the physical inventory. BRIEF EXERCISE 6-2 The items that should be included in inventoriable costs are: (a) (b) (c) (e) Freight-in Purchase Returns and Allowances Purchases Purchase Discounts BRIEF EXERCISE 6-3 (a) The ending inventory under FIFO consists of 200 units at $8 + 160 units at $7 for a total allocation of $2,720 or ($1,600 + $1,120). (b) The ending inventory under LIFO consists of 300 units at $6 + 60 units at $7 for a total allocation of $2,220 or ($1,800 + $420). 6-8 BRIEF EXERCISE 6-4 Average unit cost is $6.89 computed as follows: 300 X $6 = $1,800 400 X $7 = 2,800 200 X $8 = 1,600 900 $6,200 $6,200 ÷ 900 = $6.89 (rounded). The cost of the ending inventory is $2,480 or (360 X $6.89). BRIEF EXERCISE 6-5 (a) (b) (c) (d) FIFO would result in the highest net income. FIFO would result in the highest ending inventory. LIFO would result in the lowest income tax expense (because it would result in the lowest net income). Average-cost would result in the most stable income over a number of years because it averages out any big changes in the cost of inventory. BRIEF EXERCISE 6-6 Cost of good sold under: Purchases Cost of goods available for sale Less: Ending inventory Cost of goods sold LIFO $6 X 100 $7 X 200 $8 X 150 $ 3,200 $ 1,160 $ 2,040 FIFO $6 X 100 $7 X 200 $8 X 150 $ 3,200 $ 1,410 $ 1,790 Since the cost of goods sold is $250 less under FIFO ($2,040 – $1,790) that is the amount of the phantom profit. It is referred to as “phantom profit” because FIFO matches current selling prices with old inventory costs. To replace the units sold, the company will have to pay the current price of $8 per unit, rather than the $6 per unit which some of the units were priced at under FIFO. Therefore, profit under LIFO is more representative of what the company can expect to earn in future periods. 6-9 BRIEF EXERCISE 6-7 Inventory Categories Cameras Camcorders VCRs Total valuation Cost $12,000 9,500 14,000 Market $12,100 9,700 12,800 LCM $12,000 9,500 12,800 $34,300 BRIEF EXERCISE 6-8 The understatement of ending inventory caused cost of goods sold to be overstated $10,000 and net income to be understated $10,000. The correct net income for 2008 is $100,000 or ($90,000 + $10,000). Total assets in the balance sheet will be understated by the amount that ending inventory is understated, $10,000. BRIEF EXERCISE 6-9 Inventory turnover: Days in inventory: $270,000 $270,000 = = 5.4 ( $60,000 + $40,000 ) ÷ 2 $50,000 365 = 67.6 days 5.4 *BRIEF EXERCISE 6-10 (1) FIFO Method Date May 7 June 1 July 28 Aug. 27 Purchases (50 @ $10) $500 (30 @ $13) Product E2-D2 Cost of Goods Sold (30 @ $10) $300 (20 @ $10) (20 @ $13) } $460 $390 6-10 Balance (50 @ $10) $500 (20 @ $10) $200 (20 @ $10) } $590 (30 @ $13) (10 @ $13) $130 *BRIEF EXERCISE 6-10 (Continued) (2) LIFO Method Date May 7 June 1 July 28 Purchases (50 @ $10) $500 (30 @ $13) Product E2-D2 Cost of Goods Sold (30 @ $10) $300 (30 @ $13) (10 @ $10) } $490 $390 Aug. 27 Balance (50 @ $10) $500 (20 @ $10) $200 (20 @ $10) } $590 (30 @ $13) (10 @ $10) $100 (3) Average-Cost Date May 7 June 1 July 28 Aug. 27 Purchases (50 @ $10) $500 Product E2-D2 Cost of Goods Sold (30 @ $10) (30 @ $13) $300 $390 (40 @ $11.80) $472 Balance (50 @ $10) $500 (20 @ $10) $200 (50 @ $11.80)* $590 (10 @ $11.80) $118 *($200 + $390) ÷ 50 *BRIEF EXERCISE 6-11 (1) Net sales Less: Estimated gross profit (35% X $330,000) Estimated cost of goods sold $330,000 115,500 $214,500 (2) Cost of goods available for sale Less: Estimated cost of goods sold Estimated cost of ending inventory $230,000 214,500 $ 15,500 *BRIEF EXERCISE 6-12 At Cost $35,000 Goods available for sale Net sales Ending inventory at retail Cost-to-retail ratio = ($35,000 ÷ $50,000) = 70% Estimated cost of ending inventory = ($10,000 X 70%) = $7,000 6-11 At Retail $50,000 40,000 $10,000 SOLUTIONS TO EXERCISES EXERCISE 6-1 Ending inventory—physical count.................................................... 1. No effect—title passes to purchaser upon shipment when terms are FOB shipping point.................................... 2. No effect—title does not transfer to Lima until goods are received .................................................................... 3. Add to inventory: Title passed to Lima when goods were shipped ............................................................................... 4. Add to inventory: Title remains with Lima until purchaser receives goods ...................................................... 5. The goods did not arrive prior to year-end. The goods, therefore, cannot be included in the inventory................ Correct inventory .................................................................................... $297,000 0 0 22,000 35,000 (44,000) $310,000 EXERCISE 6-2 Ending inventory—as reported .......................................................... 1. Subtract from inventory: The goods belong to Superior Corporation. Strawser is merely holding them as a consignee ................................................................ 2. No effect—title does not pass to Strawser until goods are received (Jan. 3).................................................... 3. Subtract from inventory: Office supplies should be carried in a separate account. They are not considered inventory held for resale.................................. 4. Add to inventory: The goods belong to Strawser until they are shipped (Jan. 1)............................................... 5. Add to inventory: District Sales ordered goods with a cost of $8,000. Strawser should record the corresponding sales revenue of $10,000. Strawser’s decision to ship extra “unordered” goods does not constitute a sale. The manager’s statement that District could ship the goods back indicates that Strawser knows this over-shipment is not a legitimate sale. The manager acted unethically in an attempt to improve Strawser’s reported income by over-shipping ...................................... 6-12 $740,000 (250,000) 0 (17,000) 30,000 52,000 EXERCISE 6-2 (Continued) 6. Subtract from inventory: GAAP require that inventory be valued at the lower of cost or market. Obsolete parts should be adjusted from cost to zero if they have no other use.......................................................................................... Correct inventory........................................................................................ (40,000) $515,000 EXERCISE 6-3 (a) FIFO Cost of Goods Sold (#1012) $100 + (#1045) $90 = $190 (b) It could choose to sell specific units purchased at specific costs if it wished to impact earnings selectively. If it wished to minimize earnings it would choose to sell the units purchased at higher costs—in which case the Cost of Goods Sold would be $190. If it wished to maximize earnings it would choose to sell the units purchased at lower costs—in which case the cost of goods sold would be $170. (c) I recommend they use the FIFO method because it produces a more appropriate balance sheet valuation and reduces the opportunity to manipulate earnings. (The answer may vary depending on the method the student chooses.) EXERCISE 6-4 FIFO Beginning inventory (26 X $97)..................................................... $ 2,522 Purchases Sept. 12 (45 X $102).................................................................. $4,590 Sept. 19 (20 X $104).................................................................. 2,080 Sept. 26 (50 X $105).................................................................. 5,250 11,920 Cost of goods available for sale................................................... 14,442 Less: Ending inventory (20 X $105) ........................................... 2,100 Cost of goods sold............................................................................ $12,342 6-13 EXERCISE 6-4 (Continued) Date 9/1 9/12 9/19 9/26 Units 26 45 20 30 121 Proof Unit Cost $ 97 102 104 105 Total Cost $ 2,522 4,590 2,080 3,150 $12,342 LIFO Cost of goods available for sale.................................................................... $14,442 Less: Ending inventory (20 X $97)............................................................... 1,940 Cost of goods sold............................................................................................. $12,502 Date 9/26 9/19 9/12 9/1 Units 50 20 45 6 121 Proof Unit Cost $105 104 102 97 Total Cost $ 5,250 2,080 4,590 582 $12,502 (b) FIFO $2,100 (ending inventory) + $12,342 (COGS) = $14,442 LIFO $1,940 (ending inventory) + $12,502 (COGS) = $14,442 } Cost of goods available for sale Under both methods, the sum of the ending inventory and cost of goods sold equals the same amount, $14,442, which is the cost of goods available for sale. EXERCISE 6-5 FIFO Beginning inventory (30 X $8) ....................................................... Purchases May 15 (25 X $11) ...................................................................... May 24 (35 X $12) ...................................................................... Cost of goods available for sale................................................... Less: Ending inventory (25 X $12).............................................. Cost of goods sold............................................................................ 6-14 $240 $275 420 695 935 300 $635 EXERCISE 6-5 (Continued) Date 5/1 5/15 5/24 Units 30 25 10 Proof Unit Cost $ 8 11 12 Total Cost $240 275 120 $635 LIFO Cost of goods available for sale.................................................................... Less: Ending inventory (25 X $8) ................................................................. Cost of goods sold............................................................................................. Date 5/24 5/15 5/1 Units 35 25 5 Proof Unit Cost $12 11 8 $935 200 $735 Total Cost $420 275 40 $735 EXERCISE 6-6 (a) FIFO Beginning inventory (200 X $5)..................................... Purchases June 12 (300 X $6) .................................................... June 23 (500 X $7) .................................................... Cost of goods available for sale................................... Less: Ending inventory (120 X $7).............................. Cost of goods sold............................................................ LIFO Cost of goods available for sale................................... Less: Ending inventory (120 X $5).............................. Cost of goods sold............................................................ 6-15 $1,000 $1,800 3,500 5,300 6,300 840 $5,460 $6,300 600 $5,700 EXERCISE 6-6 (Continued) (b) The FIFO method will produce the higher ending inventory because costs have been rising. Under this method, the earliest costs are assigned to cost of goods sold and the latest costs remain in ending inventory. For Yount Company, the ending inventory under FIFO is $840 or (120 X $7) compared to $600 or (120 X $5) under LIFO. (c) The LIFO method will produce the higher cost of goods sold for Yount Company. Under LIFO the most recent costs are charged to cost of goods sold and the earliest costs are included in the ending inventory. The cost of goods sold is $5,700 or [$6,300 – (120 X $5)] compared to $5,460 or ($6,300 – $840) under FIFO. EXERCISE 6-7 (a) 1. 2. 3. FIFO Beginning inventory .................................................. Purchases...................................................................... Cost of goods available for sale ............................ Less: ending inventory (80 X $130) ..................... Cost of goods sold ..................................................... $10,000 26,000 36,000 (10,400) $25,600 LIFO Beginning inventory .................................................. Purchases...................................................................... Cost of goods available for sale ............................ Less: ending inventory (80 X $100) ..................... Cost of goods sold ..................................................... $10,000 26,000 36,000 (8,000) $28,000 AVERAGE Beginning inventory .................................................. Purchases...................................................................... Cost of goods available for sale ............................ Less: ending inventory (80 X $120) ..................... Cost of goods sold ..................................................... $10,000 26,000 36,000 (9,600) $26,400 (b) The use of FIFO would result in the highest net income since the earlier lower costs are matched with revenues. (c) The use of FIFO would result in inventories approximating current cost in the balance sheet, since the more recent units are assumed to be on hand. (d) The use of LIFO would result in Jones paying the least taxes in the first year since income will be lower. 6-16 EXERCISE 6-8 (a) Total Units Cost of Goods Available for Sale ÷ Available for Sale 1,000 $6,300 Ending inventory (120 X $6.30) Cost of goods sold (880 X $6.30) = Weighted Average Unit Cost $6.30 $ 756 5,544 (b) Ending inventory is lower than FIFO ($840) and higher than LIFO ($600). In contrast, cost of goods sold is higher than FIFO ($5,460) and lower than LIFO ($5,700). (c) The average-cost method uses a weighted-average unit cost, not a simple average of unit costs. EXERCISE 6-9 Lower of Cost or Market: Cost Market Cameras Minolta Canon Total $ 850 900 1,750 $ 780 912 1,692 $ 780 900 Light meters Vivitar Kodak Total Total inventory 1,500 1,680 3,180 $4,930 1,380 1,890 3,270 $4,962 1,380 1,680 $4,740 Market $ 7,100 10,350 9,750 $27,200 Lower of Cost or Market: $ 6,500 10,350 9,750 $26,600 EXERCISE 6-10 VCRs DVD players Ipods Total inventory Cost $ 6,500 11,250 10,000 $27,750 6-17 EXERCISE 6-11 Beginning inventory ................................................... Cost of goods purchased ......................................... Cost of goods available for sale............................. Corrected ending inventory ..................................... Cost of goods sold...................................................... a $30,000 – $3,000 = $27,000. b 2008 2009 $ 20,000 150,000 170,000 a 27,000 $143,000 $ 27,000 175,000 202,000 b 41,000 $161,000 $35,000 + $6,000 = $41,000. EXERCISE 6-12 (a) Sales ............................................................................ Cost of goods sold Beginning inventory....................................... Cost of goods purchased............................. Cost of goods available for sale ................ Ending inventory ($44,000 – $5,000)......... Cost of goods sold ......................................... Gross profit ............................................................... 2008 $210,000 2009 $250,000 32,000 173,000 205,000 39,000 166,000 $ 44,000 39,000 202,000 241,000 52,000 189,000 $ 61,000 (b) The cumulative effect on total gross profit for the two years is zero as shown below: Incorrect gross profits: Correct gross profits: Difference $49,000 + $56,000 = $105,000 $44,000 + $61,000 = 105,000 $ 0 (c) Dear Mr./Ms. President: Because your ending inventory of December 31, 2008 was overstated by $5,000, your net income for 2008 was overstated by $5,000. For 2009 net income was understated by $5,000. In a periodic system, the cost of goods sold is calculated by deducting the cost of ending inventory from the total cost of goods you have available for sale in the period. Therefore, if this ending inventory figure is overstated, as it was in December 2008, then the cost of goods sold is understated and therefore net income will be overstated by that amount. Consequently, this overstated ending inventory figure goes on to become the next period’s beginning inventory amount and is a part of the total cost of goods available for sale. Therefore, the mistake repeats itself in the reverse. 6-18 EXERCISE 6-12 (Continued) The error also affects the balance sheet at the end of 2008. The inventory reported in the balance sheet is overstated; therefore, total assets are overstated. The overstatement of the 2008 net income results in the capital account balance being overstated. The balance sheet at the end of 2009 is correct because the overstatement of the capital account at the end of 2008 is offset by the understatement of the 2009 net income and the inventory at the end of 2009 is correct. Thank you for allowing me to bring this to your attention. If you have any questions, please contact me at your convenience. Sincerely, EXERCISE 6-13 Inventory turnover 2007 2008 $900,000 ($100,000 + $300,000) ÷ 2 $1,120,000 ($300,000 + $400,000) ÷ 2 $900,000 $200,000 Days in inventory Gross profit rate 365 4.5 = 4.5 = 81.1 days $1,200,000 – $900,000 = .25 $1,200,000 $1,120,000 $350,000 365 3.2 = 3.2 = 114.1 days $1,600,000 – $1,120,000 = .30 $1,600,000 2009 $1,300,000 ($400,000 + $480,000) ÷ 2 $1,300,000 $440,000 365 2.95 = 2.95 = 123.7 days $1,900,000 – $1,300,000 = .32 $1,900,000 The inventory turnover ratio decreased by approximately 34% from 2007 to 2009 while the days in inventory increased by almost 53% over the same time period. Both of these changes would be considered negative since it’s better to have a higher inventory turnover with a correspondingly lower days in inventory. However, Santo’s Photo gross profit rate increased by 28% from 2007 to 2009, which is a positive sign. 6-19 EXERCISE 6-14 (a) Inventory Turnover O’Brien Company Weinberg Company $190,000 ($45,000 + $55,000)/2 = 3.80 $292,000 ($71,000 + $69,000)/2 = 4.17 365/3.80 = 96 days 365/4.17 = 88 days Days in Inventory (b) Weinberg Company is moving its inventory more quickly, since its inventory turnover is higher, and its days in inventory is lower. *EXERCISE 6-15 (1) Date Purchases Jan. 1 8 10 (6 @ $660) $3,960 15 Purchases Jan. 1 8 10 (6 @ $660) $3,960 15 (2 @ $600) $1,200 (1 @ $600) (3 @ $660) $2,580 (2) Date FIFO Cost of Goods Sold LIFO Cost of Goods Sold (2 @ $600) $1,200 (4 @ $660) $2,640 6-20 Balance (3 @ $600) $1,800 (1 @ $600) 600 (1 @ $600) (6 @ $660) 4,560 (3 @ $660) 1,980 Balance (3 @ $600) $1,800 (1 @ $600) 600 (1 @ $600) (6 @ $660) 4,560 (1 @ $600) (2 @ $660) 1,920 *EXERCISE 6-15 (Continued) (3) AVERAGE-COST Date Purchases Cost of Goods Sold Jan. 1 8 (2 @ $600) $1,200 10 (6 @ $660) $3,960 15 (4 @ $651.43) $2,606 Balance (3 @ $600) $1,800 (1 @ $600) 600 (7 @ $651.43)* 4,560 (3 @ $651.43) 1,954 *Average-cost = ($600 + $3,960) ÷ 7 = $651.43 (rounded) *EXERCISE 6-16 (a) The cost of goods available for sale is: June 1 Inventory 200 @ $5 June 12 Purchase 300 @ $6 June 23 Purchase 500 @ $7 Total cost of goods available for sale Date June 1 June 12 Purchases (300 @ $6) $1,800 June 15 June 23 June 27 FIFO Cost of Goods Sold $1,000 1,800 3,500 $6,300 Balance (200 @ $5) $1,000 (200 @ $5) $2,800 (300 @ $6) } (200 @ $5) (200 @ $6) $1,000 1,200 (500 @ $7) $3,500 (100 @ $6) (380 @ $7) 600 2,660 $5,460 (100 @ $6) (100 @ $6) (500 @ $7) (120 @ $7) $ 600 } $4,100 $ 840 Ending inventory: $840. Cost of goods sold: $6,300 – $840 = $5,460. 6-21 *EXERCISE 6-16 (Continued) Date Purchases June 1 June 12 (300 @ $6) $1,800 June 15 LIFO Cost of Goods Sold } (300 @ $6) (100 @ $5) $1,800 $ 500 June 23 (500 @ $7) $3,500 (480 @ $7) June 27 Balance (200 @ $5) $1,000 (200 @ $5) $2,800 (300 @ $6) $3,360 $5,660 (100 @ $5) (100 @ $5) (500 @ $7) (100 @ $5) ( 20 @ $7) $ 500 } } $4,000 $ 640 Ending inventory: $640. Cost of goods sold: $6,300 – $640 = $5,660. Date June 1 June 12 June 15 June 23 June 27 Purchases Moving-Average Cost of Goods Sold (300 @ $6) $1,800 (400 @ $5.60) $2,240 (500 @ $7) $3,500 (480 @ $6.767) $3,248 $5,488 Balance (200 @ $5) $1,000 (500 @ $5.60) $2,800 (100 @ $5.60) $ 560 (600 @ $6.767) $4,060 (120 @ $6.767) $ 812 Ending inventory: $812. Cost of goods sold: $6,300 – $812 = $5,488. (b) FIFO gives the same ending inventory and cost of goods sold values under both the periodic and perpetual inventory system. LIFO and average give different ending inventory and cost of goods sold values under the periodic and perpetual inventory systems, due to the Last-in, First-out assumption being applied to a different pool of costs. (c) The simple average would be [($5 + $6 + $7) ÷ 3)] or $6. However, the average-cost method uses a weighted-average unit cost that changes each time a purchase is made rather than a simple average. 6-22 *EXERCISE 6-17 (a) Date 9/1 9/5 9/12 FIFO Cost of Goods Sold Purchases (12 @ $ 97) $1,164 (45 @ $102) $4,590 9/16 (14 @ $ 97) (36 @ $102) $5,030 9/19 (20 @ $104) $2,080 9/26 (50 @ $105) $5,250 9/29 Date 9/1 9/5 9/12 ( 9 @ $102) (20 @ $104) (30 @ $105) $6,148 LIFO Cost of Goods Sold Purchases (12 @ $ 97) $1,164 (45 @ $102) $4,590 9/16 9/19 9/26 9/29 (45 @ $102) ( 5 @ $ 97) $5,075 (20 @ $104) (50 @ $105) $2,080 $5,250 (50 @ $105) ( 9 @ $104) $6,186 6-23 Balance (26 @ $ 97) $2,522 (14 @ $ 97) $1,358 (14 @ $ 97) (45 @ $102) $5,948 ( 9 @ $102) $ 918 ( 9 @ $102) (20 @ $104) $2,998 ( 9 @ $102) (20 @ $104) (50 @ $105) $8,248 (20 @ $105) $2,100 Balance (26 @ $ 97) $2,522 (14 @ $ 97) $1,358 (14 @ $ 97) (45 @ $102) $5,948 ( 9 @ $ 97) ( 9 @ $ 97) (20 @ $104) ( 9 @ $ 97) (20 @ $104) (50 @ $105) ( 9 @ $ 97) (11 @ $104) $ 873 $2,953 $8,203 $2,017 *EXERCISE 6-17 (Continued) Date 9/1 9/5 9/12 9/16 9/19 9/26 9/29 Purchases Average-Cost Cost of Goods Sold (12 @ $97) $1,164 (50 @ $100.81) $5,041* (59 @ $104.27) $6,152* (45 @ $102) $4,590 (20 @ $104) $2,080 (50 @ $105) $5,250 Balance (26 @ $97) (14 @ $97) (59 @ $100.81)a ( 9 @ $100.81) (29 @ $103.00)b (79 @ $104.27)c (20 @ $104.27) $2,522 $1,358 $5,948 $ 907 $2,987 $8,237 $2,085 *Rounded a $5,948 ÷ 59 = $100.81 b $2,987 ÷ 29 = $103.00 c $8,237 ÷ 79 = $104.27 (b) Periodic $2,100 $1,940 Ending Inventory FIFO Ending Inventory LIFO (c) Perpetual $2,100 $2,017 FIFO yields the same ending inventory value under both the periodic and perpetual inventory system. LIFO yields different ending inventory values when using the periodic versus perpetual inventory system. *EXERCISE 6-18 (a) Sales .................................................................................. Cost of goods sold Inventory, November 1 ..................................... Cost of goods purchased ................................ Cost of goods available for sale.................... Inventory, December 31 ................................... Cost of goods sold.................................. Gross profit ..................................................................... Gross profit rate $320,000/$800,000 = 40% 6-24 $800,000 $100,000 500,000 600,000 (120,000) 480,000 $320,000 *EXERCISE 6-18 (Continued) (b) Sales ...................................................................................................... Less: Estimated gross profit (40% X $1,000,000) .................. Estimated cost of goods sold ....................................................... $1,000,000 400,000 $ 600,000 Beginning inventory ......................................................................... Cost of goods purchased ............................................................... Cost of goods available for sale................................................... Less: Estimated cost of goods sold .......................................... Estimated cost of ending inventory ............................................ $120,000 610,000 730,000 600,000 $130,000 *EXERCISE 6-19 (a) Net sales ($51,000 – $1,000)........................................................... Less: Estimated gross profit (40% X $50,000)........................ Estimated cost of goods sold ....................................................... $50,000 20,000 $30,000 Beginning inventory ......................................................................... Cost of goods purchased ($31,200 – $1,400 + $1,200).......... Cost of goods available for sale................................................... Less: Estimated cost of goods sold .......................................... Estimated cost of merchandise lost ........................................... $20,000 31,000 51,000 30,000 $21,000 (b) Net sales ............................................................................................... Less: Estimated gross profit (30% X $50,000)........................ Estimated cost of goods sold ....................................................... $50,000 15,000 $35,000 Beginning inventory ......................................................................... Cost of goods purchased ............................................................... Cost of goods available for sale................................................... Less: Estimated cost of goods sold .......................................... Estimated cost of merchandise lost ........................................... $30,000 31,000 61,000 35,000 $26,000 6-25 *EXERCISE 6-20 Women’s Department Cost Retail Beginning inventory Goods purchased Goods available for sale Net sales Ending inventory at retail Cost/retail ratio Estimated cost of ending inventory $ 32,000 148,000 $180,000 $ 46,000 179,000 225,000 178,000 $ 47,000 $180,000 = 80% $225,000 $47,000 X 80% = $37,600 6-26 Men’s Department Cost Retail $ 45,000 136,300 $181,300 $ 60,000 185,000 245,000 185,000 $ 60,000 $181,300 = 74% $245,000 $60,000 X 74% = $44,400 SOLUTIONS TO PROBLEMS PROBLEM 6-1A (a) The goods should not be included in inventory as they were shipped FOB shipping point and shipped February 26. Title to the goods transfers to the customer February 26. Heath should have recorded the transaction in the Sales and Accounts Receivable accounts. (b) The amount should not be included in inventory as they were shipped FOB destination and not received until March 2. The seller still owns the inventory. No entry is recorded. (c) Include $500 inventory. (d) Include $400 inventory. (e) $750 should be included in inventory as the goods were shipped FOB shipping point. (f) The sale will be recorded on March 2. The goods should be included in inventory at the end of February at their cost of $250. (g) The damaged goods should not be included in inventory. They should be recorded in a loss account since they are not saleable. 6-27 PROBLEM 6-2A (a) Date March 1 5 13 21 26 COST OF GOODS AVAILABLE FOR SALE Explanation Units Unit Cost Beginning Inventory 1,500 $ 7 Purchase 3,000 8 Purchase 5,500 9 Purchase 4,000 10 Purchase 2,000 11 Total 16,000 (b) Total Cost $ 10,500 24,000 49,500 40,000 22,000 $146,000 FIFO (1) Ending Inventory Unit Date Units Cost March 26 2,000 $11 21 1,500 10 3,500* Total Cost $22,000 15,000 $37,000 *16,000 – 12,500 = 3,500 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost March 1 1,500 $ 7 $ 10,500 5 3,000 8 24,000 13 5,500 9 49,500 21 2,500 10 25,000 12,500 $109,000 6-28 (2) Cost of Goods Sold Cost of goods available for sale $146,000 Less: Ending inventory 37,000 Cost of goods sold $109,000 PROBLEM 6-2A(Continued) LIFO (1) Ending Inventory Unit Date Units Cost March 1 1,500 $7 5 2,000 8 3,500 Total Cost $10,500 16,000 $26,500 (2) Cost of Goods Sold Cost of goods available for sale $146,000 Less: Ending inventory 26,500 Cost of goods sold $119,500 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost March 26 2,000 $11 $22,000 21 4,000 10 40,000 13 5,500 9 49,500 5 1,000 8 8,000 12,500 $119,500 AVERAGE-COST (1) Ending Inventory (2) Cost of Goods Sold $146,000 ÷ 16,000 = $9.125 Cost of goods available for sale $146,000 Unit Less: Ending Units Cost Total Cost inventory 31,938 3,500 $9.125 $31,938* Cost of goods sold $114,062 *rounded to nearest dollar (c) (1) As shown in (b) above, FIFO produces the highest inventory amount, $37,000. (2) As shown in (b) above, LIFO produces the highest cost of goods sold, $119,500. 6-29 PROBLEM 6-3A (a) Date 1/1 2/20 5/5 8/12 12/8 COST OF GOODS AVAILABLE FOR SALE Explanation Units Unit Cost Beginning Inventory 400 $ 8 Purchase 600 9 Purchase 500 10 Purchase 300 11 Purchase 200 12 Total 2,000 (b) Total Cost $ 3,200 5,400 5,000 3,300 2,400 $19,300 FIFO (1) Date 12/8 8/12 Ending Inventory Unit Units Cost 200 $12 300 11 500 Total Cost $2,400 3,300 $5,700 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost 1/1 400 $ 8 $ 3,200 2/20 600 9 5,400 10 5,000 5/5 500 1,500 $13,600 6-30 (2) Cost of Goods Sold Cost of goods available for sale $19,300 Less: Ending inventory 5,700 Cost of goods sold $13,600 PROBLEM 6-3A (Continued) (b) LIFO (1) Date 1/1 2/20 Ending Inventory Unit Units Cost 400 $8 100 9 500 Total Cost $3,200 900 $4,100 (2) Cost of Goods Sold Cost of goods available for sale $19,300 Less: Ending inventory 4,100 Cost of goods sold $15,200 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost 12/8 200 $12 $ 2,400 8/12 300 11 3,300 5/5 500 10 5,000 9 4,500 2/20 500 1,500 $15,200 AVERAGE-COST (1) Ending Inventory (2) Cost of Goods Sold Cost of goods $19,300 ÷ 2,000 = $9.65 available for sale $19,300 Unit Less: Ending Total Units Cost inventory 4,825 Cost 500 $9.65 $4,825 Cost of goods sold $14,475 Proof of Cost of Goods Sold 1,500 units X 9.65 = $14,475 (c) (1) LIFO results in the lowest inventory amount for the balance sheet, $4,100. (2) FIFO results in the lowest cost of goods sold, $13,600. 6-31 PROBLEM 6-4A (a) MORALES CO. Condensed Income Statement For the Year Ended December 31, 2008 FIFO Sales............................................................................ $865,000 Cost of goods sold Beginning inventory...................................... 32,000 Cost of goods purchased............................ 595,000 Cost of goods available for sale ............... 627,000 Ending inventory............................................ 84,000a Cost of goods sold ........................................ 543,000 Gross profit............................................................... 322,000 Operating expenses............................................... 147,000 Income before income taxes............................... 175,000 Income taxes (34%) ................................................ 59,500 Net income ................................................................ $115,500 a 30,000 X $2.80 = $84,000. b LIFO $865,000 32,000 595,000 627,000 68,000b 559,000 306,000 147,000 159,000 54,060 $104,940 $32,000 + (15,000 X $2.40) = $68,000. (b) (1) The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchase prices. (2) The LIFO method produces the most meaningful net income because the costs of the most recent purchases are matched against sales. (3) The FIFO method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. (4) There will be $5,440 additional cash available under LIFO because income taxes are $54,060 under LIFO and $59,500 under FIFO. (5) Gross profit under the average cost method will be: (a) lower than FIFO and (b) higher than LIFO. 6-32 PROBLEM 6-5A Cost of Goods Available for Sale Date Explanation October 1 Beginning Inventory 9 Purchase 17 Purchase 25 Purchase Total Ending Inventory in Units: Units available for sale Sales (100 + 60 + 110) Units remaining in ending inventory Units 60 120 70 80 330 330 270 60 Unit Cost $25 26 27 28 Total Cost $1,500 3,120 1,890 2,240 $8,750 Sales Revenue Unit Date Units Price Total Sales October 11 100 $35 $ 3,500 22 60 40 2,400 40 4,400 29 110 270 $10,300 (a) (1) LIFO (i) Ending Inventory October 1 60 @ $25 = $1,500 (iii) Gross Profit Sales revenue Cost of goods sold Gross profit $10,300 7,250 $ 3,050 (ii) Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold $8,750 1,500 $7,250 (iv) Gross Profit Rate Gross profit $ 3,050 = 29.6% Net sales $10,300 6-33 PROBLEM 6-5A (Continued) (2) FIFO (i) Ending Inventory October 25 60 @ $28 = $1,680 (iii) Gross Profit Sales revenue –Cost of goods sold Gross profit (ii) Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold $10,300 7,070 $ 3,230 $ 8,750 1,680 $ 7,070 (iv) Gross Profit Rate Gross profit $ 3,230 = 31.4% Net sales $10,300 (3) Average-Cost Weighted-average cost per unit: cost of goods available for sale units available for sale $8,750 330 (i) Ending Inventory 60 @ $26.515 = $1,591* *rounded to nearest dollar (iii) Gross Profit Sales revenue Cost of goods sold Gross profit $10,300 7,159 $ 3,141 = $26.515 (ii) Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold $8,750 1,591 $7,159 (iv) Gross Profit Rate Gross profit $ 3,141 = 30.5% Net sales $10,300 (b) LIFO produces the lowest ending inventory value, gross profit, and gross profit rate because its cost of goods sold is higher than FIFO or average-cost. 6-34 PROBLEM 6-6A (a) (1) To maximize gross profit, Bernelli Diamonds should sell the diamonds with the lowest cost. Sale Date March 5 March 25 Cost of Goods Sold 150 @ $300 $ 45,000 30 @ $350 10,500 170 @ $350 59,500 230 @ $375 86,250 580 $201,250 Sales Revenue 180 @ $600 $108,000 400 @ $650 260,000 580 $368,000 Gross profit $368,000 – $201,250 = $166,750. (2) To minimize gross profit, Bernelli Diamonds should sell the diamonds with the highest cost. Sale Date March 5 March 25 Cost of Goods Sold 180 @ $350 $ 63,000 350 @ $375 131,250 20 @ $350 7,000 30 @ $300 9,000 580 $210,250 Sales Revenue 180 @ $600 $108,000 400 @ $650 260,000 580 $368,000 Gross profit $368,000 – $210,250 = $157,750. (b) FIFO Cost of goods available for sale March 1 Beginning inventory 3 Purchase 10 Purchase Goods available for sale Units sold Ending inventory 150 @ $300 200 @ $350 350 @ $375 700 $ 45,000 70,000 131,250 $246,250 700 580 120 @ $375 $45,000 6-35 PROBLEM 6-6A (Continued) Goods available for sale – Ending inventory Cost of goods sold $246,250 45,000 $201,250 Gross profit: $368,000 – $201,250 = $166,750. (c) LIFO Cost of goods available for sale (from part b) – Ending inventory 120 @ $300 Cost of goods sold $246,250 36,000 $210,250 Gross profit: $368,000 – $210,250 = $157,750. (d) The choice of inventory method depends on the company’s objectives. Since the diamonds are marked and coded, the company could use specific identification. This could, however, result in “earnings management” by the company because, as shown, it could carefully choose which diamonds to sell to result in the maximum or minimum income. Employing a cost flow assumption, such as LIFO or FIFO, would reduce record-keeping costs. FIFO would result in higher income, but LIFO would reduce income taxes and provide better matching of current sales revenue with current costs. 6-36 PROBLEM 6-7A (a) UTLEY INC. Condensed Income Statement For the Year Ended December 31, 2008 FIFO Sales ........................................................................... $665,000 Cost of goods sold Beginning inventory ..................................... 35,000 Cost of goods purchased ........................... 504,500 Cost of goods available for sale............... 539,500 Ending inventory ........................................... 133,500a Cost of goods sold........................................ 406,000 Gross profit .............................................................. 259,000 Operating expenses............................................... 130,000 Income before income taxes .............................. 129,000 Income tax expense (28%)................................... 36,120 Net income................................................................ $ 92,880 a LIFO $665,000 35,000 504,500 539,500 115,000b 424,500 240,500 130,000 110,500 30,940 $ 79,560 (25,000 @ $4.50) + ( 5,000 @ $4.20) = $133,500. (10,000 @ $3.50) + (20,000 @ $4.00) = $115,000. b (b) Answers to questions: (1) The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchase prices. (2) The LIFO method produces the most meaningful net income because the costs of the most recent purchases are matched against sales. (3) The FIFO method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. (4) There will be $5,180 additional cash available under LIFO because income taxes are $30,940 under LIFO and $36,120 under FIFO. 6-37 PROBLEM 6-7A (Continued) (5) The illusionary gross profit is $18,500 or ($259,000 – $240,500). Under LIFO, Utley Inc. has recovered the current replacement cost of the units ($424,500), whereas under FIFO, it has only recovered the earlier costs ($406,000). This means that under FIFO the company must reinvest $18,500 of the gross profit to replace the units used. Answer in business letter form: Dear Utley Inc. After preparing the comparative condensed income statements for 2008 under FIFO and LIFO methods, we have found the following: The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchase prices. This method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. The LIFO method produces the most meaningful net income because the costs of the most recent purchases are matched against sales. There will be $5,180 additional cash available under LIFO because income taxes are $30,940 under LIFO and $36,120 under FIFO. There exists an illusionary gross profit of $18,500 ($259,000 – $240,500). Under LIFO, you have recovered the current replacement cost of the units ($424,500) whereas under FIFO you have only recovered the earlier costs ($406,000). This means that under FIFO, the company must reinvest $18,500 of the gross profit to replace the units sold. Sincerely, 6-38 *PROBLEM 6-8A (a) Cost of goods available for sale: Inventory Purchases: January 2 January 9 January 10 return January 23 Sales: Date January 6 January 9 (return) January 10 January 30 Total sales (1) LIFO Date 150 units @ $17 $ 2,550 100 75 (15 100 410 units @ $21 units @ $24 units @ $24) units @ $28 units 2,100 1,800 (360) 2,800 $ 8,890 150 (10 50 110 units @ $40 units @ $40) units @ $45 units @ $50 $ 6,000 (400) 2,250 5,500 $13,350 Purchases Cost of Goods Sold Balance January 1 (150 @ $17) $2,550 January 2 January 6 (100 @ $21) $2,100 (150 @ $17) (100 @ $21) (100 @ $17) } $4,650 January 9 January 9 January 10 ( 75 @ $24) $1,800 (110 @ $17) ( 75 @ $24) (110 @ $17) ( 60 @ $24) (110 @ $17) ( 10 @ $24) (110 @ $17) ( 10 @ $24) (100 @ $28) (110 @ $17) } $3,670 } $3,310 } $2,110 (100 @ $21) ( 50 @ $17) January 30 $2,950 (–10 @ $17) ($ 170) ( 50 @ $24) $1,200 (–15 @ $24) ($ 360) January 10 January 23 } (100 @ $28) $2,800 (100 @ $28) ( 10 @ $24) } $3,040 $1,700 } $4,910 $1,870 $7,020 (i) Cost of goods sold: $8,890 – $1,870 = $7,020. (ii) Ending inventory = $1,870. (iii) Gross profit = $13,350 – $7,020 = $6,330 6-39 *PROBLEM 6-8A (Continued) (2) FIFO Date Purchases Cost of Goods Sold January 1 January January January January 2 6 9 9 (100 @ $21) $2,100 (150 @ $17) (–10 @ $17) $2,550 ($ 170) ( 75 @ $24) $1,800 January 10 January 10 (–15 @ $24) ($ 360) January 23 (100 @ $28) $2,800 ( 10 @ $17) ( 40 @ $21) January 30 ( 60 @ $21) ( 50 @ $24) } $1,010 } $2,460 Balance (150 @ $17) (150 @ $17) (100 @ $21) (100 @ $21) ( 10 @ $17) (100 @ $21) ( 75 @ $24) ( 10 @ $17) (100 @ $21) ( 60 @ $24) ( 60 @ $21) ( 60 @ $24) ( 60 @ $21) ( 60 @ $24) (100 @ $28) ( 10 @ $24) (100 @ $28) $2,550 } $4,650 $2,100 } } $4,070 $3,710 } $2,700 } $5,500 } $3,040 $5,850 (i) Cost of goods sold: $8,890 – $3,040 = $5,850. (ii) Ending inventory = $3,040. (iii) Gross profit = $13,350 – $5,850 = $7,500. (3) Moving-Average Date January 1 January 2 January 6 January 9 January 9 January 10 January 10 January 23 January 30 Purchases (100 @ $21) Cost of goods sold (150 @ $17) (250 @ $18.60)a (150 @ $18.60) $2,790 (100 @ $18.60) (–10 @ $18.60) ($ 186) (110 @ $18.60) (185 @ $20.789) b (170 @ $20.506) c ( 50 @ $20.506) $1,025 (120 @ $20.506) (220 @ $23.914) d (110 @ $23.914) $2,631 (110 @ $23.914) $6,260 $2,100 ( 75 @ $24) $1,800 (–15 @ $24) ($ 360) (100 @ $28) $2,800 a c b d $4,650 ÷ 250 = $18.60 $3,846 ÷ 185 = $20.789 Balance $2,550 $4,650 $1,860 $2,046 $3,846 $3,486 $2,461 $5,261 $2,630 $3,486 ÷ 170 = $20.506 $5,261 ÷ 220 = $23.914 (i) Cost of goods sold: $8,890 – $2,630 = $6,260. (ii) Ending inventory = $2,630. (iii) Gross profit = $13,350 – $6,260 = $7,090. 6-40 *PROBLEM 6-8A (Continued) (b) Gross profit: Sales –Cost of goods sold Gross profit Ending inventory LIFO $13,350 7,020 $ 6,330 $ 1,870 FIFO $13,350 5,850 $ 7,500 $ 3,040 Moving-Average $13,350 6,260 $ 7,090 $ 2,630 In a period of rising costs, the LIFO cost flow assumption results in the highest cost of goods sold and lowest gross profit. FIFO gives the lowest cost of goods sold and highest gross profit. The weighted average cost flow assumption results in amounts between the other two. On the balance sheet, FIFO gives the highest ending inventory (representing the most current costs); LIFO gives the lowest ending inventory (representing the oldest costs); and average-cost results in an ending inventory falling between the other two. 6-41 *PROBLEM 6-9A (a) (1) FIFO Date May 1 4 8 Cost of Goods Sold Purchases (7 @ $150) $1,050 (4 @ $150) (8 @ $170) $600 $1,360 (3 @ $150) (2 @ $170) 12 15 (6 @ $185) Balance } $790 $1,110 20 (3 @ $170) $510 25 (3 @ $170) (1 @ $185) } $695 (2) (7 @ $150) (3 @ $150) (3 @ $150) (8 @ $170) $1,050 $ 450 } $1,810 (6 @ $170) (6 @ $170) (6 @ $185) (3 @ $170) (6 @ $185) $1,020 } $2,130 } $1,620 (5 @ $185) $ 925 AVERAGE-COST Date May 1 4 8 12 15 20 25 Cost of Goods Sold Purchases (7 @ $150) (8 @ $170) (6 @ $185) Balance $1,050 (4 @ $150) $600 (5 @ $164.55) $823 (3 @ $174.75) (4 @ $174.75) $524 $699 $1,360 $1,110 *Average-cost = $1,810 ÷ 11 (rounded) **$2,097 ÷ 12 6-42 ( 7 @ $150) ( 3 @ $150) (11 @ $164.55)* ( 6 @ $164.55) (12 @ $174.75)** ( 9 @ $174.75) ( 5 @ $174.75) $1,050 $ 450 $1,810 $ 987 $2,097 $1,573 $ 874 *PROBLEM 6-9A (Continued) (3) LIFO Date May 1 4 8 Purchases (7 @ $150) $1,050 (4 @ $150) (8 @ $170) (5 @ $170) (6 @ $185) $600 $1,360 12 15 Cost of Goods Sold $850 $1,110 20 (3 @ $185) $555 25 (3 @ $185) (1 @ $170) } $725 Balance (7 @ $150) (3 @ $150) (3 @ $150) (8 @ $170) (3 @ $150) (3 @ $170) (3 @ $150) (3 @ $170) (6 @ $185) (3 @ $150) (3 @ $170) (3 @ $185) (3 @ $150) (2 @ $170) $1,050 $ 450 } } } } } $1,810 $ 960 $2,070 $1,515 $ 790 (b) (1) The highest ending inventory is $925 under the FIFO method. (2) The lowest ending inventory is $790 under the LIFO method. 6-43 *PROBLEM 6-10A (a) February $300,000 Net sales ........................................................... Cost of goods sold Beginning inventory............................ $ 4,500 Net purchases ....................................... $197,800 Add: Freight-in..................................... 2,900 Cost of goods purchased.................. 200,700 Cost of goods available for sale ..... 205,200 Ending inventory.................................. 13,200 Cost of goods sold ...................... 192,000 Gross profit...................................................... $108,000 Gross profit rate = $108,000 = 36% $300,000 (b) Net sales ......................................................................... Less: Estimated gross profit (36% X $250,000) ........................................ Estimated cost of goods sold.................................. Beginning inventory.................................................... Net purchases ............................................................... Add: Freight-in............................................................. Cost of goods purchased.......................................... Cost of goods available for sale ............................. Less: Estimated cost of goods sold..................... Estimated total cost of ending inventory .................................................................... Less: Inventory not lost (30% X $48,200)........................................................ Estimated inventory lost in fire (70% X $48,200) ....................................................... 6-44 $250,000 90,000 $160,000 $ 13,200 $191,000 4,000 195,000 208,200 160,000 48,200 14,460 $ 33,740 *PROBLEM 6-11A (a) Sporting Goods Cost Beginning inventory Purchases Purchase returns Purchase discounts Freight-in Goods available for sale Net sales Ending inventory at retail Jewelry and Cosmetics Retail $ 47,360 $ 74,000 675,000 1,066,000 (26,000) (40,000) (12,360) 9,000 $693,000 1,100,000 (1,000,000) $ 100,000 Cost $ 39,440 $ 62,000 741,000 1,158,000 (12,000) (20,000) (2,440) 14,000 $780,000 1,200,000 (1,160,000) $ 40,000 Cost-to-retail ratio: Sporting Goods—$693,000 ÷ $1,100,000 = 63%. Jewelry and Cosmetics—$780,000 ÷ $1,200,000 = 65%. Estimated ending inventory at cost: $100,000 X 63% = $63,000—Sporting Goods. $ 40,000 X 65% = $26,000—Jewelry and Cosmetics. (b) Sporting Goods—$95,000 X 60% = $57,000. Jewelry and Cosmetics—$44,000 X 64% = $28,160. 6-45 Retail PROBLEM 6-1B (a) Title to the goods does not transfer to the customer until March 2. Include the $800 in ending inventory. (b) Slaymakker owns the goods once they are shipped on February 26. Include inventory of $375. (c) Include $500 inventory. (d) Exclude the items from Slaymakker’s inventory. Title remains with the consignor. (e) Title of the goods does not transfer to Slaymakker until March 2. Exclude this amount from the February 28 inventory. (f) The sale will be recorded on February 26. The goods (cost, $300) should be excluded from Slaymakker’s inventory at the end of February. 6-46 PROBLEM 6-2B (a) Date Oct. 1 3 9 19 25 COST OF GOODS AVAILABLE FOR SALE Explanation Units Unit Cost Beginning Inventory 1,000 $5 Purchase 3,500 6 Purchase 4,000 7 Purchase 2,000 8 9 Purchase 2,000 Total 12,500 (b) Total Cost $ 5,000 21,000 28,000 16,000 18,000 $88,000 FIFO (1) Ending Inventory Unit Date Units Cost Oct. 25 2,000 $9 19 1,000 8 3,000* Total Cost $18,000 8,000 $26,000 (2) Cost of Goods Sold Cost of goods available for sale $88,000 Less: Ending inventory 26,000 Cost of goods sold $62,000 *12,500 – 9,500 = 3,000 Date Oct. 1 3 9 19 Proof of Cost of Goods Sold Units Unit Cost Total Cost 1,000 $5 $ 5,000 3,500 6 21,000 4,000 7 28,000 1,000 8 8,000 9,500 $62,000 LIFO (1) Ending Inventory Unit Date Units Cost Oct. 1 1,000 $5 3 2,000 6 3,000 Total Cost $ 5,000 12,000 $17,000 6-47 (2) Cost of Goods Sold Cost of goods available for sale $88,000 Less: Ending inventory 17,000 Cost of goods sold $71,000 PROBLEM 6-2B (Continued) Proof of Cost of Goods Sold Unit Total Date Units Cost Cost Oct. 25 2,000 $9 $18,000 19 2,000 8 16,000 9 4,000 7 28,000 3 1,500 6 9,000 9,500 $71,000 AVERAGE COST (1) Ending Inventory (2) Cost of Goods Sold $88,000 ÷ 12,500 = $7.04 Cost of goods available for sale $88,000 Units Unit Cost Total Cost Less: Ending inventory 21,120 3,000 $7.04 $21,120 Cost of goods sold $66,880 (c) (1) FIFO results in the highest inventory amount for the balance sheet, $26,000. (2) LIFO results in the highest cost of goods sold, $71,000. 6-48 PROBLEM 6-3B (a) Date 1/1 3/15 7/20 9/4 12/2 COST OF GOODS AVAILABLE FOR SALE Explanation Units Unit Cost Beginning Inventory 100 $21 Purchase 300 24 Purchase 200 25 Purchase 300 28 Purchase 100 30 Total 1,000 (b) Total Cost $ 2,100 7,200 5,000 8,400 3,000 $25,700 FIFO (1) Date 12/2 9/4 Ending Inventory Unit Units Cost 100 $30 100 28 200 Total Cost $3,000 2,800 $5,800 (2) Cost of Goods Sold Cost of goods available for sale $25,700 Less: Ending inventory 5,800 Cost of goods sold $19,900 Proof of Cost of Goods Sold Unit Total Date Units Cost Cost 1/1 100 $21 $ 2,100 3/15 300 24 7,200 7/20 200 25 5,000 28 5,600 9/4 200 800 $19,900 (c) LIFO (1) Date 1/1 3/15 Ending Inventory Unit Units Cost 100 $21 100 24 200 Total Cost $2,100 2,400 $4,500 6-49 (2) Cost of Goods Sold Cost of goods available for sale $25,700 Less: Ending inventory 4,500 Cost of goods sold $21,200 PROBLEM 6-3B (Continued) Proof of Cost of Goods Sold Unit Total Date Units Cost Cost 12/2 100 $30 $ 3,000 9/4 300 28 8,400 7/20 200 25 5,000 3/15 200 24 4,800 800 $21,200 AVERAGE COST (1) Ending Inventory (2) Cost of Goods Sold Cost of goods available $25,700 ÷ 1,000 = $25.70 for sale $25,700 Units Unit Cost 5,140 Total Cost Less: Ending inventory 200 $25.70 $5,140 Cost of goods sold $20,560 Proof of Cost of Goods Sold 800 units X $25.70 = $20,560 (c) (1) FIFO results in the highest inventory amount, $5,800, as shown in (b) above. (2) LIFO produces the highest cost of goods sold, $21,200, as shown in (b) above. 6-50 PROBLEM 6-4B (a) GRONEMAN INC. Condensed Income Statements For the Year Ended December 31, 2008 FIFO Sales ........................................................................... Cost of goods sold Beginning inventory ..................................... Cost of goods purchased ........................... Cost of goods available for sale............... Ending inventory ........................................... Cost of goods sold........................................ Gross profit .............................................................. Operating expenses .............................................. Income before income taxes .............................. Income taxes (32%) ............................................... Net income................................................................ a LIFO $865,000 $865,000 22,800 578,500 601,300 a 53,000 548,300 316,700 147,000 169,700 54,304 $115,396 22,800 578,500 601,300 b 45,800 555,500 309,500 147,000 162,500 52,000 $110,500 20,000 X $2.65 = $53,000. $22,800 + (10,000 X $2.30) = $45,800. b (b) (1) The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchase prices. (2) The LIFO method produces the most meaningful net income because the cost of the most recent purchases are matched against sales. (3) The FIFO method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. (4) There will be $2,304 additional cash available under LIFO because income taxes are $52,000 under LIFO and $54,304 under FIFO. (5) Gross profit under the average cost method will be: (a) lower than FIFO and (b) higher than LIFO. 6-51 PROBLEM 6-5B (a) Cost of Goods Available for Sale Date Explanation June 1 Beginning Inventory June 4 Purchase June 18 Purchase June 18 Purchase return June 28 Purchase Total Ending Inventory in Units: Units available for sale —Sales (70 – 10 + 40) Units remaining in ending inventory Units 25 85 35 (5) 20 160 160 100 60 Date June 10 11 25 Unit Cost $60 64 68 68 72 Total Cost $ 1,500 5,440 2,380 (340) 1,440 $10,420 Sales Revenue Unit Units Price Total Sales 70 $90 $6,300 (10) 90 (900) 95 3,800 40 100 $9,200 (1) LIFO (i) Ending Inventory June 1 25 @ $60 4 35 @ 64 60 (iii) Gross Profit Sales revenue –Cost of goods sold Gross profit $1,500 2,240 $3,740 $9,200 6,680 $2,520 (ii) Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold $10,420 3,740 $ 6,680 (iv) Gross Profit Rate Gross profit $2,520 = 27.4% Net sales $9,200 6-52 PROBLEM 6-5B (Continued) (2) FIFO (i) Ending Inventory June 28 20 @ $72 18 30 @ $68 4 10 @ $64 60 (iii) Gross Profit Sales revenue –Cost of goods sold Gross profit $1,440 2,040 640 $4,120 $9,200 6,300 $2,900 (ii) Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold $10,420 4,120 $ 6,300 (iv) Gross Profit Rate Gross profit $2,900 = 31.5% Net sales $9,200 (3) Average-Cost Weighted-average cost per unit: Cost of goods available for sale Units available for sale $10,420 = $65.125 160 (i) Ending Inventory 60 units @$65.125 (iii) Gross Profit Sales revenue –Cost of goods sold Gross profit 3,907.50 $9,200.00 6,512.50 $2,687.50 (ii) Cost of Goods Sold Cost of goods available for sale Less: Ending inventory Cost of goods sold $10,420.00 3,907.50 $ 6,512.50 (iv) Gross Profit Rate Gross profit $2,687.50 = 29.2% Net sales $9,200.00 (b) In this period of rising prices, LIFO gives the highest cost of goods sold and the lowest gross profit. FIFO gives the lowest cost of goods sold and the highest gross profit. 6-53 PROBLEM 6-6B (a) RONDELLI INC. Income Statement (partial) For the Year Ended December 31, 2008 Sales revenuea Beginning inventory Purchasesb Cost of goods available for sale Ending inventoryc Cost of goods sold Gross profit (a) (b) (c) Specific Identification $4,230 600 3,715 4,315 1,341 2,974 $1,256 FIFO $4,230 600 3,715 LIFO $4,230 600 3,715 4,315 1,443 2,872 $1,358 4,315 1,140 3,175 $1,055 (1,800 @ $.60) + (4,500 @ $.70) (2,000 @ $.45) + (3,500 @ $.49) + (2,000 @ $.55) Specific identification ending inventory consists of: Beginning inventory (1,500 litres – 900 – 400) March 3 purchase (2,000 litres – 900 – 500) March 10 purchase (3,500 litres – 2,600) March 20 purchase (2,000 litres – 1,000) 200 @ $.40 600 @ $.45 900 @ $.49 1,000 @ $.55 2,700 litres $ 80 270 441 550 $1,341 2,000 @ $.55 700 @ $.49 2,700 litres $1,100 343 $1,443 1,500 @ $.40 1,200 @ $.45 2,700 litres $ 600 540 $1,140 FIFO ending inventory consists of: March 20 purchase March 10 purchase LIFO ending inventory consists of: Beginning inventory March 3 purchase (b) Companies can choose a cost flow method that produces the highest possible cost of goods sold and lowest gross profit to justify price increases. In this example, LIFO produces the lowest gross profit and best support to increase selling prices. 6-54 PROBLEM 6-7B (a) DAINS CO. Condensed Income Statement For the Year Ended December 31, 2008 Sales ........................................................................... Cost of goods sold Beginning inventory ..................................... Cost of goods purchased ........................... Cost of goods available for sale............... Ending inventory ........................................... Cost of goods sold........................................ Gross profit .............................................................. Operating expenses............................................... Income before income taxes .............................. Income tax expense (30%)................................... Net income................................................................ a FIFO $630,000 LIFO $630,000 37,000 479,000 516,000 a 135,000 381,000 249,000 120,000 129,000 38,700 $ 90,300 37,000 479,000 516,000 121,000b 395,000 235,000 120,000 115,000 34,500 $ 80,500 (20,000 @ $4.55) + (10,000 @ $4.40) = $135,000. (10,000 @ $3.70) + (20,000 @ $4.20) = $121,000. b (b) Answers to questions: (1) The FIFO method produces the most meaningful inventory amount for the balance sheet because the units are costed at the most recent purchase prices. (2) The LIFO method produces the most meaningful net income because the costs of the most recent purchases are matched against sales. (3) The FIFO method is most likely to approximate actual physical flow because the oldest goods are usually sold first to minimize spoilage and obsolescence. (4) There will be $4,200 additional cash available under LIFO because income taxes are $34,500 under LIFO and $38,700 under FIFO. (5) The illusionary gross profit is $14,000 or ($249,000 – $235,000). Under LIFO, Dains Co. has recovered the current replacement cost of the units ($395,000), whereas under FIFO, it has only recovered the earlier costs ($381,000). This means that, under FIFO, the company must reinvest $14,000 of the gross profit to replace the units used. 6-55 *PROBLEM 6-8B (a) Cost of goods available for sale: Inventory Purchases: January 5 January 15 January 16 (return) January 25 Sales: January 8 January 10 (return) January 20 (1) LIFO Date January 1 January 5 50 units @ $12 $ 600 100 30 (5 10 185 units @ $14 units @ $18 units @ $18) units @ $20 units 1,400 540 (90) 200 $2,650 80 (10 75 145 units @ $25 units @ $25) units @ $25 units $2,000 (250) 1,875 $3,625 Purchases Cost of Goods Sold (100 @ $14) $1,400 January 8 ( 80 @ $14) $1,120 January 10 (–10 @ $14) ($ 140) January 15 January 16 ( 30 @ $18) $ 540 ( –5 @ $18) ($ 90) ( 25 @ $18) ( 30 @ $14) ( 20 @ $12) January 20 January 25 } $1,110 ( 10 @ $20) $ 200 Balance ( 50 @ $12) ( 50 @ $12) (100 @ $14) ( 50 @ $12) ( 20 @ $14) ( 50 @ $12) ( 30 @ $14) ( 50 @ $12) ( 30 @ $14) ( 30 @ $18) ( 50 @ $12) ( 30 @ $14) ( 25 @ $18) ( 30 @ $12) ( 30 @ $12) ( 10 @ $20) $ 600 } $2,000 } $ 880 } $1,020 } } $1,560 $1,470 $ 360 }$ 560 $2,090 (i) Cost of goods sold: $2,650 – $560 = $2,090. (ii) Ending inventory = $560. (iii) Gross profit = $3,625 – $2,090 = $1,535. 6-56 *PROBLEM 6-8B (Continued) (2) FIFO Date Purchases Cost of Goods Sold January 1 January 5 ( 50 @ $12) ( 50 @ $12) (100 @ $14) (100 @ $14) $1,400 ( 50 @ $12) ( 30 @ $14) (–10 @ $14) January 8 January 10 January 15 ( 30 @ $18) $ 540 January 16 ( –5 @ $18)($ } $1,020 ($ 140) 90) January 20 January 25 Balance (75 @ $14) $1,050 ( 10 @ $20) $ 200 $ 600 } $2,000 ( 70 @ $14) $ 980 ( ( ( ( ( ( ( ( ( ( $1,120 80 @ $14) 80 @ $14) 30 @ $18) 80 @ $14) 25 @ $18) 5 @ $14) 25 @ $18) 5 @ $14) 25 @ $18) 10 @ $20) } } } } $1,660 $1,570 $ 520 $ 720 $1,930 (i) Cost of goods sold: $2,650 – $720 = $1,930. (ii) Ending inventory = $720. (iii) Gross profit = $3,625 – $1,930 = $1,695. (3) Moving-Average Date January 1 January 5 January 8 January 10 January 15 January 16 January 20 January 25 Purchases (100 @ $14) Cost of Goods Sold $1,400 ( 80 @ $13.333) $1,067* (–10 @ $13.333) ($ 133)* ( 30 @ $18) $ 540 ( –5 @ $18) ($ 90) ( 75 @ $14.438) $1,083* ( 10 @ $20) $ 200 Balance ( 50 @ $12) (150 @ $13.333)a ( 70 @ $13.333) ( 80 @ $13.333) (110 @ $14.600)b (105 @ $14.438)c ( 30 @ $14.438)d ( 40 @ $15.83) $ 600 $2,000 $ 933 $1,066 $1,606 $1,516 $ 433 $ 633 $2,017 *rounded a $2,000 ÷ 150 = $13.333 b $1,606 ÷ 110 = $14.60 c $1,516 ÷ 105 = $14.438 $633 ÷ 40 = $15.83 d (i) Cost of goods sold: $2,650 – $633 = $2,017. (ii) Ending inventory = $633. (iii) Gross profit = $3,625 – $2,017 = $1,608. 6-57 *PROBLEM 6-8B (Continued) (b) Gross profit: Sales –Cost of goods sold Gross profit Ending inventory LIFO $3,625 2,090 $1,535 $ 560 FIFO $3,625 1,930 $1,695 $ 720 Moving-Average $3,625 2,017 $1,608 $ 633 In a period of rising costs, the LIFO cost flow assumption results in the highest cost of goods sold and lowest gross profit. FIFO gives the lowest cost of goods sold and highest gross profit. The moving-average-cost flow assumption results in amounts between the other two. On the balance sheet, FIFO gives the highest ending inventory (representing the most current costs); LIFO gives the lowest ending inventory (representing the oldest costs); and average cost results in an ending inventory falling between the other two. 6-58 *PROBLEM 6-9B FIFO (1) Date July 1 6 11 Purchases (4 @ $ 90) $360 (3 @ $ 90) (5 @ $ 99) (1 @ $ 90) (1 @ $ 99) (6 @ $106) $270 $495 14 21 Cost of Goods Sold } $189 $636 27 (4 @ $ 99) (1 @ $106) (2) } $502 Balance (4 @ $ (1 @ $ (1 @ $ (5 @ $ 90) 90) 90) 99) $ 360 $ 90 }$ 585 (4 @ $ 99) (4 @ $ 99) (6 @ $106) $ 396 } $1,032 (5 @ $106) $ 530 AVERAGE-COST Date July 1 6 11 14 21 27 Cost of Goods Sold Purchases (4 @ $ 90) (5 @ $ 99) (6 @ $106) Balance $360 (3 @ $ 90) $270 (2 @ $ 97.5) $195 (5 @ $102.60) $513 $495 $636 ( 4 @ $ 90) ( 1 @ $ 90) ( 6 @ $ 97.50)* ( 4 @ $ 97.50) (10 @ $102.60)** ( 5 @ $102.60) $ 360 $ 90 $ 585 $ 390 $1,026 $ 513 *$585 ÷ 6 = $97.5 **$1,026 ÷ 10 = $102.60 (3) LIFO Date July 1 6 11 Purchases (4 @ $ 90) $360 (3 @ $ 90) (5 @ $ 99) 27 (2 @ $ 99) (6 @ $106) $270 $495 14 21 Cost of Goods Sold $198 $636 (5 @ $106) $530 Balance (4 @ $ 90) (1 @ $ 90) (1 @ $ 90) (5 @ $ 99) (1 @ $ 90) (3 @ $ 99) (1 @ $ 90) (3 @ $ 99) (6 @ $106) (1 @ $ 90) (3 @ $ 99) (1 @ $106) (b) The highest ending inventory is $530 under the FIFO method. 6-59 $ 360 $ 90 } } } } $ 585 $ 387 $1,023 $ 493 *PROBLEM 6-10B (a) Net sales ................................................................ Cost of goods sold Beginning inventory.................................. Purchases..................................................... $334,975 Less: Purchase returns and Allowances................................... (11,800) Purchase discounts ..................... (7,577) Add: Freight-in.......................................... 6,402 Cost of goods purchased........................ Cost of goods available for sale ........... Ending inventory........................................ Cost of goods sold ........................... Gross profit........................................................... Gross profit rate = November $500,000 $ 34,100 322,000 356,100 31,100 325,000 $175,000 $175,000 = 35% $500,000 (b) Net sales ......................................................... Less: Estimated gross profit (35% X $400,000) ........................ Estimated cost of goods sold.................. $400,000 Beginning inventory.................................... Purchases....................................................... Less: Purchase returns and allowances.................................... Purchase discounts ....................... Net purchases ............................................... Freight-in......................................................... Cost of goods purchased.......................... Cost of goods available for sale ............. Less: Estimated cost of goods sold ................................................. Estimated inventory lost in fire ............... $ 31,100 6-60 140,000 $260,000 $246,000 $5,000 6,000 11,000 235,000 3,700 238,700 269,800 260,000 $ 9,800 *PROBLEM 6-11B (a) Hardcovers Beginning inventory Purchases Freight-in Purchase discounts Goods available for sale Net sales Ending inventory Cost Retail $ 256,000 1,180,000 4,000 (16,000) $1,424,000 $ 400,000 1,825,000 2,225,000 1,827,000 $ 398,000 Cost-to-retail ratio: Hardcovers—$1,424,000 ÷ $2,225,000 = 64%. Paperbacks—$329,000 ÷ $470,000 = 70%. Estimated ending inventory at cost: $398,000 X 64% = $254,720—Hardcovers. $85,000 X 70% = $59,500—Paperbacks. (b) Hardcovers—$395,000 X 65% = $256,750. Paperbacks—$ 88,000 X 70% = $61,600. 6-61 Paperbacks Cost $ 65,000 266,000 2,000 (4,000) $329,000 Retail $ 90,000 380,000 470,000 385,000 $ 85,000 BYP 6-1 FINANCIAL REPORTING PROBLEM (a) Inventory December 31, 2005 $1,693 million December 25, 2004 $1,541 million (b) Dollar change in inventories between 2004 and 2005: $1,693 – $1,541 = $152.0 million increase Percent change in inventories between 2004 and 2005: $152 ÷ $1,541 = 9.9% increase 2005 inventory as a percent of current assets: $1,693 ÷ $10,454 = 16.2% (c) Inventories are valued at lower of cost or market. Cost is determined using the average, first-in, first-out (FIFO) or last-in, first-out (LIFO) methods (per Note 14 on Supplemental Financial Information). (d) PepsiCo (in millions) Cost of Goods Sold 2005 $14,176 2005 cost of goods sold as a percent of sales: $14,176 ÷ $32,562 = 43.5% 6-62 2004 $12,674 2003 $11,691 BYP 6-2 (a) 1. COMPARATIVE ANALYSIS PROBLEM Inventory turnover: PepsiCo: $14,176 ÷ Coca-Cola: $8,195 ÷ 2. $1,541 + 1,693 = 8.77 times 2 $1,420 + 1,424 = 5.76 times 2 Days in inventory: PepsiCo: 365 ÷ 8.77 = 41.6 days Coca-Cola: 365 ÷ 5.76 = 63.4 days (b) PepsiCo’s turnover of 8.77 times is approximately one and a half times as high as Coca-Cola’s 5.76 times, resulting in days in inventory of 41.6 versus 63.4. Thus, PepsiCo’s inventory control is much more effective. 6-63 BYP 6-3 EXPLORING THE WEB The following responses are based on the 2005 annual report: (a) $1,297,000,000, as of July 30, 2005. (b) $1,297,000,000 – $1,207,000,000 = $90,000,000 increase. (c) 43.9 percent ($569 ÷ $1,297). (d) Lower of cost or market using standard cost, which approximates FIFO. 6-64 BYP 6-4 DECISION MAKING ACROSS THE ORGANIZATION (a) (1) Sales per trial balance................................ Cash sales 4/1–4/10 ($18,500 X 40%) .... Acknowledged credit sales 4/1–4/10..... Sales made but unacknowledged .......... Sales as of April 10 ..................................... $180,000 7,400 37,000 5,600 $230,000 (2) Purchases per trial balance ..................... Cash purchases 4/1–4/10 .......................... Credit purchases 4/1–4/10 ........................ Less: Items in transit................................. Purchases as of April 10 ........................... $ 94,000 4,200 *(b) Net sales........................................................................... Cost of goods sold Inventory, January 1............................................ Cost of goods purchased .................................. Cost of goods available for sale...................... Inventory, December 31 ..................................... Cost of goods sold............................................... Gross profit ..................................................................... Gross profit rate............................................................. Average gross profit rate................................... $12,400 1,600 10,800 $109,000 2007 2006 $600,000 $480,000 60,000 404,000 464,000 80,000 384,000 $216,000 40,000 356,000 396,000 60,000 336,000 $144,000 36% 30% 33% *(c) Sales .................................................................................................... Less: Gross profit ($230,000 X 33%)........................................ Cost of goods sold.......................................................................... $230,000 75,900 $154,100 Inventory, January 1....................................................................... Purchases .......................................................................................... Cost of goods available for sale................................................. Cost of goods sold.......................................................................... Estimated inventory at time of fire ............................................ Less: Inventory salvaged............................................................. Estimated inventory loss .............................................................. $ 80,000 109,000 189,000 154,100 34,900 17,000 $ 17,900 6-65 BYP 6-5 COMMUNICATION ACTIVITY MEMO To: From: Janice Lemay, President Student Re: 2007 ending inventory error As you know, 2007 ending inventory was overstated by $1 million. Of course, this error will cause 2007 net income to be incorrect because the ending inventory is used to compute 2007 cost of goods sold. Since the ending inventory is subtracted in the computation of cost of goods sold, an overstatement of ending inventory results in an understatement of cost of goods sold and therefore an overstatement of net income. Unfortunately, unless corrected, this error will also affect 2008 net income. The 2007 ending inventory is also the 2008 beginning inventory. Therefore, 2008 beginning inventory is also overstated, which causes an overstatement of cost of goods sold and an understatement of 2008 net income. 6-66 BYP 6-6 ETHICS CASE (a) The higher cost of the items ordered, received, and on hand at yearend will be charged to cost of goods sold, thereby lowering current year’s income and income taxes. If the purchase at year-end had been made in the next year, the next year’s cost of goods sold would have absorbed the higher cost. Next year’s income will be increased if unit purchases (next year) are less than unit sales (next year). This is because the lower costs carried from the earlier year as inventory will be charged to next year’s cost of goods sold. Therefore, next year’s income taxes will increase. (b) No. The president would not have given the same directive because the purchase under FIFO would have had no effect on net income of the current year. (c) The accountant has no grounds for not ordering the goods if the president insists. The purchase is legal and ethical. 6-67 BYP 6-7 ALL ABOUT YOU ACTIVITY Students responses to this question will vary depending on the inventory fraud they choose to investigate. Here are responses for the two examples given in the activity. The fraud at Leslie Fay involved a number of illegal actions, all of which increased net income. The company intentionally overstated ending inventory, which has the effect of understating cost of goods sold. It also understated or completely omitted discounts and allowances that it gave to retailers. In addition, it recorded inventory costs at amounts that differed from the invoice amount. It also reported sales in incorrect periods. McKesson Corporation increased its reported net income through manipulation of inventory and sales records. It back-dated many transactions to increase current period results. It also swapped inventory to increase reported revenue. Many of the transactions that it reported as sales, and which resulted in reductions in inventory, were actually not sales because they had negotiated side agreements which allowed the buyer to return the merchandise. 6-68 CHAPTER 7 Accounting Information Systems ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises A Problems B Problems 1. Identify the basic concepts of an accounting information system. 1, 2, 3, 4 1, 2, 3 2. Describe the nature and purpose of a subsidiary ledger. 5, 6, 9, 11,16 4, 5 1, 2, 3, 4, 5, 6, 7, 9, 11, 12 1A, 2A, 3A, 4A, 5A, 6A 1B, 2B, 3B, 4B, 5B 3. Explain how companies use special journals in journalizing. 7, 8, 10, 11, 12, 13, 14, 17 6, 7, 8, 9 6, 7, 8, 10, 12 1A, 2A, 3A, 4A, 5A, 6A 1B, 2B, 3B, 4B, 5B 4. Indicate how companies post a multi-column journal. 12, 15 10 1, 3, 9, 11, 13, 14 1A, 2A, 3A, 4A, 5A, 6A 1B, 2B, 3B, 4B, 5B 7-1 Exercises ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Journalize transactions in cash receipts journal; post to control account and subsidiary ledger. Simple 30–40 2A Journalize transactions in cash payments journal; post to control account and subsidiary ledgers. Simple 30–40 3A Journalize transactions in multi-column purchases journal; post to the general and subsidiary ledgers. Moderate 40–50 4A Journalize transactions in special journals. Moderate 50–60 5A Journalize in sales and cash receipts journals; post; prepare a trial balance; prove control to subsidiary; prepare adjusting entries; prepare an adjusted trial balance. Moderate 60–70 6A Journalize in special journals; post; prepare a trial balance. Complex 60–70 1B Journalize transactions in cash receipts journal; post to control account and subsidiary ledger. Simple 30–40 2B Journalize transactions in cash payments journal; post to the general and subsidiary ledgers. Simple 30–40 3B Journalize transactions in multi-column purchases journal; post to the general and subsidiary ledgers. Moderate 40–50 4B Journalize transactions in special journals. Moderate 50–60 5B Journalize in purchases and cash payments journals; post; prepare a trial balance; prove control to subsidiary; prepare adjusting entries; prepare an adjusted trial balance. Moderate 60–70 7-2 Study Objective Knowledge Comprehension Q7-1 Q7-2 Q7-3 Q7-4 Application 2. Describe the nature and purpose of a subsidiary ledger. 3. Explain how companies use special journals in journalizing. Q7-7 Q7-8 Q7-10 Q7-12 Q7-13 Q7-14 Q7-17 4. Indicate how companies post a multi-column journal. Q7-12 Q7-15 BE7-10 E7-11 E7-1 E7-3 E7-9 E7-13 E7-14 P7-1A Exploring the Web Financial Reporting (Mini Practice Set) 7-3 Identify the basic concepts of an accounting information system. Broadening Your Perspective Synthesis Evaluation BE7-1 BE7-2 BE7-3 1. Q7-5 Analysis E7-1 E7-3 E7-4 E7-5 E7-6 E7-7 E7-9 Q7-6 Q7-9 Q7-16 BE7-4 BE7-5 E7-2 E7-11 BE7-6 E7-6 BE7-7 E7-7 BE7-8 E7-10 BE7-9 E7-12 E7-8 P7-1A E7-10 P7-2A P7-3A E7-11 E7-12 P7-1A P7-2A P7-3A P7-4A P7-5A P7-6A Q7-11 P7-1B P7-2B P7-3B P7-4B P7-5B P7-4A P7-5BQ7-11 P7-5A P7-6A P7-1B P7-2B P7-3B P7-4B P7-2A P7-3A P7-4A P7-5A P7-6A P7-1B P7-2B P7-3B P7-4B P7-5B Decision Making Across the Organization Communication Ethics Case All About You BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. (a) An accounting information system collects and processes transaction data and communicates financial information to decision makers. (b) Disagree. An accounting information system applies regardless of whether manual or computerized procedures are used to process the transaction data. 2. There are three principles for developing an accounting information system: Cost effectiveness. The system must be cost-effective; that is, the benefits obtained from the information must outweigh the cost of providing it. Useful output. To be useful, information must be understandable, relevant, reliable, timely, and accurate. Flexibility. The system should accommodate a variety of users and changing information needs. 3. Common features of a computerizied accounting package beyond recording transactions and preparing financial statements are: easy data access and report preparation; audit trail, internal controls, customization; and network compatibility. 4. ERP systems go far beyond the functions of an entry level general ledger package. They integrate all aspects of the organization, including accounting, sales, human resource management, and manufacturing. 5. A subsidiary ledger is a group of accounts with a common characteristic. The accounts are assembled together to facilitate the accounting process by freeing the general ledger from details concerning individual balances. The advantages of using subsidiary ledgers are that they:
Permit transactions affecting a single customer or single creditor to be shown in a single account, thus providing necessary up-to-date information on specific account balances.
Free the general ledger of excessive details relating to accounts receivable and accounts

6. payable. As a result, a trial balance of the general ledger does not contain potentially thousands and thousands of individual account balances. Assist in locating errors in individual accounts by reducing the number of accounts in one ledger and by using control accounts. Permit a division of labor in posting by having one employee post to the general ledger and (a) different employee(s) post to the subsidiary ledgers. (a) (1) Transactions to individual accounts are generally posted daily to the subsidiary ledger. (2) In contrast, postings to the control accounts are usually made in total at the end of the month. (b) A control account is a general ledger account that summarizes subsidiary ledger data. Subsidiary ledger accounts keep track of specific account activity (i.e., specific debtors or creditors). A subsidiary ledger is an addition to, and an expansion of, the general ledger. 7-4 Questions Chapter 7 (Continued) 7. Sales journal. Records entries for all sales of merchandise on account. Cash receipts journal. Records entries for all cash received by the business. Purchases journal. Records entries for all purchases of merchandise on account. Cash payments journal. Records entries for all cash paid. Some advantages of each journal are given below:
Sales journal. (1) Since the sales journal employs only one line to record a Sales transaction,


its use reduces recording time; (2) the column totals are only posted to the general ledger once an accounting period; and (3) the journal’s use separates responsibilities between employees. Cash receipts journal. (1) Its use aids in the posting process since the totals for Cash, Sales Discounts, Accounts Receivable, and Sales are all recorded in the general ledger only at the end of the month; and (2) it allows all accounts receivable credits to be posted to the appropriate subsidiary ledger accounts daily. Purchases journal. The advantages are similar to those of the sales journal except that items involved are Merchandise Inventory debits and Accounts Payable credits. Cash payments journal. Similar advantages to cash receipts journal except the columns involved are different. In general, special journals: (1) allow greater division of labor because various individuals can record entries in different journals at the same time; and (2) reduce posting time of journals. 8. The entry for the sales return should be recorded in the general journal. Since Thogmartin Company has a single-column sales journal, only credit sales can be recorded there. A purchase by Thogmartin Company has not taken place, so the use of the purchases journal is inappropriate. Finally, no cash is received or paid, so neither the cash receipts or cash payments journal should be used. 9. At the end of the month, after all postings to both the general ledger and the subsidiary accounts have been made, the total of the subsidiary account balances should equal the balance of the control account in the general ledger. In this case, the control account balance will be $450 larger than the total of the subsidiary accounts. 10. The purpose of special journals is to facilitate the recording process of the business entity. Therefore, the columns included in any special journal should correspond to the unique needs of the entity. In particular, one type of business which might not require an Accounts Receivable column would be grocery stores. These businesses rarely sell on credit to their customers. The minimum frequency of the transaction implies no need for an Accounts Receivable column in the cash receipts journal. 11. (a) No, the customers’ ledger will not agree with the Accounts Receivable control account. The customers’ ledger will be posted correctly, but the Accounts Receivable control account will be incorrect. (b) The trial balance will balance, although Cash will be $4,000 too high and Accounts Receivable $4,000 too low. 12. The special journal is the sales journal. The other account is Sales. (The cash receipts journal is an incorrect answer because there would be more than two month-end postings to general ledger accounts.) 7-5 Questions Chapter 7 (Continued) 13. (a) General journal. (b) General journal. (c) Cash receipts journal. (d) Sales journal. (e) Cash receipts journal. (f) General journal. 14. (a) Cash receipts journal. (b) Cash receipts journal. (c) General journal. (d) Purchases journal. (e) General journal. (f) Cash payments journal. 15. Typically included would be credit purchases of equipment, office supplies, and store supplies. However, any other item purchased on credit could also be included in a special column or the “other” column. 16. One such example is a purchase return. Here the Accounts Payable control and subsidiary account must be debited for the same amount. The debit/credit equality is unaffected since the balance sheet equation is computed using general ledger (control) accounts only. The subsidiary accounts should prove to the control account balance. 17. The general journal may be used to record such transactions as the granting of credit to a customer for a sales return or allowance, the receipt of credit from a supplier for purchases returned, acceptance of a note receivable from a customer, or the purchase of a plant asset by issuing a note payable. In addition, all correcting, adjusting, and closing entries should be made in the general journal. 7-6 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 7-1 1. 2. 3. True. False. True. BRIEF EXERCISE 7-2 1. 2. 3. (e) (d) (a) 4. (b) 5. (c) BRIEF EXERCISE 7-3 1. 2. 3. 4. True. False. The benefits obtained from information provided by the accounting information system must outweigh the cost of providing that information. True. False. An accounting information system must be cost effective, provide useful output, and be flexible enough to accommodate changing information needs. BRIEF EXERCISE 7-4 Accounts Receivable Subsidiary Ledger Date Jan. 7 17 Date Jan. 15 24 Date Jan. 23 29 Ref. Ref. Ref. General Ledger Agler Co. Debit Credit 10,000 7,000 Balance Date 10,000 Jan. 31 3,000 31 Barto Co. Debit Credit 6,000 4,000 Balance 6,000 2,000 Maris Co. Debit Credit 9,000 9,000 Balance 9,000 0 7-7 Accounts Receivable Ref. Debit Credit 25,000 20,000 Balance 25,000 5,000 BRIEF EXERCISE 7-5 1. 2. General ledger Subsidiary ledger 3. General ledger 4. Subsidiary ledger BRIEF EXERCISE 7-6 1. 2. 3. Cash Receipts Journal Cash Payments Journal Cash Payments Journal 4. Sales Journal 5. Purchases Journal 6. Cash Receipts Journal BRIEF EXERCISE 7-7 1. 2. No Yes 3. Yes 4. No BRIEF EXERCISE 7-8 1. 2. 3. 4. General Journal (if a one-column Purchases Journal) Purchases Journal (if a multi-column Purchases Journal) Purchases Journal Cash Payments Journal Sales Journal BRIEF EXERCISE 7-9 1. 2. 3. 4. 5. Cash Receipts Journal Cash Receipts Journal Cash Receipts Journal Sales Journal and Cash Receipts Journal Purchases Journal BRIEF EXERCISE 7-10 1. 2. Both in total and daily In total 3. In total 4. Only daily 7-8 SOLUTIONS TO EXERCISES EXERCISE 7-1 (a) $350,400. Beginning balance of $320,000 plus $161,400 debit from sales journal less $131,000 credit from cash receipts journal. (b) $85,900. Beginning balance of $77,000 plus $56,400 credit from purchases journal less $47,500 debit from cash payments journal. (c) The column total of $161,400 in the sales journal would be posted to the credit side of the Sales account and the debit side of the Accounts Receivable account in the general ledger. (d) The accounts receivable column total of $131,000 in the cash receipts journal would be posted to the credit side of the Accounts Receivable account in the general ledger. EXERCISE 7-2 To: Andrea Barden, Chief Financial Officer From: Student Subject: Jeremy Dody account The explanation of the three entries in the subsidiary ledger for the Jeremy Dody account is as follows: Sept. 2 This was a credit sale of merchandise to Dody. The entry was recorded on page 31 of the Sales Journal. Sept. 9 This was a sales return or allowance granted to Dody. The entry was recorded on page 4 of the General Journal. Sept. 27 This was a payment by Dody of the balance due. The entry was recorded on page 8 of the Cash Receipts Journal. If I can be of further help, please let me know. 7-9 EXERCISE 7-3 (a) & (b) General Ledger Accounts Receivable Date Sept. 1 Explanation Balance Ref.
S CR G Debit Credit 4,490 7,030 220 Balance 10,960 15,450 8,420 8,200 Accounts Receivable Subsidiary Ledger Bannister Date Sept. 1 Explanation Balance Ref.
S CR Debit Credit 1,100 1,310 Balance 2,060 3,160 1,850 Crampton Date Sept. 1 Explanation Balance Ref.
S CR G Debit Ref. Debit S CR 1,330 Ref.
CR Debit Credit 800 2,300 220 Balance 4,820 5,620 3,320 3,100 Iman Date Sept. 1 Explanation Credit 380 Balance 0 1,330 950 Kingston Date Sept. 1 Explanation Balance 7-10 Credit 1,800 Balance 2,640 840 EXERCISE 7-3 (Continued) Ruiz Date Sept. 1 Explanation Balance (c) Ref.
S CR Debit Credit 1,260 1,240 Balance 1,440 2,700 1,460 SEAVER COMPANY Schedule of Customers As of September 30, 2008 Bannister .................................................................................................. Crampton.................................................................................................. Iman............................................................................................................ Kingston ................................................................................................... Ruiz............................................................................................................. Total................................................................................................... $1,850 3,100 950 840 1,460 $8,200 Accounts Receivable............................................................................ $8,200 EXERCISE 7-4 (a) (b) (c) (d) $4,500 [$11,000 – ($4,000 + $2,500). $13,000 [$11,000 + ($9,000 + $7,000 + $8,500) – ($8,000 + $2,500 + $9,000) – $3,000]. Smith ($4,000 + $9,000 – $8,000) $ 5,000 Green ($2,500 + $7,000 – $2,500 – $3,000) 4,000 Koyan ($4,500 + $8,500 – $9,000) 4,000 $13,000 The sales return ($3,000) would be recorded in the general journal. EXERCISE 7-5 (a) (b) (c) (d) $3,375 [$8,250 – ($3,000 + $1,875). $9,750 [$8,250 + ($6,750 + $5,250 + $6,375) – ($6,000 + $1,875 + $6,750) – $2,250]. Jones ($3,000 + $6,750 – $6,000) $3,750 Brown ($1,875 + $5,250 – $1,875 – $2,250) 3,000 Aatski ($3,375 + $6,375 – $6,750) 3,000 $9,750 The purchase return ($2,250) would be recorded in the general journal. 7-11 EXERCISE 7-6 (a) & (b) MONTALVO COMPANY Sales Journal S1 Date Account Debited 2008 Sept. 2 T. Hossfeld 21 P. Lowther Invoice Accounts Receivable Dr. Cost of Goods Sold Dr. No. Ref. Sales Cr. Merchandise Inventory Cr. 101 102 720 800 1,520 420 480 900 MONTALVO COMPANY Purchases Journal Date Account Credited 2008 Sept. 10 25 L. Rincon W. Barone Terms Ref. P1 Merchandise Inventory Dr. Accounts Payable Cr. 2/10, n/30 n/30 600 860 1,460 EXERCISE 7-7 (a) & (b) PHERIGO CO. Cash Receipts Journal CR1 Date Account Credited 2008 May 1 I. Pherigo, Cap. 2 22 M. Moody Ref. Cash Dr. 50,000 6,300 9,000 65,300 Sales Accounts Discounts Receivable Sales Dr. Cr. Cr. Cost of Goods Sold Other Dr. Accounts Merchandise Inventory Cr. Cr. 50,000 6,300 9,000 9,000 7-12 6,300 4,200 50,000 4,200 EXERCISE 7-7 (Continued) PHERIGO CO. Cash Payments Journal CP1 Other Accounts Ref. Dr. Date Ck. No. Account Debited 2008 May 3 14 101 102 Merchandise Inventory Salary Expense 7,200 700 7,900 Accounts Payable Dr. Cash Cr. 7,200 700 7,900 EXERCISE 7-8 (a) Journal 1. Cash Payments 2. Cash Receipts 3. Cash Payments 4. Cash Payments 5. 6. 7. 8. 9. 10. Cash Receipts Cash Payments Cash Payments Cash Receipts Cash Payments Cash Receipts (b) Columns in the journal Cash (Cr.), Other Accounts (Dr.). Cash (Dr.), Sales Discounts (Dr.), and Accounts Receivable (Cr.). Cash (Cr.), Other Accounts (Dr.). Cash (Cr.), Merchandise Inventory (Cr.), and Accounts Payable (Dr.). Cash (Dr.), Accounts Receivable (Cr.). Cash (Cr.), Other Accounts (Dr.). Cash (Cr.), Other Accounts (Dr.). Cash (Dr.), Other Accounts (Cr.). Cash (Cr.), Other Accounts (Dr.). Cash (Dr.), Sales (Cr.), Cost of Goods Sold (Dr.), and Merchandise Inventory (Cr.). 7-13 EXERCISE 7-9 (a) Mar. 2 5 7 (b) To: Equipment ............................................................... Accounts Payable—Chang Company .................................................... 9,400 Accounts Payable—Lyden Company ............................................................. Merchandise Inventory............................... 9,400 410 410 Sales Returns and Allowances......................... Accounts Receivable—Higley Company .................................................... 400 Merchandise Inventory........................................ Cost of Goods Sold ..................................... 260 400 260 President Velasquez From: Chief Accountant Subject: Posting of Control and Subsidiary Accounts The posting of these accounts varies with the journals used in recording the transactions. Sales and purchases journals—the total for the month is posted to the control accounts. The individual entries are posted daily to the subsidiary accounts. Columnar cash receipts and cash payments journals—the total of the control account column for the month is posted to the control account. The individual amounts in the column are posted daily to the subsidiary accounts. General journal—the individual entries are posted daily. Each entry that pertains to a control and a subsidiary account is dual posted. That is, it is posted to both the control account and the subsidiary account. I hope this memo answers your questions about posting. 7-14 EXERCISE 7-10 1. 2. 3. 4. 5. 6. 7. Cash Payments Journal General Journal Cash Receipts Journal Cash Receipts Journal Sales Journal Cash Receipts Journal General Journal 8. 9. 10. 11. 12. 13. Cash Receipts Journal Cash Payments Journal General Journal General Journal Cash Payments Journal Purchases Journal EXERCISE 7-11 (a) The debit posting reference on February 28 should be from the cash payments journal to record the payments made during the month. The general ledger debit amount should be $29,340 to balance. Tebbetts’ ending balance must be $2,600. (Accounts Payable control balance of $9,500 less Perez, $4,600, and Zerbe, $2,300.) (b) Only the general journal amounts were dual posted. Thus, the amounts were $1,400 (Dr.), $265 (Cr.), and $550 (Cr.). EXERCISE 7-12 (a) Purchases Journal Date Account Credited July 3 12 14 17 20 21 29 Brian Co. Erik Co. Drago Co. Chacon Corp. Brian Co. Erik Co. Chacon Corp. Ref.






7-15 P1 Merchandise Inventory Dr. Accounts Payable Cr. 2,400 500 1,100 1,400 700 600 1,600 8,300 120/201 EXERCISE 7-12 (Continued) (b) General Journal Date July 1 Accounts and Explanations Store Equipment ................................... Accounts Payable—Albin Equipment Co. ........................ Ref. 153/ Debit 3,900
201/
Credit 3,900 15 Merchandise Inventory ....................... 120/ 400 Accounts Payable—Heinen
Inc. .............................................. 201/
400 (This entry should have been recorded in the Purchases Journal.) 18 Accounts Payable—Chacon Corp...................................................... Merchandise Inventory.............
201/
120/ 100 Accounts Payable—Drago Co. ........ Merchandise Inventory.............
201/
120/ 200 25 100 200 EXERCISE 7-13 $925 ($200 + $240 + $145 + $190 + $150). All of the debit postings to the subsidiary ledger accounts should be from sales invoices. The total of all these debits should therefore be the total credit sales for the month, which would be the same amount as the end-of-month debit to Accounts Receivable. EXERCISE 7-14 (a) (b) (c) (d) (e) $14,000 + $72,000 – $46,000 = $40,000 $22,000 + $100,000 – $45,000 = $77,000 $17,000 + $61,000 – $55,000 = $23,000 $13,500 + $72,000 – $1,000 – $63,600 = $20,900 $100,000 + $6,000 = $106,000 7-16 SOLUTIONS TO PROBLEMS PROBLEM 7-1A (a) Cash Receipts Journal CR1 Account Credited Date Ref. Apr. 1 O. Grider, Capital 301 4 Baez
5 Eggleston Co.
8
10 Ogden 11 Merchandise 120 Inventory 23 Eggleston Co.

29 Chelsea Cash Dr. 7,200 1,764 920 7,245 600 740 1,500 1,200 21,169 (101) (b) Cost of Goods Sold Sales Accounts Other Dr. Discounts Receivable Sales Accounts Merchandise Inventory Dr. Cr. Cr. Cr. Cr. 7,200 36 1,800 920 7,245 4,347 600 740 36 (414) 1,500 1,200 6,020 (112) 7,245 (401) 7,940 (X) 4,347 (505)(120) General Ledger Accounts Receivable Date Apr. 1 30 Explanation Balance No. 112 Ref.
CR1 Debit Credit 6,020 Balance 7,450 1,430 Accounts Receivable Subsidiary Ledger Ogden Date Apr. 1 10 Explanation Balance Ref.
CR1 7-17 Debit Credit 600 Balance 1,550 950 PROBLEM 7-1A (Continued) Chelsea Date Apr. 1 29 Explanation Balance Ref.
CR1 Debit Ref.
CR1 CR1 Debit Ref.
CR1 Debit Credit 1,200 Balance 1,200 0 Eggleston Co. Date Apr. 1 5 23 Explanation Balance Credit 920 1,500 Balance 2,900 1,980 480 Baez Date Apr. 1 4 Explanation Balance 1,800 (c) Accounts receivable balance: $1,430 Subsidiary account balances: Ogden Eggleston Co. Total $ 950 480 $1,430 7-18 Credit Balance 1,800 0 PROBLEM 7-2A (a) Cash Payments Journal CP1 Date Ck. No. Account Debited Oct. 1 3 5 10 15 16 19 29 63 64 65 66 67 68 69 70 Merch. Inventory Equipment Bovary Company Merch. Inventory Pyron Co. T. Ming, Drawing Nyman Co. Sims Company (b) Other Accounts Merchandise Accounts Payable Inventory Dr. Cr. Ref. Dr. 120 157
120 300 800 2,700
1,800 306

54 2,250 400 3,750 (X) 1,600 2,500 8,600 (201) 32 86 (120) 300 800 2,646 2,250 1,800 400 1,568 2,500 12,264 (101) General Ledger Accounts Payable Date Oct. Cash Cr. 1 31 No. 201 Explanation Balance Ref.
CP1 Debit Credit 8,600 Balance 10,700 2,100 Accounts Payable Subsidiary Ledger Bovary Company Date Explanation Oct. 1 Balance 5 Ref.
CP1 7-19 Debit 2,700 Credit Balance 2,700 0 PROBLEM 7-2A (Continued) Nyman Co. Date Oct. 1 19 Explanation Balance Ref.
CP1 Debit Credit Balance 2,500 900 Credit Balance 1,800 0 Credit Balance 3,700 1,200 1,600 Pyron Co. Date Oct. 1 15 Explanation Balance Ref.
CP1 Debit 1,800 Sims Company Date Oct. 1 29 Explanation Balance Ref.
CP1 (c) Accounts payable balance: Debit 2,500 $2,100 Subsidiary account balances: Nyman Co. Sims Company $ 900 1,200 $2,100 7-20 PROBLEM 7-3A (a) Purchases Journal P1 Date Account Credited (Debited) July 1 2 5 13 Fritz Company Wayward Shipping Moon Company Cress Supply (Supplies) Fritz Company Anton Company Lynda Advertisements (Advertising Expense) Moon Company Cress Supply (Equipment) Wayward Shipping 15 15 18 24 26 28 Ref. Accounts Merchandise Other Payable Inventory Accounts Cr. Dr. Dr.


8,000 400 3,200 720 8,000 400 3,200

3,600 3,300 600 3,600 3,300
3,000 900 3,000 380 24,100 (201) 380 21,880 (120) 126/
610/
157/

720 600 900 2,220 (X) Sales Journal S1 Date Account Debited July 3 3 16 16 21 21 30 Pinick Company Wayne Bros. Sager Company Wayne Bros. Pinick Company Haddad Company Sager Company Accounts Receivable Dr. Cost of Goods Sold Dr. Ref. Sales Cr. Merchandise Inventory Cr.






1,300 1,500 3,450 1,570 310 2,800 5,600 16,530 (112)(401) 7-21 910 1,050 2,415 1,099 217 1,960 3,920 11,571 (505)(120) PROBLEM 7-3A (Continued) General Journal G1 Date July 8 22 Accounts and Explanations Ref. Accounts Payable—Moon
Company............................................... 201/
Merchandise Inventory............... 120/ Debit Sales Returns and Allowances 412/
Accounts Receivable— 112/
Pinick Company ....................... 40 (b) Accounts Receivable Date July 31 22 Explanation 300 300 40 General Ledger No. 112 Ref. S1 G1 Debit 16,530 Credit 40 Merchandise Inventory Date July 31 8 31 Explanation Balance 16,530 16,490 No. 120 Ref. P1 G1 S1 Debit 21,880 Credit 300 11,571 Supplies Date July 13 Credit Balance 21,880 21,580 10,009 No. 126 Explanation Ref. P1 7-22 Debit 720 Credit Balance 720 PROBLEM 7-3A (Continued) Equipment Date July 26 Explanation No. 157 Ref. P1 Debit 900 Credit Accounts Payable Date July 31 8 Explanation No. 201 Ref. P1 G1 Debit Credit 24,100 300 Sales Date July 31 Explanation Ref. S1 Debit Credit 16,530 Explanation Explanation Ref. G1 Debit 40 Credit Explanation Balance 40 No. 505 Ref. S1 Debit 11,571 Credit Advertising Expense Date July 18 Balance 16,530 No. 412 Cost of Goods Sold Date July 31 Balance 24,100 23,800 No. 401 Sales Returns and Allowances Date July 22 Balance 900 Balance 11,571 No. 610 Ref. P1 7-23 Debit 600 Credit Balance 600 PROBLEM 7-3A (Continued) Accounts Receivable Subsidiary Ledger Wayne Bros. Date July Explanation 3 16 Ref. S1 S1 Debit 1,500 1,570 Credit Balance 1,500 3,070 Ref. S1 S1 G1 Debit 1,300 310 Credit Balance 1,300 1,610 1,570 Ref. S1 S1 Debit 3,450 5,600 Credit Balance 3,450 9,050 Ref. S1 Debit 2,800 Credit Balance 2,800 Pinick Company Date July Explanation 3 21 22 40 Sager Company Date July 16 30 Explanation Haddad Company Date July 21 Explanation Accounts Payable Subsidiary Ledger Cress Supply Date Explanation July 13 26 Ref. P1 P1 7-24 Debit Credit 720 900 Balance 720 1,620 PROBLEM 7-3A (Continued) Wayward Shipping Date July Explanation 2 28 Ref. P1 P1 Debit Credit 400 380 Balance 400 780 Ref. P1 P1 Debit Credit 8,000 3,600 Balance 8,000 11,600 Ref. P1 G1 P1 Debit Credit 3,200 3,000 Balance 3,200 2,900 5,900 Ref. P1 Debit Credit 600 Balance 600 Ref. P1 Debit Credit 3,300 Balance 3,300 Fritz Company Date July Explanation 1 15 Moon Company Date July Explanation 5 8 24 300 Lynda Advertisements Date July 18 Explanation Anton Company Date July 15 Explanation 7-25 PROBLEM 7-3A (Continued) (c) Accounts receivable balance ....................................... Subsidiary account balances Wayne Bros............................................................... Pinick Company....................................................... Sager Company ....................................................... Haddad Company.................................................... Total .................................................................... $16,490 $3,070 1,570 9,050 2,800 $16,490 Accounts payable balance............................................ Subsidiary account balances Cress Supply ............................................................ Wayward Shipping.................................................. Fritz Company .......................................................... Moon Company........................................................ Lynda Advertisements .......................................... Anton Company....................................................... Total .................................................................... 7-26 $23,800 $ 1,620 780 11,600 5,900 600 3,300 $23,800 PROBLEM 7-4A (a), (b) & (c) Sales Journal S1 Account Debited Date Jan. 4 9 17 31 Milam Connor Corp. Bullock Co. Milam Invoice Accounts Receivable Dr. Cost of Goods Sold Dr. No. Ref. Sales Cr. Merchandise Inventory Cr. 371 372 373 374



3,150 3,840 720 5,598 13,308 (505)(120) 5,250 6,400 1,200 9,330 22,180 (112)(401) Purchases Journal Date Account Credited Jan. 3 8 11 23 24 Wortham Co. Noyes Co. Betz Co. Wortham Co. Forgetta Corp. Ref.




P1 Merchandise Inventory Dr. Accounts Payable Cr. 10,000 4,500 3,700 7,800 5,100 31,100 (120)(201) General Journal G1 Date Jan. 5 19 Accounts and Explanations Ref.
Accounts Payable—Wortham Co. .......... 201/
Merchandise Inventory ................ 120 Debit 300 Equipment.................................................. Accounts Payable—Murphy Corp............................................... 5,500 7-27 157/ 
201/
Credit 300 5,500 PROBLEM 7-4A (Continued) Cash Receipts Journal CR1 Date Account Credited Jan. 6 13 15 Connor Corp. 17 Milam 20 27 30 Bullock Co. Ref.


Sales Accounts Discounts Receivable Dr. Cr. Cash Dr. 3,150 6,260 6,336 5,250 3,200 4,230 1,200 29,626 (101) 64 64 (414) Sales Cr. Cost of Goods Sold Other Dr. Accounts Merchandise Inventory Cr. Cr. 3,150 6,260 1,890 3,756 3,200 4,230 1,920 2,538 6,400 5,250 1,200 12,850 (112) 16,840 (401) 0 (X) 10,104 (505)(120) Cash Payments Journal CP1 Date Account Debited Jan. 4 13 15 20 31 Supplies Wortham Co. Salaries Expense Noyes Co. Salaries Expense Other Accounts Dr. Ref. 126 80
726 9,700 194 4,500 90 14,200 (201) 284 (120) 14,300
726 Accounts Merchandise Inventory Payable Cr. Dr. 13,200 27,580 (X) 7-28 Cash Cr. 80 9,506 14,300 4,410 13,200 41,496 (101) PROBLEM 7-5A (a), (d) & (g) Cash Date July 31 31 Explanation Accounts Receivable Date Explanation July 31 31 General Ledger Ref. CR1 CP1 Ref. S1 CR1 Debit 101,035 Credit 39,066 Debit 19,700 Credit 14,700 Merchandise Inventory Date July 31 29 31 31 31 Explanation Store Supplies Date Explanation July 4 31 Adjusting entry Prepaid Rent Date Explanation July 11 31 Adjusting entry No. 101 Balance 101,035 61,969 No. 112 Balance 19,700 5,000 No. 120 Ref. P1 CR1 CP1 S1 CR1 Ref. CP1 G1 Ref. CP1 G1 7-29 Debit 44,020 Credit 420 234 12,805 3,900 Debit 600 Credit 460 Debit 6,000 Credit 500 Balance 44,020 43,600 43,366 30,561 26,661 No. 127 Balance 600 140 No. 131 Balance 6,000 5,500 PROBLEM 7-5A (Continued) Accounts Payable Date July 31 31 Explanation No. 201 Ref. P1 CP1 Debit Credit 44,020 30,200 Reyes, Capital Date July Explanation 1 No. 301 Ref. CR1 Debit Credit 80,000 Reyes, Drawing Date July 19 Explanation Ref. CP1 Debit 2,500 Credit Balance 2,500 No. 401 Explanation Sales Discounts Date Explanation July 31 Ref. S1 CR1 Ref. CR1 Debit Debit 85 Credit 19,700 6,000 Balance 19,700 25,700 Credit No. 414 Balance 85 Cost of Goods Sold Date July 31 31 Balance 80,000 No. 306 Sales Date July 31 31 Balance 44,020 13,820 Explanation No. 505 Ref. S1 CR1 7-30 Debit 12,805 3,900 Credit Balance 12,805 16,705 PROBLEM 7-5A (Continued) Supplies Expense Date July 31 No. 631 Explanation Adjusting entry Ref. G1 Debit 460 Credit Rent Expense Date July 31 Balance 460 No. 729 Explanation Adjusting entry Ref. G1 (b) Debit 500 Credit Balance 500 Sales Journal S1 Date Account Debited July 6 8 10 21 Ewing Co. S. Beauty W. Pitts H. Prince Ref. Accounts Receivable Dr. Cost of Goods Sold Dr. Sales Cr. Merchandise Inventory Cr.



4,030 2,340 3,185 3,250 12,805 (505)(120) 6,200 3,600 4,900 5,000 19,700 (112)(401) Cash Receipts Journal CR1 Date Account Credited July 1 Reyes, Capital 7 13 S. Beauty 16 W. Pitts 20 Ewing Co. 29 Merchandise Inventory Ref. 301


120 Cash Dr. 80,000 6,000 3,564 4,851 6,200 420 101,035 (101) Cost of Goods Sold Sales Accounts Other Dr. Discounts Receivable Sales Accounts Merchandise Inventory Dr. Cr. Cr. Cr. Cr. 80,000 6,000 36 49 3,600 4,900 6,200 85 (414) 14,700 (112) 7-31 6,000 (401) 3,900 420 80,420 (X) 3,900 (505)(120) PROBLEM 7-5A (Continued) (c) Accounts Receivable Subsidiary Ledger Ewing Co. Date July Explanation Ref. S1 CR1 Debit 6,200 Explanation Ref. S1 Debit 5000 Credit Balance 5,000 Explanation Ref. S1 CR1 Debit 4,900 Credit Balance 4,900 0 Ref. S1 CR1 Debit 3,600 6 20 Credit 6,200 Balance 6,200 0 H. Prince Date July 21 W. Pitts Date July 10 16 4,900 S. Beauty Date July Explanation 8 13 Credit 3,600 Balance 3,600 0 Accounts Payable Subsidiary Ledger C. Tabor Date July 13 21 Explanation Ref. P1 CP1 Debit Credit 15,300 Balance 15,300 0 Credit 8,100 Balance 8,100 0 15,300 A. Ernst Date July Explanation 5 10 Ref. P1 CP1 7-32 Debit 8,100 PROBLEM 7-5A (Continued) M. Sneezy Date July 20 Explanation Ref. P1 Debit Credit 7,900 Balance 7,900 Ref. P1 CP1 Debit Credit 6,800 Balance 6,800 0 Ref. P1 Debit Credit 5,920 Balance 5,920 G. Clemens Date July Explanation 4 15 6,800 J. Happy Date July 11 (e) Explanation REYES CO. Trial Balance July 31, 2008 Cash ............................................................................ Accounts Receivable............................................. Merchandise Inventory ......................................... Store Supplies ......................................................... Prepaid Rent............................................................. Accounts Payable................................................... Reyes, Capital.......................................................... Reyes, Drawing ....................................................... Sales ........................................................................... Sales Discounts ...................................................... Cost of Goods Sold................................................ 7-33 Debit $ 61,969 5,000 26,661 600 6,000 Credit $ 13,820 80,000 2,500 25,700 85 16,705 $119,520 $119,520 PROBLEM 7-5A (Continued) (f) Accounts receivable balance ......................................................... $ 5,000 Subsidiary accounts balance H. Prince....................................................................................... $ 5,000 Accounts payable balance.............................................................. $13,820 Subsidiary accounts balance M. Sneezy..................................................................................... J. Happy........................................................................................ $ 7,900 5,920 $13,820 (g) General Journal G1 Date July 31 31 Accounts and Explanations Supplies Expense.................................. Store Supplies.............................. Ref. 631 127 Debit 460 Rent Expense.......................................... Prepaid Rent ................................. 729 131 500 7-34 Credit 460 500 PROBLEM 7-5A (Continued) (h) REYES CO. Adjusted Trial Balance July 31, 2008 Cash ........................................................................... Accounts Receivable............................................ Merchandise Inventory ........................................ Store Supplies......................................................... Prepaid Rent ............................................................ Accounts Payable.................................................. Reyes, Capital ......................................................... Reyes, Drawing....................................................... Sales........................................................................... Sales Discounts...................................................... Cost of Goods Sold............................................... Supplies Expense .................................................. Rent Expense .......................................................... 7-35 Debit $ 61,969 5,000 26,661 140 5,500 Credit $ 13,820 80,000 2,500 25,700 85 16,705 460 500 $119,520 $119,520 PROBLEM 7-6A (b) & (c) Cash Receipts Journal CR1 Date Account Credited Jan. 7 13 23 29 T. Dudley M. Rensing Notes Receivable Ref.

115 Cash Dr. 3,500 4,900 9,100 40,000 57,500 (101) Sales Discounts Dr. Accounts Receivable Cr. 100 3,500 5,000 Sales Cr. Other Accounts Cr. Cost of Goods Sold Dr. Merchandise Inventory Cr. 9,100 0 100 (414) 8,500 (112) 9,100 (401) 5,460 40,000 40,000 (X) 5,460 (505)(120) Cash Payments Journal CP1 Date Account Debited Other Accounts Merchandise Accounts Payable Inventory Ref. Dr. Dr. Cr. Jan. 11 12 15 18 18 27 Merchandise Inventory Rent Expense K. Inwood Sales Salaries Expense Office Salaries Expense E. Vietti 120 729
726 727
300 1,000 15,000 150 950 15,950 (201) 150 (120) 2,800 2,000 6,100 (X) Cash Cr. 300 1,000 14,850 2,800 2,000 950 21,900 (101) Sales Journal S1 Date Account Debited Jan. 3 M. Rensing 24 F. Cone Ref.

Accounts Receivable Dr. Cost of Goods Sold Dr. Sales Cr. Merchandise Inventory Cr. 5,000 7,400 12,400 (112)(401) 7-36 3,000 4,440 7,440 (505)(120) PROBLEM 7-6A (Continued) Purchases Journal Date Account Credited Jan. 5 17 E. Vietti G. Marley P1 Merchandise Inventory Dr. Accounts Payable Cr. Ref.

2,000 1,600 3,600 (120)(201) General Journal G1 Date Jan. 14 20 30 Accounts and Explanations Sales Returns and Allowances......... Accounts Receivable— J. Anders................................... Merchandise Inventory........................ ($300 X .60) Cost of Goods Sold.................... Ref. /412 Accounts Payable—D. Goodman .... Notes Payable ..............................
/201 /200 18,000 Accounts Payable—G. Marley .......... Merchandise Inventory .............
/201 120 300
/112 /120 Debit 300 Credit 300 180 180 /505 18,000 300 (a) & (c) General Ledger Cash Date Jan. No. 101 1 31 31 Explanation Balance Ref.
CR1 CP1 7-37 Debit Credit 57,500 21,900 Balance 41,500 99,000 77,100 PROBLEM 7-6A (Continued) Accounts Receivable Date Jan. 1 14 31 31 Explanation Balance Notes Receivable Date Explanation Jan. 1 Balance 29 No. 112 Ref.
G1 CR1 S1 Ref.
CR1 Debit Credit 300 8,500 12,400 Debit Credit 40,000 Merchandise Inventory Date Jan. 1 11 14 30 31 31 31 31 Explanation Balance 1 Explanation Balance No. 115 Balance 45,000 5,000 No. 120 Ref.
CP1 G1 G1 P1 CP1 CR1 S1 Debit Credit 300 180 300 3,600 150 5,460 7,440 Equipment Date Jan. Balance 15,000 14,700 6,200 18,600 Balance 23,000 23,300 23,480 23,180 26,780 26,630 21,170 13,730 No. 157 Ref.
Accumulated Depreciation—Equipment Date Explanation Ref. Jan. 1 Balance
7-38 Debit Debit Credit Credit Balance 6,450 No. 158 Balance 1,500 PROBLEM 7-6A (Continued) Notes Payable Date Jan. 20 Explanation Accounts Payable Date Explanation Jan. 1 Balance 20 30 31 31 No. 200 Ref. G1 Ref.
G1 G1 P1 CP1 Debit Debit Credit 18,000 Credit 18,000 300 3,600 15,950 B. Cortez, Capital Date Jan. 1 Sales Date Jan. 31 31 Explanation Balance Explanation Explanation Sales Discounts Date Explanation Jan. 31 No. 201 Balance 43,000 25,000 24,700 28,300 12,350 No. 301 Ref.
Ref. CR1 S1 Debit Debit Credit Credit 9,100 12,400 Sales Returns and Allowances Date Jan. 14 Balance 18,000 Balance 86,450 No. 401 Balance 9,100 21,500 No. 412 Ref. G1 Ref. CR1 7-39 Debit 300 Debit 100 Credit Credit Balance 300 No. 414 Balance 100 PROBLEM 7-6A (Continued) Cost of Goods Sold Date Jan. 31 31 14 Explanation No. 505 Ref. CR1 S1 G1 Debit 5,460 7,440 Credit 180 Sales Salaries Expense Date Jan. 18 Explanation No. 726 Ref. CP1 Debit 2,800 Credit Office Salaries Expense Date Jan. 18 Explanation Balance 2,800 No. 727 Ref. CP1 Debit 2,000 Credit Rent Expense Date Jan. 12 Balance 5,460 12,900 12,720 Balance 2,000 No. 729 Explanation Ref. CP1 Debit 1,000 Credit Balance 1,000 Accounts Receivable Subsidiary Ledger J. Anders Date Jan. 1 14 Explanation Balance Ref.
G1 Debit Ref.
S1 Debit Credit 300 Balance 2,500 2,200 F. Cone Date Jan. 1 24 Explanation Balance 7-40 7,400 Credit Balance 7,500 14,900 PROBLEM 7-6A (Continued) T. Dudley Date Jan. 1 7 Explanation Balance Ref.
CR1 Debit Ref. S1 CR1 Debit 5,000 Credit 3,500 Balance 5,000 1,500 M. Rensing Date Jan. Explanation 3 13 Credit 5,000 Balance 5,000 0 Accounts Payable Subsidiary Ledger G. Marley Date Jan. 17 30 Explanation J. Feeney Date Explanation Jan. 1 Balance Ref. P1 G1 Debit Credit 1,600 Balance 1,600 1,300 Ref.
Debit Credit Balance 10,000 Ref.
G1 Debit Credit Balance 18,000 0 Credit Balance 15,000 0 300 D. Goodman Date Jan. 1 20 Explanation Balance 18,000 K. Inwood Date Jan. 1 15 Explanation Balance Ref.
CP1 7-41 Debit 15,000 PROBLEM 7-6A (Continued) E. Vietti Date Jan. (d) Explanation 5 27 Ref. P1 CP1 Debit Credit 2,000 950 Balance 2,000 1,050 CORTEZ CO. Trial Balance January 31, 2009 Cash ............................................................................ Accounts Receivable............................................. Notes Receivable .................................................... Merchandise Inventory.......................................... Equipment ................................................................. Accumulated Depreciation—Equipment......... Notes Payable .......................................................... Accounts Payable................................................... B. Cortez, Capital .................................................... Sales............................................................................ Sales Returns and Allowances........................... Sales Discounts....................................................... Cost of Goods Sold ................................................ Sales Salaries Expense......................................... Office Salaries Expense........................................ Rent Expense ........................................................... Debit $ 77,100 18,600 5,000 13,730 6,450 $ 300 100 12,720 2,800 2,000 1,000 $139,800 (e) Accounts Receivable Subsidiary Ledger J. Anders ....................................................................................... F. Cone........................................................................................... T. Dudley ....................................................................................... Accounts Receivable Control ......................................................... 7-42 Credit 1,500 18,000 12,350 86,450 21,500 $139,800 $ 2,200 14,900 1,500 $18,600 $18,600 PROBLEM 7-6A (Continued) Accounts Payable Subsidiary Ledger G. Marley........................................................................................ J. Feeney........................................................................................ E. Vietti ........................................................................................... Accounts Payable Control................................................................ 7-43 $ 1,300 10,000 1,050 $12,350 $12,350 PROBLEM 7-1B (a) Cash Receipts Journal CR1 Date Account Credited Sales Accounts Cash Discounts Receivable Ref. Dr. Dr. Cr. June 1 J. Darby, Capital 301 10,000 1,274 3 Lenninger Co.
1,862
6 Farley Co. 6,135 7 2,450 9 Deering & Son
11 Merchandise 320 120 Inventory 4,500 15 1,600
20 Grinnell Bros. 28,141 (101) (b) Sales Cr. Cost of Goods Sold Other Dr. Accounts Merchandise Inventory Cr. Cr. 10,000 26 38 1,300 1,900 50 2,500 6,135 4,090 320 4,500 114 (414) 1,600 7,300 (112) 10,635 (401) 3,000 10,320 (X) General Ledger Accounts Receivable Date June 7,090 (505/120) 1 30 Explanation Balance No. 112 Ref.
CR1 Debit Credit 7,300 Balance 7,300 0 Accounts Receivable Subsidiary Ledger Deering & Son Date June 1 9 Explanation Balance Ref.
CR1 7-44 Debit Credit 2,500 Balance 2,500 0 PROBLEM 7-1B (Continued) Farley Co. Date June 1 6 Explanation Balance Ref.
CR1 Debit Ref.
CR1 Debit Ref.
CR1 Debit Credit 1,900 Balance 1,900 0 Grinnell Bros. Date June 1 20 Explanation Balance Credit 1,600 Balance 1,600 0 Lenninger Co. Date June 1 3 Explanation Balance (c) Accounts receivable balance = 0. Sum of all subsidiary accounts = 0. 7-45 Credit 1,300 Balance 1,300 0 PROBLEM 7-2B (a) Cash Payments Journal CP1 Date Ck. No. Account Debited Nov. 1 3 5 11 15 16 19 25 30 11 12 13 14 15 16 17 18 19 Merch. Inventory Equipment Wex Bros. Merch. Inventory G. Ruttan B. Gonya, Drawing C. Kimberlin Prepaid Insurance A. Hess & Co. Other Accounts Ref. Dr. 120 157
120
306
130
1,140 1,700 1,500 15 1,000 30 1,150 23 2,000 500 3,000 8,340 (X) (b) Accounts Merchandise Payable Inventory Dr. Cr. 3,500 7,150 (201) 00 68 (120) Cash Cr. 1,140 1,700 1,485 2,000 970 500 1,127 3,000 3,500 15,422 (101) General Ledger Accounts Payable Date Explanation Nov. 1 Balance 30 Ref.
CP1 Debit Credit 7,150 No. 201 Balance 9,350 2,200 Accounts Payable Subsidiary Ledger A. Hess & Co. Date Explanation Nov. 1 Balance 30 Ref.
CP1 7-46 Debit 3,500 Credit Balance 4,500 1,000 PROBLEM 7-2B (Continued) C. Kimberlin Date Nov. 1 19 Explanation Balance Ref.
CP1 Debit Credit Balance 2,350 1,200 Credit Balance 1,000 0 Credit Balance 1,500 0 1,150 G. Ruttan Date Nov. 1 15 Explanation Balance Ref.
CP1 Debit 1,000 Wex Bros. Date Nov. 1 5 Explanation Balance Ref.
CP1 (c) Accounts payable balance: Debit 1,500 $2,200 Subsidiary account balances: A. Hess & Co. C. Kimberlin $1,000 1,200 $2,200 7-47 PROBLEM 7-3B (a) Purchases Journal P1 Ref. Accounts Merchandise Other Payable Inventory Accounts Cr. Dr. Dr. Date Account Credited (Debited) May 2 3 8 8 15 16 16 18 25 28
Younger Company
Ruden Freight
Utley Company
Zeider Company 126/
Rodriguez Supply (Supplies)
Younger Company
Utley Company
Ruden Freight Amster Advertising (Adv. Exp.) 610/
Rodriguez Supply (Equipment) 157/
0 7,500 360 8,000 8,700 900 4,500 7,200 500 900 500 39,060 (201) 7,500 360 8,000 8,700 900 4,500 7,200 500 36,760 (120) 900 500 2,300 (X) Sales Journal S1 Date Account Debited May 5 5 5 23 23 Ellie Company DeShazer Bros. Liu Company DeShazer Bros. Liu Company Accounts Receivable Dr. Ref. Sales Cr.




1,980 2,700 1,500 2,400 3,600 12,180 (112)(401) 7-48 Cost of Goods Sold Dr. Merchandise Inventory Cr. 1,287 1,755 975 1,560 2,340 7,917 (505)(120) PROBLEM 7-3B (Continued) General Journal Date May 10 17 20 26 Accounts and Explanations Accounts Payable—Zeider Company ............................................. Merchandise Inventory ............. Ref. Debit
201/
120/ 500 Accounts Payable—Rodriguez Supply .................................................. Supplies.........................................
201/
126 100 Accounts Payable—Younger Company ............................................. Merchandise Inventory .............
201/
120/ 300 Sales Returns and Allowances......... Accounts Receivable— Liu Company ........................... 412/ 
112/
200 (b) 500 100 300 200 General Ledger Accounts Receivable Date May 31 26 Explanation No. 112 Ref. S1 G1 Debit 12,180 Credit 200 Merchandise Inventory Date May 31 10 20 31 Credit Explanation Balance 12,180 11,980 No. 120 Ref. P1 G1 G1 S1 7-49 Debit 36,760 Credit 500 300 7,917 Balance 36,760 36,260 35,960 28,043 PROBLEM 7-3B (Continued) Supplies Date May 15 17 No. 126 Explanation Equipment Date Explanation May 28 Ref. P1 G1 Ref. P1 Debit 900 Credit 100 Debit 500 Credit Accounts Payable Date May 31 10 17 20 Explanation Ref. P1 G1 G1 G1 Debit Credit 39,060 500 100 300 Explanation Explanation Cost of Goods Sold Date Explanation May 31 Ref. S1 Debit Credit 12,180 Explanation Balance 12,180 No. 412 Ref. G1 Ref. S1 Debit 200 Debit 7,917 Credit Credit Advertising Expense Date May 25 Balance 39,060 38,560 38,460 38,160 No. 401 Sales Returns and Allowances Date May 26 No. 157 Balance 500 No. 201 Sales Date May 31 Balance 900 800 Balance 200 No. 505 Balance 7,917 No. 610 Ref. P1 7-50 Debit 900 Credit Balance 900 PROBLEM 7-3B (Continued) Accounts Receivable Subsidiary Ledger Ellie Company Date May Explanation 5 Ref. S1 Debit 1,980 Credit Balance 1,980 Ref. S1 S1 Debit 2,700 2,400 Credit Balance 2,700 5,100 Ref. S1 S1 G1 Debit 1,500 3,600 Credit 200 Balance 1,500 5,100 4,900 DeShazer Bros. Date May 5 23 Explanation Liu Company Date May Explanation 5 23 26 Accounts Payable Subsidiary Ledger Ruden Freight Date May Explanation 3 18 Ref. P1 P1 Debit Credit 360 500 Balance 360 860 Ref. P1 P1 G1 Debit Credit 7,500 4,500 Balance 7,500 12,000 11,700 Younger Company Date May 2 16 20 Explanation 7-51 300 PROBLEM 7-3B (Continued) Rodriguez Supply Date May 15 17 28 Explanation Ref. P1 G1 P1 Debit Ref. P1 P1 Credit 900 500 Balance 900 800 1,300 Debit Credit 8,000 7,200 Balance 8,000 15,200 Ref. P1 G1 Debit Credit 8,700 Balance 8,700 8,200 Ref. P1 Debit Credit 900 Balance 900 100 Utley Company Date May Explanation 8 16 Zeider Company Date May Explanation 8 10 500 Amster Advertising Date May 25 Explanation (c) Accounts receivable balance ........................................ Subsidiary account balances Ellie Company ........................................................... DeShazer Bros. ......................................................... Liu Company.............................................................. Total ..................................................................... Accounts payable balance............................................. 7-52 $11,980 $1,980 5,100 4,900 $11,980 $38,160 PROBLEM 7-3B (Continued) Subsidiary account balances Ruden Freight .......................................................... Younger Company.................................................. Rodriguez Supply ................................................... Utley Company ........................................................ Zeider Company ...................................................... Amster Advertising ................................................ Total.................................................................... 7-53 $ 860 11,700 1,300 15,200 8,200 900 $38,160 PROBLEM 7-4B (a), (b) & (c) Sales Journal S1 Date Account Debited Oct. 4 17 25 30 Enos Co. G. Richter & Co. Hunt Corp. G. Richter & Co. Invoice Accounts Receivable Dr. Cost of Goods Sold Dr. No. Ref. Sales Cr. Merchandise Inventory Cr.



204 205 206 207 7,700 5,350 5,220 4,600 22,870 (112)(401) 5,390 3,745 3,654 3,220 16,009 (505)(120) Purchases Journal Date Account Credited Oct. 2 10 27 30 Camacho Company Finn Corp. Kudro Co. Camacho Company Ref.



P1 Merchandise Inventory Dr. Accounts Payable Cr. 16,500 3,500 8,500 14,000 42,500 (120)(201) General Journal Date Oct. 13 25 Accounts and Explanations Accounts Payable—Finn Corp. ...................................................... Merchandise Inventory.............. Supplies .................................................... Accounts Payable— Robinson Co. .......................... 7-54 Ref. Debit
201/
120/ 210 126/
201/
260 G1 Credit 210 260 PROBLEM 7-4B (Continued) Cash Receipts Journal CR1 Account Credited Date Oct. 7 12 14 16 21 25 Enos Co. Land G. Richter & Co. Ref.
140
28 Cash Dr. Sales Accounts Discounts Receivable Dr. Cr. Cost of Goods Sold Other Dr. Sales Accounts Merchandise Inventory Cr. Cr. Cr. 9,160 9,160 7,546 8,180 27,000 8,200 154 6,412 7,700 8,180 5,726 27,000 8,200 107 5,243 7,540 000 72,869 261 (101) (414) 5,740 5,350 00 13,050 (112) 7,540 33,080 (401) 5,278 23,156 (505)(120) 27,000 (X) Cash Payments Journal CP1 Date Account Debited Ref. Oct. 5 9 18 Supplies Camacho Co. Merchandise Inventory Finn Corp. Land Buildings Advertising Expense 126 23 26 30 Other Accounts Dr. Merchandise Inventory Cr. Cash Cr. 330 80 16,170 80 16,500
120 Accounts Payable Dr. 2,125 3,290 2,125 3,290
140 145 21,000 14,000 35,000 610 400 37,605 (X) 400 57,065 (101) 7-55 19,790 (201) 330 (120) PROBLEM 7-5B (b) Purchases Journal Date Account Credited Feb. 2 7 16 21 J. Vopat P. Kneiser J. Nunez G. Reedy P1 Merchandise Inventory Dr. Accounts Payable Cr. Ref.



4,600 30,000 2,400 7,800 44,800 (120)(201) Cash Payments Journal CP1 Other Accounts Dr. Date Account Debited Ref. Feb. 9 12 15 17 20 Supplies J. Vopat Equipment P. Kneiser A. Wyrick, Drawing J. Nunez 126
157
1,250 306
1,100 28 Accounts Payable Dr. 4,600 92 30,000 300 392 (120) 1,100 2,400 45,958 (101) 2,400 37,000 (201) General Ledger Cash Date Feb. 28 28 Cash Cr. 1,250 4,508 7,000 29,700 7,000 9,350 (X) (a), (d) & (g) Merchandise Inventory Cr. No. 101 Explanation Ref. CR1 CP1 7-56 Debit 48,595 Credit 45,958 Balance 48,595 2,637 PROBLEM 7-5B (Continued) Accounts Receivable Date Feb. 28 28 Explanation No. 112 Ref. S1 CR1 Debit 27,000 Credit 12,000 Merchandise Inventory Date Feb. 28 18 28 28 28 Explanation No. 120 Ref. P1 CR1 CP1 S1 CR1 Debit 44,800 Credit 150 392 17,820 4,290 Supplies Date Feb. Adjusting entry Equipment Date Explanation Feb. 15 Ref. CP1 G1 Ref. CP1 Debit 1,250 Credit 950 Debit 7,000 Credit Accumulated Depreciation—Equipment Date Feb. 28 Explanation Adjusting entry Ref. G1 Explanation Balance 1,250 300 No. 157 Balance 7,000 No. 158 Debit Credit 200 Accounts Payable Date Feb. 28 28 Balance 44,800 44,650 44,258 26,438 22,148 No. 126 Explanation 9 28 Balance 27,000 15,000 Balance 200 No. 201 Ref. P1 CP1 7-57 Debit 37,000 Credit 44,800 Balance 44,800 7,800 PROBLEM 7-5B (Continued) A. Wyrick, Capital Date Feb. Explanation 1 No. 301 Ref. CR1 Debit Credit 30,000 A. Wyrick, Drawing Date Feb. 20 Explanation No. 306 Ref. CP1 Debit 1,100 Credit Sales Date Feb. 28 28 Explanation Explanation Cost of Goods Sold Date Explanation Feb. 28 28 Ref. S1 CR1 Debit Credit 27,000 6,500 Explanation Adjusting entry Ref. CR1 Ref. S1 CR1 Debit 55 Debit 17,820 4,290 Credit Credit Explanation Adjusting entry Balance 55 No. 505 Balance 17,820 22,110 No. 631 Ref. G1 Debit 950 Credit Depreciation Expense Date Feb. 28 Balance 27,000 33,500 No. 414 Supplies Expense Date Feb. 28 Balance 1,100 No. 401 Sales Discounts Date Feb. 28 Balance 30,000 Balance 950 No. 711 Ref. G1 7-58 Debit 200 Credit Balance 200 PROBLEM 7-5B (Continued) (c) Accounts Receivable Subsidiary Ledger S. Arndt Date Feb. Explanation Ref. S1 CR1 Debit 5,500 Explanation Ref. S1 Debit 8,000 Credit Balance 8,000 Explanation Ref. S1 CR1 Debit 6,500 Credit Balance 6,500 0 Ref. S1 Debit 7,000 3 13 Credit 5,500 Balance 5,500 0 F. Catt Date Feb. 12 C. Boyd Date Feb. 9 26 6,500 M. Didde Date Feb. 26 Explanation Credit Balance 7,000 Accounts Payable Subsidiary Ledger G. Reedy Date Feb. 21 Explanation Ref. P1 Debit Credit 7,800 Balance 7,800 Explanation Ref. P1 CP1 Debit Credit 4,600 Balance 4,600 0 J. Vopat Date Feb. 2 12 7-59 4,600 PROBLEM 7-5B (Continued) P. Kneiser Date Feb. Explanation 7 17 Ref. P1 CP1 Debit Credit 30,000 Balance 30,000 0 Credit 2,400 Balance 2,400 0 30,000 J. Nunez Date Feb. 16 28 (e) Explanation Ref. P1 CP1 Debit 2,400 WYRICK CO. Trial Balance February 28, 2008 Cash.................................................................................. Accounts Receivable .................................................. Merchandise Inventory............................................... Supplies .......................................................................... Equipment ...................................................................... Accounts Payable ........................................................ A. Wyrick, Capital......................................................... A. Wyrick, Drawing ...................................................... Sales................................................................................. Sales Discounts............................................................ Cost of Goods Sold ..................................................... 7-60 Debit $ 2,637 15,000 22,148 1,250 7,000 Credit $ 7,800 30,000 1,100 33,500 55 22,110 $71,300 $71,300 PROBLEM 7-5B (Continued) (f) Accounts Receivable control account.................... Accounts Receivable subsidiary accounts F. Catt........................................................................ M. Didde ................................................................... $15,000 $8,000 7,000 $15,000 Accounts Payable control account.......................... $ 7,800 Accounts Payable subsidiary account G. Reedy................................................................... $ 7,800 (g) General Journal G1 Date Feb. 28 28 Accounts and Explanations Supplies Expense ................................. Supplies......................................... Ref. 631 126 Debit 950 Depreciation Expense ......................... Accumulated Depreciation— Equipment................................ 711 200 7-61 158 Credit 950 200 PROBLEM 7-5B (Continued) (h) WYRICK CO. Adjusted Trial Balance February 28, 2008 Cash.................................................................................. Accounts Receivable .................................................. Merchandise Inventory............................................... Supplies .......................................................................... Equipment ...................................................................... Accumulated Depreciation—Equipment .............. Accounts Payable ........................................................ A. Wyrick, Capital......................................................... A. Wyrick, Drawing ...................................................... Sales................................................................................. Sales Discounts............................................................ Cost of Goods Sold ..................................................... Supplies Expense ........................................................ Depreciation Expense ................................................ 7-62 Debit $ 2,637 15,000 22,148 300 7,000 Credit $ 200 7,800 30,000 1,100 33,500 55 22,110 950 200 $71,500 $71,500 COMPREHENSIVE PROBLEM: CHAPTERS 3 TO 7 Note: If the working papers that accompany this text are not used in solving this problem, account numbers may differ from those presented in this solution. (a) Sales Journal Date Account Debited Jan. 3 3 11 11 22 22 25 25 B. Remy J. Fine R. Draves S. Ingles B. Remy R. Draves B. Hachinski J. Fine Invoice No. 510 511 512 513 514 515 516 517 Ref.







S1 Accounts Receivable Dr. Sales Cr. 3,100 1,800 1,900 900 3,700 800 3,500 6,100 21,800 (112)(401) Purchases Journal P1 Date Account Credited Jan. 5 5 16 16 16 27 27 27 S. Yost D. Laux D. Moreno S. Kosko S. Yost D. Moreno D. Laux S. Yost Terms 7-63 Ref.







Purchases Dr. Accounts Payable Cr. 3,000 2,700 15,000 13,900 1,500 12,500 1,200 2,800 52,600 (510)(201) COMPREHENSIVE PROBLEM (Continued) Cash Receipts Journal CR1 Date Jan. 7 7 10 13 13 20 21 31 Account Credited Ref. S. Ingles B. Hachinski

B. Remy J. Fine


S. Ingles Accounts Receivable Cr. Cash Dr. Sales Cr. Other Accounts Cr. 4,000 2,000 4,000 2,000 15,500 3,100 1,500 17,500 900 22,920 67,420 (101) 15,500 3,100 1,500 17,500 900 11,500 (112) 22,920 55,920 (401) Cash Payments Journal CP1 Date Jan. 8 9 9 12 15 17 23 23 28 31 31 Account Debited Freight In S. Kosko D. Moreno Rent Expense I. Packard, Drawing Ref. 516 Other Accounts Dr. Office Supplies Dr. 180

729 306 Accounts Payable Dr. 9,000 11,000 1,000 800 400 D. Moreno S. Kosko

15,000 13,700 200 Sales Salaries Expense Office Salaries Expense 627 727 4,300 3,600 9,880 (X) 7-64 48,700 (201) 600 (125) Cash Cr. 180 9,000 11,000 1,000 800 400 15,000 13,700 200 4,300 3,600 59,180 (101) COMPREHENSIVE PROBLEM (Continued) (a) & (e) General Journal G1 Date Jan. 9 18 21 Account Titles and Explanations Sales Returns and Allowances ......................................... Accounts Receivable— J. Fine......................................... (Issued credit for merchandise returned) Accounts Payable—S. Kosko ........... Purchase Returns and Allowances ............................... (Received credit for returned goods) Accounts Payable— R. Mikush............................................. Notes Payable .............................. (Issued note for balance due) Ref. 412 Debit 300
112/

201/
300 200 512
201/
200 Credit 200 15,000 15,000 Adjusting Entries 31 31 31 31 Office Supplies Expense .................... Office Supplies ............................ 728 125 900 Insurance Expense............................... (1/10 X 2,000) Prepaid Insurance ...................... 722/ 200 200 130/ Depreciation Expense ......................... (1/12 X 1,500) Accumulated Depreciation— Equipment 711 Interest Expense.................................... Interest Payable........................... 718 230 7-65 900 125 158 125 30 30 COMPREHENSIVE PROBLEM (Continued) General Journal G1 Date Jan. 31 31 31 31 Account Titles and Explanations Merchandise Inventory (Jan. 31) ...... Sales .......................................................... Purchase Returns and Allowances.......................................... Income Summary ........................ Ref. 120 401 Debit 15,000 77,720 512 350 200 Income Summary................................... Merchandise Inventory (Jan. 1)........................................ Sales Returns and Allowances................................ Purchases...................................... Freight In ........................................ Rent Expense ............................... Sales Salaries Expense............. Office Salaries Expense............ Office Supplies Expense .......... Insurance Expense ..................... Depreciation Expense................ Interest Expense.......................... 350 83,235 Income Summary................................... I. Packard, Capital ....................... 350 301 9,685 I. Packard, Capital.................................. I. Packard, Drawing..................... 301 306 800 (b) & (e) Cash Date Jan. 1 31 31 Credit 92,920 120 20,000 412 510 516 729 627 727 728 722 711 718 300 52,600 180 1,000 4,300 3,600 900 200 125 30 9,685 800 General Ledger Explanation Balance Ref.
CR1 CP1 7-66 Debit Credit 67,420 59,180 No. 101 Balance 33,750 101,170 41,990 COMPREHENSIVE PROBLEM (Continued) Accounts Receivable Date Jan. 1 31 31 9 Explanation Balance No. 112 Ref.
S1 CR1 G1 Debit Credit 21,800 11,500 300 Notes Receivable Date Jan. 1 Explanation Balance No. 115 Ref.
Debit Credit Merchandise Inventory Date Jan. 1 31 31 Explanation Balance 1 31 31 Explanation Balance Ref.
G1 G1 Debit Credit 15,000 20,000 1 31 Explanation Balance Ref.
CP1 G1 Debit Credit 600 900 Explanation 1 Balance 1,000 1,600 700 No. 130 Ref.
G1 Debit Credit 200 Equipment Date Jan. Balance 20,000 35,000 15,000 No. 125 Prepaid Insurance Date Jan. Balance 39,000 No. 120 Office Supplies Date Jan. Balance 13,000 34,800 23,300 23,000 Balance 2,000 1,800 No. 157 Ref.
7-67 Debit Credit Balance 6,450 COMPREHENSIVE PROBLEM (Continued) Accumulated Depreciation—Equipment Date Jan. 1 31 Explanation Balance Ref.
G1 No. 158 Debit Credit 125 Notes Payable Date Jan. 21 Explanation Balance No. 200 Ref. G1 Debit Credit 15,000 Accounts Payable Date Jan. 1 31 31 18 21 Explanation Balance Explanation Ref.
P1 CP1 G1 G1 Debit Credit 52,600 48,700 200 15,000 1 31 31 Explanation Balance Ref. G1 Debit Credit 30 Explanation Balance 30 No. 301 Ref.
G1 G1 Debit Credit 9,685 800 I. Packard, Drawing Date Jan. 15 31 Balance 35,000 87,600 38,900 38,700 23,700 No. 230 I. Packard, Capital Date Jan. Balance 15,000 No. 201 Interest Payable Date Jan. 31 Balance 1,500 1,625 Balance 78,700 88,385 87,585 No. 306 Ref. CP1 G1 7-68 Debit 800 Credit 800 Balance 800 0 COMPREHENSIVE PROBLEM (Continued) Income Summary Date Jan. 31 31 31 Explanation No. 350 Ref. G1 G1 G1 Debit Credit 92,920 83,235 9,685 Sales No. 401 Date Jan. 31 31 31 Explanation Ref. S1 CR1 G1 Debit Credit 21,800 55,920 77,720 Sales Returns and Allowances Date Jan. Explanation 9 31 Date Jan. 31 31 Explanation Ref. G1 G1 Debit 300 Credit 300 Explanation Ref. P1 G1 Debit 52,600 Credit 52,600 Balance 52,600 0 No. 512 Ref. G1 G1 Debit Credit 200 200 Freight-In Balance 200 0 No. 516 Explanation 8 31 Balance 300 0 No. 510 Purchase Returns and Allowances Date Jan. 18 31 Balance 21,800 77,720 0 No. 412 Purchases Date Jan. Balance 92,920 9,685 0 Ref. CP1 G1 7-69 Debit 180 Credit 180 Balance 180 0 COMPREHENSIVE PROBLEM (Continued) Sales Salaries Expense Date Jan. 31 31 Explanation No. 627 Ref. CP1 G1 Debit 4,300 Credit 4,300 Depreciation Expense Date Jan. 31 31 Explanation No. 711 Ref. G1 G1 Debit 125 Credit 125 Interest Expense Date Jan. 31 31 Explanation Insurance Expense Date Explanation Jan. 31 31 Explanation Ref. G1 G1 Ref. G1 G1 Debit 30 Credit 30 Debit 200 Credit 200 Explanation Balance 30 0 No. 722 Balance 200 0 No. 727 Ref. CP1 G1 Debit 3,600 Credit 3,600 Office Supplies Expense Date Jan. 31 31 Balance 125 0 No. 718 Office Salaries Expense Date Jan. 31 31 Balance 4,300 0 Balance 3,600 0 No. 728 Ref. G1 G1 7-70 Debit 900 Credit 900 Balance 900 0 COMPREHENSIVE PROBLEM (Continued) Rent Expense Date Jan. 12 31 No. 729 Explanation Ref. CP1 G1 Debit 1,000 Credit 1,000 Balance 1,000 0 Accounts Receivable Subsidiary Ledger R. Draves Date Explanation Jan. 1 Balance 11 22 Ref.
S1 S1 Debit Credit Balance 1,500 3,400 4,200 Credit Balance 1,800 1,500 0 6,100 1,900 800 J. Fine Date Jan. Explanation Ref. S1 G1 CR1 S1 Debit 1,800 B. Hachinski Date Explanation Jan. 1 Balance 7 25 Ref.
CR1 S1 Debit S. Ingles Date Explanation Jan. 1 Balance 7 11 21 Ref.
CR1 S1 CR1 3 9 13 25 7-71 300 1,500 6,100 Credit 2,000 3,500 Debit Credit 4,000 900 900 Balance 7,500 5,500 9,000 Balance 4,000 0 900 0 COMPREHENSIVE PROBLEM (Continued) B. Remy Date Jan. Explanation 3 13 22 Ref. S1 CR1 S1 Debit 3,100 Credit 3,100 3,700 Balance 3,100 0 3,700 Accounts Payable Subsidiary Ledger D. Laux Date Jan. Explanation Ref. P1 P1 Debit Credit 2,700 1,200 Balance 2,700 3,900 Explanation Balance Ref.
CP1 P1 G1 CP1 Debit Credit Balance 9,000 0 13,900 13,700 0 5 27 S. Kosko Date Jan. 1 9 16 18 23 9,000 13,900 200 13,700 R. Mikush Date Jan. 1 21 Explanation Balance Ref.
G1 Debit Credit Balance 15,000 0 Credit Balance 11,000 0 15,000 0 12,500 15,000 D. Moreno Date Jan. 1 9 16 23 27 Explanation Balance Ref.
CP1 P1 CP1 P1 7-72 Debit 11,000 15,000 15,000 12,500 COMPREHENSIVE PROBLEM (Continued) S. Yost Date Jan. Explanation 5 16 27 Ref. P1 P1 P1 7-73 Debit Credit 3,000 1,500 2,800 Balance 3,000 4,500 7,300 PACKARD COMPANY Worksheet For the Month Ended January 31, 2008 Trial Balance Account Titles 7-74 Cash Accounts Receivable Notes Receivable Merchandise Inventory Office Supplies Prepaid Insurance Equipment Accum. Depreciation—Equipment Notes Payable Accounts Payable Interest Payable I. Packard, Capital I. Packard, Drawing Sales Sales Returns and Allowances Purchases Purchase Returns and Allowances Freight In Sales Salaries Expense Office Salaries Expense Rent Expense Totals Office Supplies Expense Insurance Expense Depreciation Expense Interest Expense Totals Net Income Totals Dr. Adjusted Trial Balance Adjustments Cr. Dr. 41,990 23,000 39,000 20,000 1,600 2,000 6,450 1,500 15,000 23,700 Cr. Dr. (1) (2) 900 200 (3) 125 (4) 30 41,990 23,000 39,000 20,000 700 1,800 6,450 20,000 Cr. 15,000 Dr. 300 52,600 41,990 23,000 39,000 15,000 700 1,800 6,450 77,720 300 52,600 200 200 Cr. 800 77,720 300 52,600 Balance Sheet 1,625 15,000 23,700 30 78,700 800 77,720 180 4,300 3,600 1,000 196,820 Dr. 1,625 15,000 23,700 30 78,700 78,700 800 Cr. Income Statement 200 180 4,300 3,600 1,000 180 4,300 3,600 1,000 900 200 125 30 196,975 900 200 125 30 83,235 9,685 92,920 196,820 (1) (2) (3) (4) 900 200 125 30 1,255 1,255 , 196,975 92,920 128,740 92,920 128,740 119,055 9,685 128,740 COMPREHENSIVE PROBLEM (Continued) (c) COMPREHENSIVE PROBLEM (Continued) (d) PACKARD CO. Income Statement For the Month Ended January 31, 2008 Sales revenues Sales ........................................................ Less: Sales returns and allowances ........................... Net sales revenue ................................ Cost of goods sold Merchandise inventory, 1/1/08 ........ Purchases .............................................. Less: Purchase returns and allowances ........................... Net purchases....................................... Freight in ................................................ Total merchandise available for sale....................................................... Less: Merchandise inventory, 1/31/08 .............................................. Cost of goods sold....................... Gross profit on sales.......................... Operating expenses Selling expenses Sales salaries expense ............... Administrative expenses Office salaries expense .............. Rent expense ................................. Office supplies expense............. Insurance expense....................... Depreciation expense ................. Total admin. expenses......... Total oper. expenses............ Income from operations ........................... Other expenses and losses Interest expense................................... Net income .................................................... 7-75 $77,720 300 77,420 $20,000 $52,600 200 52,400 180 52,580 72,580 15,000 57,580 19,840 4,300 3,600 1,000 900 200 125 5,825 10,125 9,715 30 $ 9,685 COMPREHENSIVE PROBLEM (Continued) PACKARD CO. Statement of Owner’s Equity For the Month Ended January 31, 2008 I. Packard, Capital, January 1, 2008 .............................................. Add: Net income ............................................................................... Less: Drawing ..................................................................................... I. Packard, Capital, January 31, 2008............................................ $78,700 9,685 88,385 800 $87,585 PACKARD CO. Balance Sheet January 31, 2008 Assets Current assets Cash....................................................................... Notes receivable ................................................ Accounts receivable......................................... Merchandise inventory.................................... Office supplies ................................................... Prepaid insurance ............................................. Total current assets................................. $41,990 39,000 23,000 15,000 700 1,800 Capital assets Equipment ........................................................... Less: Accumulated depreciation ................ Total assets ................................................ 6,450 1,625 $121,490 4,825 $126,315 Liabilities and Owner’s Equity Current liabilities Notes payable..................................................... Accounts payable ............................................. Interest payable ................................................. Total liabilities ........................................... Owner’s equity I. Packard, Capital ............................................. Total liabilities and owner’s equity ....................................................... 7-76 $15,000 23,700 30 $ 38,730 87,585 $126,315 COMPREHENSIVE PROBLEM (Continued) (f) PACKARD CO. Post-Closing Trial Balance January 31, 2008 Cash ............................................................................ Notes Receivable.................................................... Accounts Receivable............................................. Merchandise Inventory ......................................... Office Supplies ........................................................ Prepaid Insurance .................................................. Equipment................................................................. Accumulated Depreciation—Equipment ........ Notes Payable.......................................................... Accounts Payable................................................... Interest Payable ...................................................... I. Packard, Capital................................................... Debit $ 41,990 39,000 23,000 15,000 700 1,800 6,450 $ $127,940 Accounts Receivable balance ................................... Subsidiary account balances R. Draves ................................................................. J. Fine ....................................................................... B. Hachinski............................................................ B. Remy.................................................................... Credit 1,625 15,000 23,700 30 87,585 $127,940 $23,000 $ 4,200 6,100 9,000 3,700 $23,000 Accounts Payable balance ......................................... Subsidiary account balances D. Laux...................................................................... D. Moreno ................................................................ S. Yost ...................................................................... $23,700 $ 3,900 12,500 7,300 $23,700 7-77 BYP 7-1 FINANCIAL REPORTING PROBLEM—A MINI PRACTICE SET (a) Sales Journal S1 Date Jan. 3 3 11 11 22 22 25 25 Account Debited Invoice Accounts Receivable Dr. Cost of Goods Sold Dr. No. Ref. Sales Cr. Merchandise Inventory Cr. B. Richey J. Forbes R. Dvorak S. LaDew B. Richey R. Dvorak B. Garcia J. Forbes 510 511 512 513 514 515 516 517







3,100 1,800 1,600 900 2,700 1,300 3,500 6,100 21,000 (112)(401) 1,860 1,080 960 540 1,620 780 2,100 3,660 12,600 (505)(120) Purchases Journal Date Account Credited Jan. 5 5 16 16 16 27 27 27 S. Vogel D. Lynch D. Omara S. Hoyt S. Vogel D. Omara D. Lynch S. Vogel Terms n/30 n/30 1/10, n/30 2/10, n/30 n/30 1/10, n/30 n/30 n/30 7-78 Ref.







P1 Merchandise Inventory Dr. Accounts Payable Cr. 5,000 2,200 18,000 14,200 1,500 14,500 1,200 5,400 62,000 (120)(201) BYP 7-1 (Continued) Cash Receipts Journal CR1 Date Jan. 7 7 10 13 13 20 21 31 Account Credited Ref. S. LaDew B. Garcia

B. Richey J. Forbes

S. LaDew
Cash Dr. 4,000 2,000 15,500 3,038 1,470 20,100 882 21,300 68,290 (101) Sales Accounts Discounts Receivable Dr. Cr. Sales Cr. Cost of Goods Sold Other Dr. Accounts Merchandise Inventory Cr. Cr. 4,000 2,000 62 30 3,100 1,500 18 900 110 (414) 11,500 (112) 15,500 9,300 20,100 12,060 21,300 56,900 (401) 12,780 34,140 (505)(120) Cash Payments Journal CP1 Date Account Debited Ref. Jan. 8 9 9 12 15 17 23 23 28 31 31 Merchandise Inventory S. Hoyt D. Omara Rent Expense M. Bluma, Drawing 120 Other Accounts Dr. Office Supplies Dr. Merchandise Inventory Cr. 235

729 306 Accounts Payable Dr. 9,000 11,000 180 110 1,000 800 400 D. Omara S. Hoyt

18,000 14,000 180 280 200 Sales Salaries Expense Office Salaries Expense 627 727 4,300 3,800 10,135 (X) 7-79 52,000 (201) 600 (125) 750 (120) Cash Cr. 235 8,820 10,890 1,000 800 400 17,820 13,720 200 4,300 3,800 61,985 (101) BYP 7-1 (Continued) (a) & (e) General Journal G1 Date Jan. 9 18 21 Account Titles and Explanations Sales Returns and Allowances ......... Accounts Receivable— J. Forbes.................................... (Issued credit for merchandise returned) Ref. 412 Debit 300 Merchandise Inventory ........................ ($300 X .60) Cost of Goods Sold .................... 120 Accounts Payable—S. Hoyt ............... Merchandise Inventory.............. (Received credit for returned goods)
201/
120/ 200 Accounts Payable—R. Moses ........... Notes Payable............................... (Payment of balance due)
201/
200/ 15,000
112/
Credit 300 180 180 505 200 15,000 Adjusting Entries 31 31 31 31 31 Office Supplies Expense..................... Office Supplies............................. 728 125 700 Insurance Expense................................ Prepaid Insurance....................... 722 130 200 711 125 Depreciation Expense ($1,500 ÷ 12) ........................................... Accumulated Depreciation— Equipment................................. 700 200 158 125 Interest Expense................................... Interest Payable ........................... 718 230 50 Sales......................................................... Income Summary ........................ 401 350 77,900 7-80 50 77,900 BYP 7-1 (Continued) General Journal G1 Date Jan. 31 31 31 Account Titles and Explanations Income Summary .................................. Sales Discounts .......................... Sales Returns and Allowances ............................... Cost of Goods Sold.................... Rent Expense ............................... Sales Salaries Expense ............ Office Salaries Expense ........... Office Supplies Expense .......... Insurance Expense..................... Depreciation Expense ............... Interest Expense ......................... Ref. 350 414 Income Summary .................................. M. Bluma, Capital........................ 350 301 20,755 M. Bluma, Capital .................................. M. Bluma, Drawing ..................... 301 306 800 (b) & (e) Debit 57,145 110 412 505 729 627 727 728 722 711 718 300 46,560 1,000 4,300 3,800 700 200 125 50 20,755 800 General Ledger Cash Date Jan. No. 101 1 31 31 Explanation Balance Ref.
CR1 CP1 Debit Credit 68,290 61,985 Accounts Receivable Date Jan. Credit 1 31 31 9 Explanation Balance Balance 35,750 104,040 42,055 No. 112 Ref.
S1 CR1 G1 7-81 Debit Credit 21,000 11,500 300 Balance 13,000 34,000 22,500 22,200 BYP 7-1 (Continued) Notes Receivable Date Jan. 1 Explanation Balance No. 115 Ref.
Debit Credit Merchandise Inventory Date Jan. 1 31 31 31 8 31 9 18 Explanation Balance No. 120 Ref.
P1 S1 CR1 CP1 CP1 G1 G1 Debit Credit 62,000 12,600 34,140 235 750 180 200 Office Supplies Date Jan. 1 31 31 Explanation Balance 1 31 Explanation Balance Ref.
CP1 G1 Debit Credit 600 700 1 Explanation Balance Balance 1,000 1,600 900 No. 130 Ref.
G1 Debit Credit 200 Equipment Date Jan. Balance 18,000 80,000 67,400 33,260 33,495 32,745 32,925 32,725 No. 125 Prepaid Insurance Date Jan. Balance 39,000 Balance 2,000 1,800 No. 157 Ref.
7-82 Debit Credit Balance 6,450 BYP 7-1 (Continued) Accumulated Depreciation—Equipment Date Jan. 1 31 Explanation Balance Ref.
G1 No. 158 Debit Credit 125 Notes Payable Date Jan. 21 Explanation No. 200 Ref. G1 Debit Credit 15,000 Accounts Payable Date Jan. 1 31 31 18 21 Explanation Balance Explanation Ref.
P1 CP1 G1 G1 Debit Credit 62,000 52,000 200 15,000 1 31 31 Explanation Balance Ref. G1 Debit Credit 50 Explanation Balance 50 No. 301 Ref.
G1 G1 Debit Credit 20,755 800 M. Bluma, Drawing Date Jan. 15 31 Balance 35,000 97,000 45,000 44,800 29,800 No. 230 M. Bluma, Capital Date Jan. Balance 15,000 No. 201 Interest Payable Date Jan. 31 Balance 1,500 1,625 Balance 78,700 99,455 98,655 No. 306 Ref. CP1 G1 7-83 Debit 800 Credit 800 Balance 800 0 BYP 7-1 (Continued) Income Summary Date Jan. 31 31 31 Sales Date Jan. 31 31 31 Explanation Explanation No. 350 Ref. G1 G1 G1 Ref. S1 CR1 G1 Debit Credit 77,900 57,145 20,755 Debit Credit 21,000 56,900 77,900 Sales Returns and Allowances Date Jan. 9 31 Explanation Explanation Cost of Goods Sold Date Explanation Jan. 31 31 9 31 No. 401 Balance 21,000 77,900 0 No. 412 Ref. G1 G1 Debit 300 Credit 300 Sales Discounts Date Jan. 31 31 Balance 77,900 20,755 0 Balance 300 0 No. 414 Ref. CR1 G1 Ref. S1 CR1 G1 G1 7-84 Debit 110 Credit 110 Debit 12,600 34,140 Credit 180 46,560 Balance 110 0 No. 505 Balance 12,600 46,740 46,560 0 BYP 7-1 (Continued) Sales Salaries Expense Date Jan. 31 31 Explanation No. 627 Ref. CP1 G1 Debit 4,300 Credit 4,300 Depreciation Expense Date Jan. 31 31 Explanation No. 711 Ref. G1 G1 Debit 125 Credit 125 Interest Expense Date Jan. 31 31 Explanation Insurance Expense Date Explanation Jan. 31 31 Explanation Ref. G1 G1 Ref. G1 G1 Debit 50 Credit 50 Debit 200 Credit 200 Explanation Balance 50 0 No. 722 Balance 200 0 No. 727 Ref. CP1 G1 Debit 3,800 Credit 3,800 Office Supplies Expense Date Jan. 31 31 Balance 125 0 No. 718 Office Salaries Expense Date Jan. 31 31 Balance 4,300 0 Balance 3,800 0 No. 728 Ref. G1 G1 7-85 Debit 700 Credit 700 Balance 700 0 BYP 7-1 (Continued) Rent Expense Date Jan. 12 31 No. 729 Explanation Ref. CP1 G1 Debit 1,000 Credit 1,000 Balance 1,000 0 Accounts Receivable Subsidiary Ledger R. Dvorak Date Explanation Jan. 1 Balance 11 22 Ref.
S1 S1 J. Forbes Date Explanation Jan. 3 9 13 25 Ref. S1 G1 CR1 S1 Debit 1,800 Ref.
CR1 S1 Debit Debit Credit Balance 1,500 3,100 4,400 Credit Balance 1,800 1,500 0 6,100 1,600 1,300 300 1,500 6,100 B. Garcia Date Jan. 1 7 25 Explanation Balance S. LaDew Date Explanation Jan. 1 Balance 7 11 21 Ref.
CR1 S1 CR1 7-86 Credit 2,000 3,500 Debit Credit 4,000 900 900 Balance 7,500 5,500 9,000 Balance 4,000 0 900 0 BYP 7-1 (Continued) B. Richey Date Jan. Explanation 3 13 22 Ref. S1 CR1 S1 Debit 3,100 Credit 3,100 2,700 Balance 3,100 0 2,700 Accounts Payable Subsidiary Ledger D. Lynch Date Jan. Explanation Ref. P1 P1 Debit Credit 2,200 1,200 Balance 2,200 3,400 Explanation Balance Ref.
CP1 P1 G1 CP1 Debit Credit Balance 9,000 0 14,200 14,000 0 5 27 S. Hoyt Date Jan. 1 9 16 18 23 9,000 14,200 200 14,000 R. Moses Date Jan. 1 21 Explanation Balance Ref.
G1 Debit Credit Balance 15,000 0 Credit Balance 11,000 0 18,000 0 14,500 15,000 D. Omara Date Jan. 1 9 16 23 27 Explanation Balance Ref.
CP1 P1 CP1 P1 7-87 Debit 11,000 18,000 18,000 14,500 BYP 7-1 (Continued) S. Vogel Date Jan. Explanation 5 16 27 Ref. P1 P1 P1 7-88 Debit Credit 5,000 1,500 5,400 Balance 5,000 6,500 11,900 BLUMA COMPANY Worksheet For the Month Ended January 31, 2008 Trial Balance Account Titles 7-89 Cash Accounts Receivable Notes Receivable Merchandise Inventory Office Supplies Prepaid Insurance Equipment Accum. Depreciation—Equipment Notes Payable Accounts Payable Interest Payable M. Bluma, Capital M. Bluma, Drawing Sales Sales Returns and Allowances Sales Discounts Cost of Goods Sold Sales Salaries Expense Office Salaries Expense Rent Expense Totals Office Supplies Expense Insurance Expense Depreciation Expense Interest Expense Totals Net Income Totals Dr. Adjusted Trial Balance Adjustments Cr. Dr. 42,055 22,200 39,000 32,725 1,600 2,000 6,450 1,500 15,000 29,800 Cr. Dr. (1) (2) 700 200 (3) 125 (4) 50 Cr. Balance Sheet Dr. Cr. 42,055 22,200 39,000 32,725 900 1,800 6,450 1,625 15,000 29,800 50 78,700 1,625 15,000 29,800 50 78,700 800 800 77,900 77,900 300 110 46,560 4,300 3,800 1,000 202,900 Dr. 42,055 22,200 39,000 32,725 900 1,800 6,450 78,700 800 Cr. Income Statement 77,900 300 110 46,560 4,300 3,800 1,000 300 110 46,560 4,300 3,800 1,000 700 200 125 50 203,075 700 200 125 50 57,145 20,755 77,900 202,900 (1) (2) (3) (4) 700 200 125 50 1,075 1,075 203,075 77,900 145,930 77,900 145,930 125,175 20,755 145,930 BYP 7-1 (Continued) (c) BYP 7-1 (Continued) (d) BLUMA CO. Income Statement For the Month Ended January 31, 2008 Sales revenues Sales ........................................................ Less: Sales discounts ...................... Sales returns and allowances ........................... Net sales revenue................................ Cost of goods sold ............................. Gross profit ........................................... Operating expenses Selling expenses Sales salaries expense............. Administrative expenses Office salaries expense............ Rent expense ............................... Office supplies expense........... Insurance expense..................... Depreciation expense ............... Total administrative expenses.......................... Total operating expenses................. Income from operations............................. $77,900 $ 110 300 410 77,490 46,560 30,930 4,300 $3,800 1,000 700 200 125 5,825 10,125 20,805 Other expenses and losses Interest expense .................................. 50 Net income...................................................... $20,755 7-90 BYP 7-1 (Continued) BLUMA CO. Owner’s Equity Statement For the Month Ended January 31, 2008 M. Bluma, Capital, January 1, 2008................................................ Add: Net income................................................................................ Less: Drawings.................................................................................... M. Bluma, Capital, January 31, 2008 ............................................. $78,700 20,755 99,455 800 $98,655 BLUMA CO. Balance Sheet January 31, 2008 Assets Current assets Cash ....................................................................... Accounts receivable ......................................... Notes receivable................................................. Merchandise inventory .................................... Office supplies.................................................... Prepaid insurance.............................................. Total current assets ................................. $42,055 22,200 39,000 32,725 900 1,800 Property, plant, and equipment Equipment ............................................................ Less: Accumulated depreciation................. Total assets................................................. 6,450 1,625 $138,680 4,825 $143,505 Liabilities and Owner’s Equity Current liabilities Notes payable ..................................................... Accounts payable .............................................. Interest payable.................................................. Total liabilities............................................ Owner’s equity M. Bluma, Capital............................................... Total liabilities and owner’s equity........................................................ 7-91 $15,000 29,800 50 $ 44,850 98,655 $143,505 BYP 7-1 (Continued) (f) BLUMA CO. Post-Closing Trial Balance January 31, 2008 Cash ............................................................................ Notes Receivable .................................................... Accounts Receivable............................................. Merchandise Inventory.......................................... Office Supplies ........................................................ Prepaid Insurance................................................... Equipment ................................................................. Accumulated Depreciation—Equipment......... Notes Payable .......................................................... Accounts Payable................................................... Interest Payable....................................................... M. Bluma, Capital .................................................... Debit $ 42,055 39,000 22,200 32,725 900 1,800 6,450 $ $145,130 Accounts Receivable balance.................................... Subsidiary account balances R. Dvorak.................................................................. J. Forbes .................................................................. B. Garcia................................................................... B. Richey .................................................................. Credit 1,625 15,000 29,800 50 98,655 $145,130 $22,200 $ 4,400 6,100 9,000 2,700 $22,200 Accounts Payable balance.......................................... Subsidiary account balances D. Lynch ................................................................... D. Omara .................................................................. S. Vogel..................................................................... $29,800 $ 3,400 14,500 11,900 $29,800 7-92 BYP 7-2 EXPLORING THE WEB (a) Some of the key features of the general ledger module highlighted by the company are:
Highly flexible account and fiscal period setup, including different account structures for separate companies.
Account numbers can be up to 20 characters long in 10 segments.
Statistical accounts for tracking nonfinancial information, such as head count and square footage.
Standard, recurring, auto-reversing, clearing, and “quick-journal” entries.
Unlimited budgets, unlimited years of history. (b) Some of the key features of the payables management module highlighted by the company are:
Handles purchases on account, manual and computer check payments, and credit memos.
Vendor classes provide a fast, consistent method for entering new records by entering common information for you.
Changes to one vendor in a class can be made to all vendors in the same class.
Automatically calculates the number of days it takes to pay each vendor.
Enter recurring transactions.
Put transactions on “hold” until you want to pay them.
A variety of inquiry windows and reports provide multiple ways to view vendor information.
Complete vendor and transaction history. 7-93 BYP 7-3 DECISION MAKING ACROSS THE ORGANIZATION (a) The special journals for Hughey & Payne should be: (1) sales journal, (2) purchases journal, (3) cash receipts journal, and (4) cash payments journal. (1) Sales Journal columns: Date. Account Debited. Invoice Number. Reference. Accounts Receivable, Dr. and Sales—Appliances, Cr. Cost of Goods Sold, Dr. and Merchandise Inventory—Appliances, Cr. (2) Purchases Journal columns: Date. Account Credited. Terms. Reference. Accounts Payable, Cr. Merchandise Inventory—Appliances, Dr. Merchandise Inventory—Parts, Dr. Note: Because two different types of merchandise are purchased on credit, a three-column purchases journal might be used. (3) Cash Receipts Journal columns: Date. Account Credited. Reference. Cash, Dr. Accounts Receivable, Cr. Sales—Appliances, Cr. Sales—Parts, Cr. Revenue from Repairs, Cr. Other Accounts, Cr. Cost of Goods Sold, Dr. and Merchandise Inventory— Appliances, Cr. Cost of Goods Sold, Dr. and Merchandise Inventory—Parts, Cr. Note: A Sales Discounts, Dr. column is not needed because all credit terms are net/30 days. 7-94 BYP 7-3 (Continued) (4) Cash Payments Journal columns: Date. Check Number. Account Debited. Reference. Other Accounts, Dr. Accounts Payable, Dr. Advertising Expense, Dr. Salaries Expense, Dr. Merchandise Inventory—Appliances, Cr. Merchandise Inventory—Parts, Cr. Cash, Cr. (b) Hughey & Payne should have: (1) An accounts receivable control account with individual customers’ accounts in a customers’ subsidiary ledger. (2) An accounts payable control account with individual creditors in a creditors’ subsidiary ledger. The use of control accounts and subsidiary ledgers will: (1) provide necessary up-to-date information on specific customer and creditor balances, (2) free the general ledger of excessive detail, (3) help locate errors in individual accounts, and (4) make possible a division of labor in posting. 7-95 BYP 7-4 COMMUNICATION ACTIVITY Mr. Jim Houser 2 Main Street Central City, Michigan 48172 Dear Mr. Houser: Thank you for hiring two additional bookkeepers a month ago to help me with the accounting. Unfortunately, the inefficiencies in recording transactions have continued at an even higher rate. The reason is that there are often times when more than one person needs to use the journal. In addition, the daily posting of transactions continues to be very time consuming. I would like to suggest some changes in the accounting system. Because of the increased volume of business, I believe it is time for us to use special journals for journalizing transactions. Special journals would be in addition to the journal that we are using now. There would be four special journals: 1. 2. 3. 4. Sales journal—for all sales of merchandise on account. Cash receipts journal—for all cash received. Purchases journal—for all purchases of merchandise on account. Cash payments journal—for all cash payments. To use special journals, we will need columnar journal paper which can be obtained at any office supply store at very low cost. I can also quickly train the new bookkeepers in the use of special journals. Special journals will permit a division of labor so that all three of us can be recording transactions at the same time. Thus, the inefficiencies in journalizing will be eliminated. Special journals also make it possible to do some postings monthly. This will significantly reduce the time required to make daily postings. As a result, it should free up some time for us to do other things! I am confident that the use of special journals will improve the efficiency of the accounting department. If you have any questions on this recommendation, please let me know. Yours sincerely, Barb 7-96 BYP 7-5 ETHICS CASE (a) The stakeholders in this case are:
Jose Molina, manager of Roniger’s centralized computer accounting operation.
The employees of Roniger’s three divisions at Freeport, Rockport, and Bayport. (b) Jose’s instructions to assign the Bayport code to all uncoded and incorrectly coded sales documents overstates the sales of Bayport and understates the sales of Freeport and Rockport, thereby affecting the employee bonus plan. Jose’s intent and action are unethical. He is padding the sales of his wife’s, relatives’, and friends’ Bayport division sales and unfairly aiding them in the bonus competition. (c) Roniger Products Company should have a written policy covering uncoded and incorrectly coded sales documents. This would prevent the manager from arbitrarily designating the division to be credited for the uncoded sales. 7-97 BYP 7-6 ALL ABOUT YOU ACTIVITY The process begins when journal entries are recorded for transactions in a journal. Once entries are made in the journal, they are posted to the ledger by using the Post function. After entries have been posted, you can click on Reports in the Main Menu and choose from a variety of reports. These include the following: Chart of Accounts, Trial Balance, General Ledger, Subsidiary Ledger, Journals, Balance Sheet, Income Statement, Owner’s Equity Statement. 7-98 CHAPTER 8 Internal Control and Cash ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises A Problems B Problems 1. Define internal control. 1 1, 2 2. Identify the principles of internal control. 2, 3, 4, 5, 6, 7, 8 3 1, 2, 3, 5, 6 1A, 6A 1B, 6B 3. Explain the applications of internal control principles to cash receipts. 3, 10, 11, 12 4 2, 5, 6 6A 1B, 6B 4. Explain the applications of internal control principles to cash disbursements. 13, 14, 15, 16, 17 5 3, 4, 5, 6 1A, 6A 6B 5. Describe the operation of a petty cash fund. 18 6 7, 8 2A 2B 6. Indicate the control features of a bank account. 19 7 7. Prepare a bank reconciliation. 20, 21, 22 8, 9, 10, 11 9,10, 11, 12, 13 3A, 4A, 5A 3B, 4B, 5B, 6B 8. Explain the reporting of cash. 9, 23 12 14 8-1 Exercises ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Identify internal control principles over cash disbursements. Simple 20–30 2A Journalize and post petty cash fund transactions. Simple 20–30 3A Prepare a bank reconciliation and adjusting entries. Simple 20–30 4A Prepare a bank reconciliation and adjusting entries from detailed data. Moderate 40–50 5A Prepare a bank reconciliation and adjusting entries. Moderate 30–40 6A Identify internal control weaknesses in cash receipts and cash disbursements. Complex 35–45 1B Identify internal control weaknesses over cash receipts. Simple 20–30 2B Journalize and post petty cash fund transactions. Simple 20–30 3B Prepare a bank reconciliation and adjusting entries. Simple 20–30 4B Prepare a bank reconciliation and adjusting entries from detailed data. Moderate 40–50 5B Prepare a bank reconciliation and adjusting entries. Moderate 30–40 6B Prepare comprehensive bank reconciliation with theft and internal control deficiencies. Complex 40–50 8-2 Study Objective Knowledge Comprehension 1. Define internal control. Q8-1 BE8-1 BE8-2 2. Identify the principles of internal control. Q8-2 Q8-3 Q8-4 Q8-5 3. Explain the applications of internal control principles to cash receipts. 8-3 4. Explain the applications of internal control principles to cash disbursements. Q8-15 Q8-16 Q8-17 Synthesis Evaluation E8-2 E8-3 P8-1B P8-6A Q8-3 Q8-10 Q8-11 Q8-12 BE8-4 E8-5 E8-6 E8-2 P8-1B P8-6A P8-6B Q8-13 Q8-14 BE8-5 E8-5 E8-6 P8-1A E8-3 E8-4 P8-6A Q8-18 6. Indicate the control features of a bank account. Q8-19 BE8-7 Q8-21 Analysis E8-1 E8-5 E8-6 P8-1A 5. Describe the operation of a petty cash fund. 7. Prepare a bank reconciliation. Application E8-6 Q8-7 Q8-8 BE8-3 P8-6B P8-6B BE8-6 P8-2A P8-2B E8-7 E8-8 BE8-10 BE8-11 E8-10 Q8-20 Q8-22 BE8-8 BE8-9 E8-9 E8-11 E8-12 E8-13 P8-3A P8-4A P8-5A P8-3B P8-4B P8-5B P8-6B E8-14 Q8-9 E8-14 8. Explain the reporting of cash. Q8-23 BE8-12 Broadening Your Perspective Financial Reporting Decision Making Across the Organization Comparative Analysis All About You Ethics Case Communication Exploring the Web BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. Disagree. Internal control is also concerned with the safeguarding of company assets from employee theft, robbery, and unauthorized use. 2. The principles of internal control are: (a) establishment of responsibility, (b) segregation of duties, (c) documentation procedures, (d) physical, mechanical, and electronic controls, (e) independent internal verification, and (f) other controls. 3. This is a violation of the internal control principle of establishing responsibility. In this case, each sales clerk should have a separate cash register or cash register drawer. 4. The two applications of segregation of duties are: (1) Different individuals should be responsible for related activities. (2) Responsibility for the record keeping for an asset should be separate from the physical custody of that asset. 5. Documentation procedures contribute to good internal control by providing evidence that transactions and events have occurred and, when signatures (or initials) are added, the documents establish responsibility for the transactions. The prompt transmittal of documents to accounting contributes to recording transactions in the proper period, and the prenumbering of documents helps to ensure that a transaction is not recorded more than once or not at all. 6. Physical controls include safes, vaults, and locked warehouses. These controls contribute to the safeguarding of company assets. Mechanical and electronic controls include cash registers and time clocks that contribute to the accuracy and reliability of the accounting records, and electronic burglary systems and sensors that help to safeguard assets. 7. (a) Independent internal verification involves the review of data prepared by employees. (b) Maximum benefit is obtained from independent internal verification when: (1) The verification is made periodically or on a surprise basis. (2) The verification is done by an employee who is independent of the personnel responsible for the information. (3) Discrepancies and exceptions are reported to a management level that can take appropriate corrective action. 8. (a) The concept of reasonable assurance rests on the premise that the costs of establishing control procedures should not exceed their expected benefit. (b) The human element is an important factor in a system of internal control. A good system can become ineffective through employee fatigue, carelessness, or indifference. Moreover, internal control may become ineffective as a result of collusion. 9. Cash should be reported at $20,850 ($8,000 + $850 + $12,000). 10. Daily cash counts pertain primarily to the principles of segregation of duties and independent internal verification. Daily cash counts also involve the establishment of responsibility for performing the counts. 8-4 Questions Chapter 8 (Continued) 11. Cash registers are readily visible to the customer. Thus, they prevent the sales clerk from ringing up a lower amount and pocketing the difference. In addition, the customer receives an itemized receipt, and the cash register tape is locked into the register for further verification. 12. Two mail clerks contribute to a more accurate listing of mail receipts and to the endorsement of all checks “For Deposit Only.” In addition, two clerks reduce the likelihood of mail receipts being diverted to personal use. 13. Payment by check contributes to effective internal control over cash disbursements. However, effective control is also possible when small payments are made from petty cash. 14. The procedure and related principle are: Procedure Principle (1) (2) * Establishment of responsibility. * Physical, mechanical, and electronic controls. (3) Treasurer signs checks. Checks imprinted by a machine in indelible ink. Comparing check with approved invoice before signing. * Independent internal verification. 15. Physical, mechanical, and electronic controls apply to cash disbursements when: (a) blank checks are stored in a safe, and access to the safe is restricted to authorized personnel, and (b) a checkwriting machine and indelible ink are used to imprint amounts on checks. Other controls apply when the approved invoice is stamped PAID after payment. 16. (a) A voucher system is a network of approvals by authorized individuals acting independently to ensure that all disbursements by check are proper. (b) The internal control principles applicable to a voucher system are: (1) establishment of responsibility, (2) segregation of duties, and (3) independent internal verification. 17. Electronic funds transfer is a cash disbursement system that uses wire, telephone, or computers to transfer cash from one location to another. 18. The activities in a petty cash system and the related principles are: (a) (b) 19. (1) (2) Establishing the fund. Making payments from the fund. (3) Replenishing the fund. * Establishment of responsibility for custody of fund. * Documentation procedures because the custodian must use a prenumbered petty cash receipt. * Independent internal verification because the request for replenishment must be approved before the check is written. Journal entries are required for a petty cash fund when it is established and replenished. Entries are also required when the size of the fund is increased or decreased. A bank contributes significantly to internal control over cash because it: (1) safeguards cash on deposit, (2) minimizes the amount of currency that must be kept on hand, and (3) provides a double record of all bank transactions. 8-5 Questions Chapter 8 (Continued) 20. The lack of agreement between the balances may be due to either: (1) Time lags—a check written in July does not clear the bank until August. (2) Errors—a check for $110 is recorded by the depositor at $101. 21. The four steps are: (1) determine deposits in transit, (2) determine outstanding checks, (3) discover any errors made, and (4) trace bank memoranda. 22. (a) An NSF check occurs when the checkwriter’s bank balance is less than the amount of the check. (b) In a bank reconciliation, a customer’s NSF check is deducted from the balance per books. (c) An NSF check results in an adjusting entry in the company’s books, as a debit to Accounts Receivable and a credit to Cash. 23. (a) Cash equivalents are highly liquid investments that can be converted into a specific amount of cash with maturities of three months or less when purchased. Cash equivalents may be reported with cash in the current assets section of the balance sheet. (b) Cash restricted for a special purpose should be reported as a current or noncurrent asset depending on when the cash is expected to be used. 8-6 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 8-1 1. 2. 3. True. True. False. The Sarbanes-Oxley Act of 2002 requires U.S. corporations to maintain an adequate system of internal control. BRIEF EXERCISE 8-2 The purposes of internal control are to: 1. Safeguard a company’s assets from employee theft, robbery, and unauthorized use. An application for Ready Parking is the use of a cash register to safeguard assets. 2. Enhance the accuracy and reliability of a company’s accounting records by reducing the risk of errors (unintentional mistakes) and irregularities (intentional mistakes and misrepresentations) in the accounting process. An application for Ready Parking is preparation of a bank reconciliation. Both purposes are important to the success of any business endeavor. BRIEF EXERCISE 8-3 (a) Segregation of duties. (b) Independent internal verification. (c) Documentation procedures. BRIEF EXERCISE 8-4 1. 2. 3. 4. 5. Physical, mechanical, and electronic controls. Other controls. Independent internal verification. Segregation of duties. Establishment of responsibility. 8-7 BRIEF EXERCISE 8-5 1. 2. 3. 4. 5. Documentation procedures. Independent internal verification. Physical, mechanical, and electronic controls. Establishment of responsibility. Segregation of duties. BRIEF EXERCISE 8-6 Mar. 20 Postage Expense .................................................................... Freight-out ................................................................................ Travel Expense........................................................................ Cash Over and Short ............................................................. Cash ................................................................................... 52 26 10 5 93 BRIEF EXERCISE 8-7 (a) A check provides documentary evidence of the payment of a specified sum of money to a designated payee. (b) A bank statement provides a double record of a depositor’s bank transactions. It also is used in making periodic independent bank reconciliations. BRIEF EXERCISE 8-8 (1) (2) (3) (4) Outstanding checks—deducted from cash balance per bank. Bank service charge—deducted from cash balance per books. Collection of note by bank—added to cash balance per books. Deposits in transit—added to cash balance per bank. 8-8 BRIEF EXERCISE 8-9 (a) The reconciling items per the books, items (2) and (3) above, will require adjustment on the books of the depositor. (b) The other reconciling items, deposits in transit and outstanding checks, do not require adjustment by the bank. When these items reach the bank, the bank balance will automatically adjust itself. BRIEF EXERCISE 8-10 Cash balance per bank................................................................................... Add: Deposits in transit................................................................................ Less: Outstanding checks ........................................................................... Adjusted cash balance per bank ................................................................ $7,420 1,120 8,540 762 $7,778 BRIEF EXERCISE 8-11 Cash balance per books ................................................................................ Add: Interest earned ...................................................................................... Less: Charge for printing company checks........................................... Adjusted cash balance per books.............................................................. $8,500 40 8,540 35 $8,505 BRIEF EXERCISE 8-12 Quirk Company should report Cash in Bank and Payroll Bank account as current assets. Plant Expansion Fund Cash should be reported as a noncurrent asset, assuming the fund is not expected to be used during the next year. 8-9 SOLUTIONS TO EXERCISES EXERCISE 8-1 1. Establishment of responsibility. The counter clerk is responsible for handling cash. Other employees are responsible for making the pizzas. 2. Segregation of duties. Employees who make the pizzas do not handle cash. 3. Documentation procedures. The counter clerk uses your order invoice (ticket) in registering the sale on the cash register. The cash register produces a tape of all sales. 4. Physical, mechanical, and electronic controls. A cash register is used to record the sale. 5. Independent internal verification. The counter clerk, in handling the pizza, compares the size of the pizza with the size indicated on the order. 6. Other controls. No visible application possible. EXERCISE 8-2 (a) Procedure Weakness (b) Principle Recommended Change 1. Cash is not adequately protected from theft. Physical, mechanical, and electronic controls. Cash should be stored in a safe until it is deposited in bank. 2. Inability to establish responsibility for cash with a specific clerk. Establishment of responsibility. There should be separate cash drawers and register codes for each clerk. 8-10 EXERCISE 8-2 (Continued) (a) Procedure Weakness (b) Principle Recommended Change 3. The accountant should not handle cash. Segregation of duties. The cashier’s department should make the deposits. 4. Cash is not independently counted. Independent internal verification. A cashier office supervisor should count cash. 5. Cashiers are not bonded. Other controls. All cashiers should be bonded. EXERCISE 8-3 (a) Procedure Weakness (b) Principle Recommended Change 1. The bank reconciliation is not independently prepared. Independent internal verification. Someone with no other cash responsibilities should prepare the bank reconciliation. 2. The approval and payment of bills is done by the same individual. Segregation of duties. The store manager should approve bills for payment and the treasurer should sign and issue checks. 3. Checks are not stored in a secure area. Physical, mechanical, and electronic controls. Checks should be stored in a safe or locked file drawer. 8-11 EXERCISE 8-3 (Continued) (a) Procedure Weakness (b) Principle Recommended Change 4. Filing does not prevent a bill from being paid more than once. Other controls. Bills should be stamped PAID after payment. 5. Checks are not prenumbered. Documentation procedures. Checks should be prenumbered and subsequently accounted for. EXERCISE 8-4 (a) Weaknesses (b) Suggested Improvement 1. Checks are not prenumbered. Use prenumbered checks. 2. The purchasing agent signs checks. Only the treasurer’s department personnel should sign checks. 3. Unissued checks are stored in unlocked file cabinet. Unissued checks should be stored in a locked file cabinet with access restricted to authorized personnel. 4. Purchasing agent approves and pays for goods purchased. Purchasing should approve bills for payment by the treasurer. 5. After payment, the invoice is filed. The invoice should be stamped PAID. 6. The purchasing agent records payments in cash disbursements journal. Only accounting department personnel should record cash disbursements. 8-12 EXERCISE 8-4 (Continued) (a) Weaknesses (b) Suggested Improvement 7. The treasurer records the checks in cash disbursements journal. Same as answer to No. 6 above. 8. The treasurer reconciles the bank statement. An internal auditor should reconcile the bank statement. (b) To: Treasurer, Hutchingson Company From: Accounting Student I have reviewed your cash disbursements system and suggest that you make the following improvements: 1. Hutchingson Company should use prenumbered checks. These should be stored in a locked file cabinet or safe with access restricted to authorized personnel. 2. The purchasing department should approve bills for payment. The treasurer’s department should prepare and sign the checks. The invoices should be stamped paid so that they cannot be paid twice. 3. Only the accounting department personnel should record cash disbursements. 4. An internal auditor should reconcile the bank statement. If you have any questions about implementing these suggestions, please contact me. 8-13 EXERCISE 8-5 Procedure 1. 2. 3. 4. 5. IC good or weak? Weak Good Weak Good Weak Related internal control principle Establishment of Responsibility Independent Internal Verification Segregation of Duties Segregation of Duties Documentation Procedures IC good or weak? Good Weak Weak Good Good Related internal control principle Other Controls Establishment of Responsibility Segregation of Duties Independent Internal Verification Physical, Mechanical, and Electronic Controls EXERCISE 8-6 Procedure 1. 2. 3. 4. 5. EXERCISE 8-7 May 1 June 1 July 1 July 10 Petty Cash................................................................. Cash ................................................................ 100.00 Delivery Expense.................................................... Postage Expense.................................................... Miscellaneous Expense ....................................... Cash Over and Short............................................. Cash................................................................... 31.25 39.00 25.00 2.00 Delivery Expense.................................................... Entertainment Expense........................................ Miscellaneous Expense ....................................... Cash................................................................... 21.00 51.00 24.75 Petty Cash................................................................. Cash ................................................................ 50.00 8-14 100.00 97.25 96.75 50.00 EXERCISE 8-8 Mar. 1 15 20 Petty Cash ............................................................................. Cash ............................................................................... 100 Stamp Inventory .................................................................. Freight-out............................................................................. Miscellaneous Expense .................................................... Travel Expense .................................................................... Cash Over and Short ......................................................... Cash ............................................................................... 39 21 11 24 2 Petty Cash ............................................................................. Cash ............................................................................... 50 100 97 50 EXERCISE 8-9 (a) Cash balance per bank statement ....................... Add: Deposits in transit ......................................... $3,560.20 530.00 4,090.20 930.00 $3,160.20 Less: Outstanding checks .................................... Adjusted cash balance per bank.......................... Cash balance per books ......................................... Less: NSF check....................................................... Bank service charge ................................... Adjusted cash balance per books ....................... $3,875.20 $690.00 25.00 (b) Accounts Receivable .............................................. Cash..................................................................... 690.00 Miscellaneous Expense ......................................... Cash..................................................................... 25.00 8-15 715.00 $3,160.20 690.00 25.00 EXERCISE 8-10 The outstanding checks are as follows: No. Amount 255 260 264 $ 820 890 560 Total $2,270 EXERCISE 8-11 (a) FAMILY VIDEO COMPANY Bank Reconciliation July 31 Cash balance per bank statement ........................................... Add: Deposits in transit ............................................................ $7,263 1,500 8,763 591 $8,172 Less: Outstanding checks......................................................... Adjusted cash balance per bank.............................................. Cash balance per books.............................................................. Add: Collection of note receivable ($900 plus accrued interest $36, less collection fee $20) ............................................. $7,284 916 8,200 28 $8,172 Less: Bank service charge........................................................ Adjusted cash balance per books ........................................... (b) July 31 31 Cash ............................................................................... Miscellaneous Expense........................................... Notes Receivable .............................................. Interest Revenue ............................................... 916 20 Miscellaneous Expense........................................... Cash ...................................................................... 28 8-16 900 36 28 EXERCISE 8-12 (a) ROBERTSON COMPANY Bank Reconciliation September 30 Cash balance per bank statement ............................... Add: Deposits in transit ................................................. $16,422 4,450 20,872 2,383 $18,489 Less: Outstanding checks ............................................ Adjusted cash balance per bank.................................. Cash balance per books ................................................. Add: Collection of note receivable ($1,500 + $30)....... Interest earned ...................................................... Less: NSF check............................................................... Safety deposit box rent...................................... Adjusted cash balance per books ............................... (b) Sept. 30 30 30 30 $17,404 $ 1,530 45 425 65 Cash................................................................. Notes Receivable................................ Interest Revenue................................. 1,530 Cash................................................................. Interest Revenue................................. 45 Miscellaneous Expense ............................ Cash........................................................ 65 Accounts Receivable—J. E. Hoover ........ Cash........................................................ 425 1,575 18,979 490 $18,489 1,500 30 45 65 425 EXERCISE 8-13 (a) Deposits in transit: Deposits per books in July .................................. Less: Deposits per bank in July........................ Deposits in transit, June 30.................... July receipts deposited in July........................... Deposits in transit, July 31 .................................. 8-17 $15,750 $15,600 (720) 14,880 $ 870 EXERCISE 8-13 (Continued) (b) Outstanding checks: Checks per books in July .................................. Less: Checks clearing bank in July .............. Outstanding checks, June 30.............. July checks cleared in July............................... Outstanding checks, July 31 ............................ $17,200 $16,400 (680) 15,720 $ 1,480 (c) Deposits in transit: Deposits per bank statement in September ....................... Add: Deposits in transit, September 30.............................. Total deposits to be accounted for........................................ Less: Deposits per books........................................................ Deposits in transit, August 31................................................. $26,700 2,100 28,800 25,400 $ 3,400 (d) Outstanding checks: Checks clearing bank in September ..................................... Add: Outstanding checks, September 30 .......................... Total checks to be accounted for........................................... Less: Cash disbursements per books................................. Outstanding checks, August 31 ............................................. $25,000 2,100 27,100 23,700 $ 3,400 EXERCISE 8-14 (a) Cash and cash equivalents should be reported at $93,500. Cash in bank.................................................................................. Cash on hand................................................................................ Petty cash....................................................................................... Highly liquid investments ......................................................... $47,000 12,000 500 34,000 $93,500 (b) “Cash in plant expansion fund” should be reported as part of long-term investments (a noncurrent asset). “Receivables from customers” should be reported as accounts receivable in the current assets. “Stock investments” should also be reported in the current assets. (c) Lipkus should disclose in the financial statements the details about the compensating balances. These are generally minimum cash balances the bank requires the borrower to maintain. They are a restriction on the use of cash that may affect the company’s liquidity. 8-18 SOLUTIONS TO PROBLEMS PROBLEM 8-1A Principles Application to Cash Disbursements Establishment of responsibility. Only the treasurer and assistant treasurer are authorized to sign checks. Segregation of duties. Invoices must be approved by both the purchasing agent and the receiving department supervisor. Payment can only be made by the treasurer or assistant treasurer, and the check signers do not record the cash disbursement transactions. Documentation procedures. Checks are prenumbered. Physical, mechanical, and electronic controls. Blank checks are kept in a safe in the treasurer’s office. Only the treasurer and assistant treasurer have access to the safe. A checkwriting machine is used in writing checks. Independent internal verification. The check signer compares the check with the approved invoice prior to issue. Bank and book balances are reconciled monthly by the assistant chief accountant. Other controls. Following payment, invoices are stamped PAID. 8-19 PROBLEM 8-2A (a) July 1 15 31 Aug. 15 16 31 Petty Cash ....................................................... Cash ......................................................... 200.00 Freight-out....................................................... Postage Expense .......................................... Entertainment Expense .............................. Miscellaneous Expense.............................. Cash Over and Short ................................... Cash ......................................................... 94.00 42.40 46.60 11.20 1.80 Freight-out....................................................... Charitable Contributions Expense.......... Postage Expense .......................................... Miscellaneous Expense.............................. Cash ......................................................... 82.10 45.00 25.50 39.40 Freight-out....................................................... Entertainment Expense .............................. Postage Expense .......................................... Miscellaneous Expense.............................. Cash Over and Short .......................... Cash ......................................................... 75.60 43.00 33.00 37.00 Petty Cash ....................................................... Cash ......................................................... 100.00 Postage Expense .......................................... Travel Expense .............................................. Freight-out....................................................... Cash Over and Short ................................... Cash ......................................................... 140.00 95.60 47.10 1.30 200.00 196.00 192.00 1.60 187.00 100.00 284.00 (b) Petty Cash Date Explanation July 1 Aug. 16 Ref. CP CP 8-20 Debit 200 100 Credit Balance 200 300 PROBLEM 8-2A (Continued) (c) The internal control features of a petty cash fund include: (1) A custodian is responsible for the fund. (2) A prenumbered petty cash receipt signed by the custodian and the individual receiving payment is required for each payment from the fund. (3) The treasurer’s office examines all payments and stamps supporting documents to indicate they were paid when the fund is replenished. (4) Surprise counts can be made at any time to determine whether the fund is intact. 8-21 PROBLEM 8-3A (a) JAMES LOGAN COMPANY Bank Reconciliation May 31, 2008 Cash balance per bank statement ....................... Add: Deposit in transit .......................................... Bank error—Bridgetown check ............... $6,404.60 $1,916.15 800.00 Less: Outstanding checks..................................... Adjusted cash balance per bank .......................... Cash balance per books.......................................... Add: Collection of note receivable ($2,500 note plus $80 interest less $20 fee) .............................................. Less: NSF check ....................................................... Error in May 12 deposit ($886.15 – $836.15) .................................. Error in recording check No. 1181.......... Check printing charge ................................ Adjusted cash balance per books ....................... 2,716.15 9,120.75 576.25 $8,544.50 $6,781.50 2,560.00 9,341.50 $ 680.00 50.00 27.00* 40.00 797.00 $8,544.50 *$685 – $658 (b) May 31 31 31 31 31 Cash ........................................................................ Miscellaneous Expense.................................... Notes Receivable ....................................... Interest Revenue ........................................ 2,560 20 Accounts Receivable—S. Grifton.................. Cash ............................................................... 680 Sales........................................................................ Cash ............................................................... 50 Accounts Payable—B. Trest ........................... Cash ............................................................... 27 Miscellaneous Expense.................................... Cash ............................................................... 40 8-22 2,500 80 680 50 27 40 PROBLEM 8-4A (a) BACKHAUS COMPANY Bank Reconciliation December 31, 2008 Cash balance per bank statement .......................... Add: Deposits in transit........................................... $20,154.30 1,690.40 21,844.70 Less: Outstanding checks No. 3470 ......................................................... $ 720.10 No. 3474 ......................................................... 1,050.00 No. 3478 ......................................................... 621.30 No. 3481 ......................................................... 807.40 No. 3484 ......................................................... 798.00 No. 3486 ......................................................... 1,889.50 Adjusted cash balance per bank............................. Cash balance per books ............................................ Add: Note collected by bank ($4,000 note plus $160 interest less $15 fee)................................................. 5,886.30 $15,958.40 $12,485.20 4,145.00 16,630.20 Less: NSF check.......................................................... $ 572.80 Error in recording check No. 3485 ............ 90.00* Error in 12-21 deposit ($2,954 – $2,945)........................................ 9.00 671.80 Adjusted cash balance per books .......................... $15,958.40 *$540.80 – $450.80 (b) Dec. 31 31 31 31 Cash .............................................................. Miscellaneous Expense .......................... Notes Receivable ............................ Interest Revenue ............................. 4,145.00 15.00 Accounts Receivable—D. Chagnon....... Cash .................................................... 572.80 Accounts Payable..................................... Cash .................................................... 90.00 Accounts Receivable............................... Cash .................................................... 9.00 8-23 4,000.00 160.00 572.80 90.00 9.00 PROBLEM 8-5A (a) HAVERMAN COMPANY Bank Reconciliation July 31, 2008 Cash balance per bank statement ............................... Add: Deposits in transit (1).......................................... Less: Outstanding checks (2) ...................................... Bank error ($255 – $155) .................................... Adjusted cash balance per bank .................................. Cash balance per books.................................................. Add: Collection of note receivable by bank ($3,400 note plus $70 interest)..................... Book error ($320 – $230) .................................... $24,514 9,400 33,914 $ 8,460 100 $21,850 $ 3,470 90 Less: Check printing charge ........................................ Adjusted cash balance per books ............................... (1) July receipts per books ........................... July deposits per bank ............................ Less: Deposits in transit, June 30 ..................................................... Deposits in transit, July 31..................... (2) Disbursements per books in July........................................................ Less: Book error ....................................... Total disbursements to be accounted for ................................... Checks clearing bank in July........................................................ Add: Bank error ....................................... Less: June 30 outstanding checks.............................. Outstanding checks, July 31....................................................... 8-24 8,560 $25,354 3,560 25,410 56 $25,354 $81,400 $79,000 7,000 72,000 $ 9,400 $77,150 90 77,060 $74,700 $ 100 6,200 6,100 68,600 $ 8,460 PROBLEM 8-5A (Continued) (b) July 31 31 31 Cash........................................................................... Notes Receivable.......................................... Interest Revenue........................................... 3,470 Miscellaneous Expense ...................................... Cash.................................................................. 56 Cash........................................................................... Accounts Payable ........................................ 90 8-25 3,400 70 56 90 PROBLEM 8-6A Tom has created a situation that leaves many opportunities for undetected theft. Here is a list of some of the deficiencies in internal control. You may find others. 1. Documentation procedures. The tickets were unnumbered. By numbering the tickets, the students could have been held more accountable for the tickets. See number 3 below. 2. Physical controls and establishment of responsibility. The tickets were left in an unlocked box on his desk. Instead, Tom should have assigned control of the tickets to one individual, in a locked box which that student alone had control over. 3. Documentation procedures. No record was kept of which students took tickets to sell or how many they took. In combination with items 1 and 2 above, the student assigned control over the tickets should have kept a record of which tickets were issued to each student for resale. (Note: This problem could have been largely avoided if the tickets had only been sold at the door on the day of the dance.) 4. Documentation procedures. There was no control over unsold tickets. This deficiency made it possible for students to sell the tickets, keep the cash, and tell Tom that they had disposed of the unsold tickets. Instead, students should have been required to return the unsold tickets to the student maintaining control over tickets, and the cash to Tom. In each case, the students should have been issued a receipt for the cash they turned in and the tickets they returned. 5. Establishment of responsibility. Inadequate control over the cash box. In effect, it was operated like a petty cash fund, but too many people had the key. Instead, Tom should have had the key and dispersed funds when necessary for purchases. 6. Documentation procedures. Instead of receipts, students simply wrote notes saying how they used the funds. Instead, it should have been required that they provided a valid receipt. 8-26 PROBLEM 8-6A (Continued) 7. Segregation of duties. Luke Gilmor counted the funds, made out the deposit slip, and took the funds to the bank. This made it possible for Luke Gilmor to take some of the money and deposit the rest since there was no external check on his work. Tom should have counted the funds, with someone observing him. Then he could have made out the deposit slip and had Luke Gilmor deposit the funds. 8. Documentation procedures. Tom did not receive a receipt from Obnoxious Ed. Without a receipt, there is no way to verify how much Obnoxious Ed was actually paid. For example, it is possible that he was only paid $100 and that Tom took the rest. 9. Separation of duties. Mel Harris was collecting tickets and receiving cash for additional tickets sold. Instead, there should have been one person selling tickets at the door and a second person collecting tickets. 8-27 PROBLEM 8-1B (a) Principles Application to Starr Theater Establishment of responsibility. Only cashiers are authorized to sell tickets. Only the manager and cashier can handle cash. Segregation of duties. The duties of receiving cash and admitting customers are assigned to the cashier and to the usher. The manager maintains custody of the cash, and the company accountant records the cash. Documentation procedures. Tickets are prenumbered. Cash count sheets are prepared. Deposit slips are prepared. Physical, mechanical, and electronic controls. A safe is used for the storage of cash and a machine is used to issue tickets. Independent internal verification. Cash counts are made by the manager at the end of each cashier’s shift. Daily comparisons are made by the company treasurer. Other controls. Cashiers are bonded. (b) Actions by the usher and cashier to misappropriate cash might include: (1) Instead of tearing the tickets, the usher could return the tickets to the cashier who could resell them, and the two could divide the cash. (2) The cashier could issue a lower price ticket than paid for and the usher would admit the customer. The difference between the ticket issued and the cash received could be divided between the usher and cashier. 8-28 PROBLEM 8-2B (a) July 1 15 31 Aug. 15 16 31 Petty Cash.......................................................... Cash............................................................ 200.00 Freight-out ......................................................... Postage Expense............................................. Entertainment Expense................................. Miscellaneous Expense ................................ Cash Over and Short...................................... Cash............................................................ 94.00 42.40 45.90 10.70 1.30 Freight-out ......................................................... Charitable Contributions Expense ............ Postage Expense............................................. Miscellaneous Expense ................................ Cash............................................................ 82.10 30.00 47.80 32.10 Freight-out ......................................................... Entertainment Expense................................. Postage Expense............................................. Miscellaneous Expense ................................ Cash Over and Short...................................... Cash............................................................ 74.40 41.50 33.00 36.00 3.10 Petty Cash.......................................................... Cash............................................................ 100.00 Postage Expense............................................. Entertainment Expense................................. Freight-out ......................................................... Cash Over and Short...................................... Cash............................................................ 145.00 90.60 46.00 1.40 200.00 194.30 192.00 188.00 100.00 283.00 (b) Petty Cash Date Explanation July 1 Aug. 16 Ref. CP CP 8-29 Debit 200 100 Credit Balance 200 300 PROBLEM 8-2B (Continued) (c) The internal control features of a petty cash fund include: (1) A custodian is responsible for the fund. (2) A prenumbered petty cash receipt signed by the custodian and the individual receiving payment is required for each payment from the fund. (3) The treasurer’s office examines all payments and stamps supporting documents to indicate they were paid when the fund is replenished. (4) Surprise counts can be made at any time to determine whether the fund is intact. 8-30 PROBLEM 8-3B (a) FLINT HILLS GENETICS COMPANY Bank Reconciliation May 31, 2008 Cash balance per bank statement .......................... Add: Deposit in transit............................................. Bank error—Bohr check ............................... $6,804.60 $936.15 600.00 Less: Outstanding checks ....................................... Adjusted cash balance per bank............................. Cash balance per books ............................................. Add: Collection of note receivable ($2,000 note plus $80 interest less $25 fee)................................................. 1,536.15 8,340.75 515.25 $7,825.50 $6,781.50 2,055.00 8,836.50 Less: NSF check........................................................... $934.00 Error in May 12 deposit................................. 10.00 Error in recording check No. 1181 ............ 27.00* Check printing charge ................................... 40.00 Adjusted cash balance per books .......................... 1,011.00 $7,825.50 *$685 – $658 (b) May 31 31 31 31 31 Cash ............................................................................ Miscellaneous Expense ........................................ Notes Receivable........................................... Interest Revenue............................................ 2,055 25 Accounts Receivable—Tyler Gricius ............... Cash................................................................... 934 Sales............................................................................ Cash................................................................... 10 Accounts Payable—M. Datz ................................ Cash................................................................... 27 Miscellaneous Expense ........................................ Cash................................................................... 40 8-31 2,000 80 934 10 27 40 PROBLEM 8-4B (a) CONLIN COMPANY Bank Reconciliation November 30, 2008 Balance per bank statement ............................... Add: Deposits in transit ..................................... Less: Outstanding checks No. 2451.................................................... No. 2472.................................................... No. 2478.................................................... No. 2482.................................................... No. 2484.................................................... No. 2485.................................................... No. 2487.................................................... No. 2488.................................................... Adjusted cash balance per bank ....................... $17,069.40 2,338.00 19,407.40 $1,260.40 503.60 538.20 612.00 829.50 974.80 398.00 1,200.00 Balance per books ................................................. Add: Note collected by bank ($2,400 note plus $120 interest less $15 fee) ........................................... Less: Check printing charge ............................. Error in recording check No. 2479 ......... Error in 11-21 deposit ($2,954 – $2,945) ..................................... Adjusted cash balance per books .................... *$1,750 – $1,570 8-32 6,316.50 $13,090.90 $10,846.90 2,505.00 13,351.90 $ 72.00 180.00* 9.00 261.00 $13,090.90 PROBLEM 8-4B (Continued) (b) Nov. 30 30 30 30 Cash ..................................................................... Miscellaneous Expense................................. Notes Receivable .................................... Interest Revenue..................................... 2,505 15 Miscellaneous Expense................................. Cash ............................................................ 72 Accounts Payable............................................ Cash ............................................................ 180 Accounts Receivable...................................... Cash ............................................................ 9 8-33 2,400 120 72 180 9 PROBLEM 8-5B (a) BAUMGARDNER COMPANY Bank Reconciliation August 31, 2008 Cash balance per bank statement ........................... Add: Deposits in transit (1)...................................... Bank error ($278 – $275) ................................ $25,932 $ 7,890 3 Less: Outstanding checks (2) .................................. Adjusted cash balance per bank .............................. Cash balance per books.............................................. Add: Collection of note receivable by bank ($6,800 note plus $130 interest)............... Book error ($420 – $240) ................................ Interest earned .................................................. $20,330 $ 6,930 180 32 Less: Safety deposit box rent .................................. Adjusted cash balance per books ........................... (1) August receipts per books ................................ August deposits per bank ................................. Less: Deposits in transit, July 31................... Deposits in transit, August 31.......................... (2) Disbursements per books in August ............................................. Less: Book error .............................. Total disbursements to be accounted for ................................ Checks clearing bank in August ............................................. Less: Bank error .............................. July 31 outstanding checks................................. Outstanding checks, August 31........................................ 8-34 7,893 33,825 6,393 $27,432 7,142 27,472 40 $27,432 $77,000 $73,110 4,000 69,110 $ 7,890 $73,570 180 73,390 $71,500 $ 3 4,500 4,503 66,997 $ 6,393 PROBLEM 8-5B (Continued) (b) Aug. 31 31 31 31 Cash .......................................................................... Notes Receivable ......................................... Interest Revenue .......................................... 6,930 Cash .......................................................................... Interest Revenue .......................................... 32 Miscellaneous Expense...................................... Cash ................................................................. 40 Cash .......................................................................... Accounts Payable........................................ 180 8-35 6,800 130 32 40 180 PROBLEM 8-6B (a) RICHARDSON COMPANY Bank Reconciliation October 31, 2008 Balance per bank statement ....................................................... Plus: Undeposited receipts ....................................................... $18,180.00 3,795.51 21,975.51 Less: Outstanding checks No. Amount No. Amount 62 183 284 $126.75 150.00 253.25 862 863 864 $190.71 226.80 165.28 ......................... 1,112.79 Adjusted balance per bank.......................................................... $20,862.72 Cash balance per books............................................................... Add: Bank credit (collection of note receivable)............... Adjusted balance per books (before theft) ............................ Theft .................................................................................................... Adjusted balance per books ....................................................... $21,892.72 400.00 22,292.72 1,430.00* $20,862.72 *$22,292.72 – $20,862.72 (b) The cashier attempted to cover the theft of $1,430.00 by: 1. Not listing as outstanding three checks totaling $530.00 (No. 62, $126.75; No. 183, $150.00; and No. 284, $253.25). 2. Underfooting the outstanding checks listed by $100. (The correct total is $582.79.) 3. Subtracting the $400 bank credit from the book balance instead of adding it to the book balance, thereby concealing $800 of the theft. 8-36 PROBLEM 8-6B (Continued) (c) 1. The principle of independent internal verification has been violated because the cashier prepared the bank reconciliation. 2. The principle of segregation of duties has been violated because the cashier had access to the accounting records and also prepared the bank reconciliation. 8-37 BYP 8-1 FINANCIAL REPORTING PROBLEM (a) In the Independent Auditors’ Report, it states that “consolidated financial statements referred to above [including the statement of cash flows] present fairly, in all material respects, the financial position of PepsiCo, Inc. and subsidiaries as of December 31, 2005 and December 25, 2004, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2005, in conformity with United States generally accepted accounting principles.” (b) Cash and cash equivalents are reported at $1,716 million for 2005 and $1,280 million for 2004. (c) Cash equivalents are defined as “investments with original maturities of three months or less which we do not intend to rollover beyond three months.” (d) PepsiCo’s management states that “our system of internal control is based on the control criteria framework of the Committee of Sponsoring Organizations of the Treadway Commission published in their report titled, Internal Control—Integrated Framework. The system is designed to provide reasonable assurance that transactions are executed as authorized and accurately recorded; that assets are safeguarded; and that accounting records are sufficiently reliable to permit the preparation of financial statements that conform in all material respects with accounting principles generally accepted in the U.S. We maintain disclosure controls and procedures designed to ensure that information required to be disclosed in reports under the Securities Exchange Act of 1934 is recorded, processed summarized and reported within the specified time periods. We monitor these internal controls through self-assessments and an ongoing program of internal audits. Our internal controls are reinforced through our Worldwide Code of Conduct, which sets forth our commitment to conduct business with integrity, and within both the letter and the spirit of the law.” 8-38 BYP 8-2 COMPARATIVE ANALYSIS PROBLEM PepsiCo (a) (1) $1,716 million Coca-Cola $4,701 million (2) $436 million increase $2,006 million decrease (3) $5,852 million $6,423 million (b) Both companies generated over 5.5 billion dollars from operating activities. This cash is used for investing and financing activities. Both companies use the cash provided by operating activities to purchase land, buildings and equipment, to make acquisitions of other companies, to buy back their stock, and to pay dividends. Both companies have large cash balances at the end of 2005 and are capable of generating huge amounts of cash. 8-39 BYP 8-3 EXPLORING THE WEB (a) The system of internal control should be evaluated by: (1) responsible individuals from a particular university unit, (2) internal auditors, and (3) university management. (b) Reconciliations ensure accuracy and completeness of transactions. In particular, a reconciliation ensures that all cash received is: (1) properly deposited in university bank accounts and (2) recorded accurately in the financial records. The reconciliation should be reviewed by the department manager. (c) Some examples given of physical controls are a safe, vault, locked doors, campus police, computer passwords, and card key systems. (d) Two ways to accomplish inventory counts are: (1) annual complete inventory or (2) cycle counting programs. 8-40 BYP 8-4 DECISION MAKING ACROSS THE ORGANIZATION (a) The weaknesses in internal accounting control over collections are: (1) Each usher could take cash from the collection plates enroute to the basement office. (2) The head usher counts the cash alone. (3) The head usher’s notation of the count is left in the safe. (4) The financial secretary counts the cash alone. (5) The financial secretary withholds $150 to $200 per week. (6) The cash is vulnerable to robbery when kept in the safe overnight. (7) Checks are made payable to “cash.” (8) The financial secretary has custody of the cash, maintains church records, and prepares the bank reconciliation. (b) The improvements should include the following: (1) The ushers should transfer their cash collections to a cash pouch (or bag) held by the head usher. The transfer should be witnessed by a member of the finance committee. (2) The head usher and finance committee member should take the cash to the office. The cash should be counted by the head usher and the financial secretary in the presence of the finance committee member. (3) Following the count, the financial secretary should prepare a deposit slip in duplicate for the total cash received, and the secretary should immediately deposit the cash in the bank’s night deposit vault. (4) At the end of each month, a member of the finance committee should prepare the bank reconciliation. (c) The policies that should be changed are: (1) Members should make checks payable to the church. (2) A petty cash fund should be established for the financial secretary to be used for weekly cash expenditures and requests for replenishment of the fund should be sent to the chairperson of the finance committee for approval. (3) The financial secretary should be bonded. (4) The financial secretary should be required to take an annual vacation. 8-41 BYP 8-5 COMMUNICATION ACTIVITY Mr. Jerry Mays Manhattan Company Main Street, USA Dear Mr. Mays: During our audit of your financial statements, we reviewed the internal controls over cash receipts. The weaknesses we discovered and our suggested improvements are listed below. (a) Weaknesses (b) Suggested Improvement 1. A list of checks received is not prepared by the person who opens the mail. This list should be prepared so that it can later be compared with the daily cash summary. While this procedure does not assure that all checks will be listed, it does allow the company to verify that all checks on the list did get deposited. 2. Mail is opened by only one person. When this occurs, there is no assurance that all incoming checks are forwarded to the cashier’s department. 3. The cashier is allowed to open the mail. Under this arrangement, it is possible for the cashier to open the mail, prepare the cash summary and make the bank deposit. This involves no segregation of duties as the cashier controls the cash from the time it is received until it is deposited in the bank. 4. The accounts receivable clerk is allowed to open the mail. Again, there is poor segregation of duties. In this case, the clerk could writeoff a customer’s account as uncollectible and then misappropriate the collection when it’s received. 8-42 BYP 8-5 (Continued) 5. (a) Weaknesses (b) Suggested Improvement Mail receipts are deposited weekly. This makes the receipts vulnerable to robbery and to misappropriation. The receipts should be deposited intact daily. We would be pleased to discuss the weaknesses and our recommended improvements with you, at your convenience. Yours sincerely, Croix, Marais, and Kale Certified Public Accountants 8-43 BYP 8-6 ETHICS CASE (a) You, as assistant controller, may suffer some negative effects from Gena Schmitt, the financial vice-president, if you don’t follow her instructions. Maybe the insurance company will react the way Gena suggests, but probably not. If you comply and falsify the June 30 cash balance by holding the cash receipts book open for one day, you will suffer personally by sacrificing your integrity. If you are found out, you could be prosecuted for preparing a fraudulent report. The insurance company, as the lender and creditor, is deceived. (b) Holding the cash receipts book open in order to overstate the cash balance is a fraudulent, deceitful, unethical action. The financial vicepresident should not encourage such behavior and a controller should not follow such instructions. (c) (1) You can follow the vice-president’s instructions and misstate the cash balance—wrong! (2) You can advise the vice-president against holding the books open, prepare an accurate report, and have the vice-president or the president discuss the situation with the insurance company. It can be explained that the low cash balance was only temporary. Honesty is still the best policy. 8-44 BYP 8-7 ALL ABOUT YOU ACTIVITY Answers are provided to students on the government website as they complete the ID Theft Faceoff quiz. 8-45 CHAPTER 9 Accounting for Receivables ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises A Problems B Problems 1. Identify the different types of receivables. 1, 2 1 2. Explain how companies recognize accounts receivable. 3 2 1, 2, 14 1A, 3A, 4A, 6A, 7A 1B, 3B, 4B, 6B, 7B 3. Distinguish between the methods and bases companies use to value accounts receivable. 4, 5, 6, 7, 8 3, 4, 5, 6, 7 3, 4, 5, 6 1A, 2A, 3A, 4A, 5A 1B, 2B, 3B, 4B, 5B 4. Describe the entries to record the disposition of accounts receivable. 9, 10, 11 8 7, 8, 9, 14 6A, 7A 6B, 7B 5. Compute the maturity date of and interest on notes receivable. 12, 13, 14, 15, 16 9, 10 10, 11, 12, 13 6A, 7A 6B, 7B 6. Explain how companies recognize notes receivable. 11 10, 11, 12 7A 7B 7. Describe how companies value notes receivable. 7A 7B 8. Describe the entries to record the disposition of notes receivable. 17 12, 13 6A, 7A 6B, 7B 9. Explain the statement presentation and analysis of receivables. 18, 19 14, 15 1A, 6A 1B, 6B 3, 12 9-1 Exercises ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) Simple 15–20 1A Prepare journal entries related to bad debts expense. 2A Compute bad debts amounts. Moderate 20–25 3A Journalize entries to record transactions related to bad debts. Moderate 20–30 4A Journalize transactions related to bad debts. Moderate 20–30 5A Journalize entries to record transactions related to bad debts. Moderate 20–30 6A Prepare entries for various notes receivable transactions. Moderate 40–50 7A Prepare entries for various receivable transactions. Complex 50–60 1B Prepare journal entries related to bad debts expense. Simple 15–20 2B Compute bad debts amounts. Moderate 20–25 3B Journalize entries to record transactions related to bad debts. Moderate 20–30 4B Journalize transactions related to bad debts. Moderate 20–30 5B Journalize entries to record transactions related to bad debts. Moderate 20–30 6B Prepare entries for various notes receivable transactions. Moderate 40–50 7B Prepare entries for various receivable transactions. Complex 50–60 9-2 Study Objective Knowledge Q9-2 9-3 1. Identify the different types of receivables. 2. Explain how companies recognize accounts receivable. 3. Distinguish between the methods and bases used to value accounts receivable. Q9-8 4. Describe the entries to record the disposition of accounts receivable. 5. Compute the maturity date of and interest on notes receivable. 6. Comprehension Q9-1 Application Analysis Synthesis BE9-1 Q9-3 BE9-2 E9-1 E9-2 E9-14 P9-7A P9-1A P9-7B P9-3A P9-4A P9-6A P9-1B P9-3B P9-4B P9-6B Q9-4 Q9-5 Q9-6 BE9-4 BE9-5 BE9-6 E9-5 E9-6 Q9-7 BE9-3 BE9-7 E9-3 E9-4 P9-1A P9-2A P9-3A P9-4A P9-5A P9-1B P9-2B P9-3B P9-4B P9-5B Q9-9 Q9-10 Q9-11 BE9-8 E9-7 E9-8 E9-9 E9-14 P9-7A P9-6A P9-7B P9-6B Q9-13 Q9-12 Q9-16 Q9-14 Q9-15 BE9-9 BE9-10 E9-12 E9-13 P9-7A P9-7B Explain how companies recognize notes receivable. BE9-11 P9-7A P9-7B E9-10 E9-12 E9-11 7. Describe how companies value notes receivable. P9-7A P9-7B 8. Describe the entries to record the disposition of notes receivable. 9. Explain the statement presentation and analysis of receivables. Broadening Your Perspective Q9-17 Q9-18 Evaluation E9-12 E9-13 Q9-19 BE9-12 E9-15 E9-10 E9-11 P9-6A P9-6B P9-7A P9-6A P9-7B P9-6B BE9-3 E9-14 P9-1A P9-6A P9-1B P9-6B Exploring the Web Decision Making Across the Organization Comparative Analysis All About You Financial Reporting Comparative Analysis Ethics Case Communication BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. Accounts receivable are amounts owed by customers on account. They result from the sale of goods and services in the normal course of business operations (i.e., in trade). Notes receivable represent claims that are evidenced by formal instruments of credit. 2. Other receivables include nontrade receivables such as interest receivable, loans to company officers, advances to employees, and income taxes refundable. 3. Accounts Receivable ............................................................................................................... Interest Revenue ............................................................................................................. 40 40 4. The essential features of the allowance method of accounting for bad debts are: (1) Uncollectible accounts receivable are estimated and matched against revenue in the same accounting period in which the revenue occurred. (2) Estimated uncollectibles are debited to Bad Debts Expense and credited to Allowance for Doubtful Accounts through an adjusting entry at the end of each period. (3) Actual uncollectibles are debited to Allowance for Doubtful Accounts and credited to Accounts Receivable at the time the specific account is written off. 5. Jerry Gatewood should realize that the decrease in cash realizable value occurs when estimated uncollectibles are recognized in an adjusting entry. The write-off of an uncollectible account reduces both accounts receivable and the allowance for doubtful accounts by the same amount. Thus, cash realizable value does not change. 6. The two bases of estimating uncollectibles are: (1) percentage-of-sales and (2) percentage-ofreceivables. The percentage-of-sales basis establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts. This method emphasizes the matching of expenses with revenues. Under the percentage-of-receivables basis, the balance in the allowance for doubtful accounts is derived from an analysis of individual customer accounts. This method emphasizes cash realizable value. 7. The adjusting entry under the percentage-of-sales basis is: Bad Debts Expense ............................................................................................ Allowance for Doubtful Accounts ............................................................ 4,100 The adjusting entry under the percentage-of-receivables basis is: Bad Debts Expense ............................................................................................ Allowance for Doubtful Accounts ($5,800 – $3,500)........................... 2,300 4,100 2,300 8. Under the direct write-off method, bad debt losses are not estimated and no allowance account is used. When an account is determined to be uncollectible, the loss is debited to Bad Debts Expense. The direct write-off method makes no attempt to match bad debts expense to sales revenues or to show the cash realizable value of the receivables in the balance sheet. 9. From its own credit cards, the DeVito Company may realize financing charges from customers who do not pay the balance due within a specified grace period. National credit cards offer the following advantages: (1) The credit card issuer makes the credit investigation of the customer. (2) The issuer maintains individual customer accounts. 9-4 Questions Chapter 9 (Continued) (3) The issuer undertakes the collection process and absorbs any losses from uncollectible accounts. (4) The retailer receives cash more quickly from the credit card issuer than it would from individual customers. 10. The reasons companies are selling their receivables are: (1) Receivables may be sold because they may be the only reasonable source of cash. (2) Billing and collection are often time-consuming and costly. It is often easier for a retailer to sell the receivables to another party with expertise in billing and collection matters. 11. Cash.......................................................................................................................... Service Charge Expense (3% X $600,000) ...................................................... Accounts Receivable.................................................................................... 582,000 18,000 600,000 12. A promissory note gives the holder a stronger legal claim than one on an accounts receivable. As a result, it is easier to sell to another party. Promissory notes are negotiable instruments, which means they can be transferred to another party by endorsement. The holder of a promissory note also can earn interest. 13. The maturity date of a promissory note may be stated in one of three ways: (1) on demand, (2) on a stated date, and (3) at the end of a stated period of time. 14. The maturity dates are: (a) March 13 of the next year, (b) August 4, (c) July 20, and (d) August 30. 15. The missing amounts are: (a) $20,000, (b) $9,000, (c) 8%, and (d) four months. 16. If a financial institution uses 360 days rather than 365 days, it will receive more interest revenue. The reason is that the denominator is smaller, which makes the fraction larger and, therefore, the interest revenue larger. 17. When Cain Company dishonors a note, it may: (1) issue a new note for the maturity value of the dishonored note, or (2) refuse to make any settlement, or (3) it might make partial payment and issue a new note for the unpaid balance. 18. Each of the major types of receivables should be identified in the balance sheet or in the notes to the financial statements. Both the gross amount of receivables and the allowance for doubtful accounts should be reported. If collectible within a year or the operating cycle, whichever is longer, these receivables are reported as current assets immediately below short-term investments. 19. Net credit sales for the period are 8.14 X $400,000 = $3,256,000. 9-5 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 9-1 (a) Accounts receivable. (b) Notes receivable. (c) Other receivables. BRIEF EXERCISE 9-2 (a) Accounts Receivable................................................... Sales......................................................................... 15,200 (b) Sales Returns and Allowances ................................ Accounts Receivable.......................................... 3,800 (c) Cash ($11,400 – $228) ................................................. Sales Discounts ($11,400 X 2%) .............................. Accounts Receivable ($15,200 – $3,800) ......... 11,172 228 15,200 3,800 11,400 BRIEF EXERCISE 9-3 (a) Bad Debts Expense...................................................... Allowance for Doubtful Accounts .................. 35,000 (b) Current assets Cash ......................................................................... Accounts receivable ........................................... $600,000 Less: Allowance for doubtful Accounts............................................... 35,000 Merchandise inventory ...................................... Prepaid expenses ................................................ Total current assets ....................................... 9-6 35,000 $ 90,000 565,000 130,000 7,500 $792,500 BRIEF EXERCISE 9-4 (a) Allowance for Doubtful Accounts .................................. Accounts Receivable—Ristau ................................ (b) (1) Before Write-Off Accounts receivable Allowance for doubful accounts Cash realizable value 5,400 5,400 (2) After Write-Off $700,000 $694,600 54,000 $646,000 48,600 $646,000 BRIEF EXERCISE 9-5 Accounts Receivable—Ristau .................................................. Allowance for Doubtful Accounts .................................. 5,400 Cash................................................................................................... Accounts Receivable—Ristau ......................................... 5,400 5,400 5,400 BRIEF EXERCISE 9-6 Bad Debts Expense [($800,000 – $45,000) X 2%]................ Allowance for Doubtful Accounts .................................. 15,100 15,100 BRIEF EXERCISE 9-7 (a) Bad Debts Expense [($450,000 X 1%) – $1,500] ............. Allowance for Doubtful Accounts.......................... 3,000 3,000 (b) Bad Debts Expense [($450,000 X 1%) + $800] = 5,300 BRIEF EXERCISE 9-8 (a) Cash ($150 – $6) ................................................................... Service Charge Expense ($150 X 4%) ........................... Sales ................................................................................ 144 6 (b) Cash ($60,000 – $1,800)...................................................... Service Charge Expense ($60,000 X 3%)...................... Accounts Receivable ................................................. 58,200 1,800 9-7 150 60,000 BRIEF EXERCISE 9-9 Interest (a) $800 (b) $875 (c) $200 Maturity Date August 9 October 12 July 11 BRIEF EXERCISE 9-10 Maturity Date Annual Interest Rate Total Interest 9% 8% 10% $9,000 $ 600 $6,000 (a) May 31 (b) August 1 (c) September 7 BRIEF EXERCISE 9-11 Jan. 10 Feb. 9 Accounts Receivable .............................................. Sales .................................................................... 13,600 Notes Receivable...................................................... Accounts Receivable ..................................... 13,600 BRIEF EXERCISE 9-12 Accounts Receivable Turnover Ratio: $20B $20B = = 7.3 times $2.75B ($2.7B + $2.8B) ÷ 2 Average Collection Period for Accounts Receivable: 365 days = 50 days 7.3 times 9-8 13,600 13,600 SOLUTIONS TO EXERCISES EXERCISE 9-1 March 1 Accounts Receivable—CC Company............. 3,000 Sales................................................................. 3 Sales Returns and Allowances......................... Accounts Receivable—CC Company........ 9 500 500 Cash .......................................................................... 2,450 Sales Discounts..................................................... 50 Accounts Receivable—CC Company........ 15 31 3,000 Accounts Receivable ........................................... Sales................................................................. 400 Accounts Receivable ........................................... Interest Revenue .......................................... 6 2,500 400 6 EXERCISE 9-2 (a) Jan. 6 16 (b) Jan. 10 Feb. 12 Mar. 10 Accounts Receivable—Cortez.......................... 9,000 Sales................................................................. 9,000 Cash ($9,000 – $180) ............................................ 8,820 Sales Discounts (2% X $9,000) ......................... 180 Accounts Receivable—Cortez ................. 9,000 Accounts Receivable—Dawes.......................... 9,000 Sales................................................................. 9,000 Cash .......................................................................... 5,000 Accounts Receivable—Dawes................. 5,000 Accounts Receivable—Dawes.......................... Interest Revenue .......................................... [2% X ($9,000 – $5,000)] 9-9 80 80 EXERCISE 9-3 (a) Dec. 31 (b) (1) Dec. 31 (2) Dec. 31 (c) (1) Dec. 31 (2) Dec. 31 Bad Debts Expense .............................. Accounts Receivable—Fell ........... 1,400 Bad Debts Expense ............................... [($840,000 – $30,000) X 1%] Allowance for Doubtful Accounts .................................... 8,100 Bad Debts Expense .............................. Allowance for Doubtful Accounts ......................................... [($120,000 X 10%) – $2,100] 9,900 Bad Debts Expense .............................. [($840,000 – $30,000) X .75%] Allowance for Doubtful Accounts .................................... 6,075 Bad Debts Expense .............................. Allowance for Doubtful Accounts ......................................... [($120,000 X 6%) + $200] 7,400 1,400 8,100 9,900 6,075 7,400 EXERCISE 9-4 (a) Accounts Receivable 1–30 days 30–60 days 60–90 days Over 90 days (b) Mar. 31 Amount % Estimated Uncollectible $60,000 17,600 8,500 7,000 2.0 5.0 30.0 50.0 $1,200 880 2,550 3,500 $8,130 Bad Debts Expense ............................................. Allowance for Doubtful Accounts.......... ($8,130 – $1,200) 9-10 6,930 6,930 EXERCISE 9-5 Allowance for Doubtful Accounts .......................................... Accounts Receivable ......................................................... 13,000 Accounts Receivable .................................................................. Allowance for Doubtful Accounts ................................. 1,800 Cash.................................................................................................. Accounts Receivable ......................................................... 1,800 Bad Debts Expense ..................................................................... Allowance for Doubtful Accounts ................................. [$19,000 – ($15,000 – $13,000 + $1,800)] 15,200 13,000 1,800 1,800 15,200 EXERCISE 9-6 December 31, 2008 Bad Debts Expense (2% X $400,000)..................................... Allowance for Doubtful Accounts ................................. 8,000 May 11, 2009 Allowance for Doubtful Accounts .......................................... Accounts Receivable—Frye ............................................ 1,100 June 12, 2009 Accounts Receivable—Frye ..................................................... Allowance for Doubtful Accounts ................................. 1,100 Cash.................................................................................................. Accounts Receivable—Frye ............................................ 8,000 1,100 1,100 1,100 1,100 EXERCISE 9-7 (a) Mar. 3 (b) May 10 Cash ($680,000 – $20,400)............................ 659,600 Service Charge Expense .............................. 20,400 (3% X $680,000) Accounts Receivable ............................ Cash ($3,500 – $140) ...................................... Service Charge Expense .............................. (4% X $3,500) Sales........................................................... 9-11 680,000 3,360 140 3,500 EXERCISE 9-8 (a) Apr. 2 May 3 June 1 (b) July 4 Accounts Receivable—Nancy Hansel ..... Sales .......................................................... 1,500 Cash.................................................................... Accounts Receivable—Nancy Hansel ................................................... 700 Accounts Receivable—Nancy Hansel ..... Interest Revenue.................................... [($1,500 – $700) X 1%] 8 Cash.................................................................... Service Charge Expense.............................. (3% X $200) Sales .......................................................... 194 6 Accounts Receivable ..................................... Sales ........................................................... 18,000 Cash ($4,300 – $86)......................................... Service Charge Expense............................... ($4,300 X 2%) Sales ........................................................... 4,214 86 Cash..................................................................... Accounts Receivable ............................ 10,000 Accounts Receivable ($8,000 X 1%).......... Interest Revenue..................................... 80 1,500 700 8 200 EXERCISE 9-9 (a) Jan. 15 20 Feb. 10 15 18,000 4,300 10,000 (b) Interest Revenue is reported under other revenues and gains. Service Charge Expense is a selling expense. 9-12 80 EXERCISE 9-10 (a) Nov. 1 Dec. 11 16 31 2008 Notes Receivable..................................................... Cash .................................................................... 15,000 15,000 Notes Receivable..................................................... Sales ................................................................... 6,750 Notes Receivable..................................................... Accounts Receivable—Reber..................... 4,000 Interest Receivable ................................................. Interest Revenue* ........................................... 295 6,750 4,000 295 *Calculation of interest revenue: Givens’s note: $15,000 X 10% X 2/12 = $250 Countryman’s note: 6,750 X 8% X 20/360 = 30 Reber’s note: 4,000 X 9% X 15/360 = 15 Total accrued interest $295 (b) Nov. 1 2009 Cash ............................................................................. Interest Receivable......................................... Interest Revenue* ........................................... Notes Receivable ............................................ *($15,000 X 10% X 10/12) 16,500 250 1,250 15,000 EXERCISE 9-11 May 1 Dec. 31 31 2008 Notes Receivable..................................................... Accounts Receivable—Julia ....................... Gonzalez ....................................................... 7,500 7,500 Interest Receivable ................................................. Interest Revenue............................................. ($7,500 X 10% X 8/12) 500 Interest Revenue...................................................... Income Summary............................................ 500 9-13 500 500 EXERCISE 9-11 (Continued) May 1 2009 Cash ............................................................................. Notes Receivable ............................................ Interest Receivable......................................... Interest Revenue ............................................. ($7,500 X 10% X 4/12) 8,250 7,500 500 250 EXERCISE 9-12 4/1/08 7/1/08 12/31/08 4/1/09 Notes Receivable ..................................................... Accounts Receivable—Wilson ................... 20,000 Notes Receivable ..................................................... Cash..................................................................... 25,000 Interest Receivable.................................................. Interest Revenue ............................................. ($20,000 X 12% X 9/12) 1,800 Interest Receivable.................................................. Interest Revenue ............................................. ($25,000 X 10% X 6/12) 1,250 Cash.............................................................................. Notes Receivable ............................................ Interest Receivable......................................... Interest Revenue ............................................. ($20,000 X 12% X 3/12 = $600) 22,400 Accounts Receivable .............................................. Notes Receivable ............................................ Interest Receivable......................................... Interest Revenue ............................................. ($25,000 X 10% X 3/12 = $625) 26,875 9-14 20,000 25,000 1,800 1,250 20,000 1,800 600 25,000 1,250 625 EXERCISE 9-13 (a) May 2 (b) Nov. 2 (c) Nov. 2 Notes Receivable .............................................. Cash .............................................................. Accounts Receivable—Everhart Inc....................................................................... Notes Receivable ...................................... Interest Revenue ....................................... ($7,600 X 9% X 1/2) (To record the dishonor of Everhart Inc. note with expectation of collection) Allowance for Doubtful Accounts ................ Notes Receivable ...................................... (To record the dishonor of Everhart Inc. note with no expectation of collection) 7,600 7,600 7,942 7,600 342 7,600 7,600 EXERCISE 9-14 (a) Sales ......................................................................................... Cost of Goods Sold Beginning Inventory................................................... Add: Purchases (net)................................................ Goods Available for Sale .......................................... Less: Ending Inventory............................................ Cost of Goods Sold .................................................... Gross Profit............................................................................ $83,000 $36,000 60,000 96,000 33,000 63,000 $20,000 Total Sales = $83,000 ($20,000 + $63,000) Cash Sales = $18,000 Credit Sales = $65,000 (b) Accounts Receivable at December 31 is $10,000, as shown below: Accounts Receivable Beg. Bal. $24,000 Write-offs Credit sales 65,000 Collections End bal. 10,000 9-15 1,000 78,000 EXERCISE 9-15 (a) Beginning accounts receivable ............................................... Net credit sales.............................................................................. Cash collections ........................................................................... Accounts written off .................................................................... Ending accounts receivable ..................................................... (b) $1,000,000/[($100,000 + $170,000)/2] = 7.41 (c) 365/7.41 = 49.3 days 9-16 $ 100,000 1,000,000 (900,000) (30,000) $ 170,000 SOLUTIONS TO PROBLEMS PROBLEM 9-1A (a) 1. 2. 3. 4. 5. Accounts Receivable ....................................... Sales ............................................................. 3,200,000 Sales Returns and Allowances..................... Accounts Receivable .............................. 50,000 Cash....................................................................... Accounts Receivable .............................. 2,810,000 Allowance for Doubtful Accounts ............... Accounts Receivable .............................. 90,000 Accounts Receivable ....................................... Allowance for Doubtful Accounts.......... 24,000 Cash....................................................................... Accounts Receivable .............................. 24,000 3,200,000 50,000 2,810,000 90,000 24,000 24,000 (b) Bal. (1) (5) Bal. Accounts Receivable 960,000 (2) 50,000 3,200,000 (3) 2,810,000 24,000 (4) 90,000 (5) 24,000 1,210,000 9-17 Allowance for Doubtful Accounts (4) 90,000 Bal. 80,000 (5) 24,000 Bal. 14,000 PROBLEM 9-1A (Continued) (c) Balance before adjustment [see (b)] ........................................... Balance needed.................................................................................. Adjustment required......................................................................... $ 14,000 115,000 $101,000 The journal entry would therefore be as follows: Bad Debts Expense................................................ Allowance for Doubtful Accounts ............ (d) 101,000 $3,200,000 – $50,000 $3,150,000 = = 3.19 times ($880,000 + $1,095,000) ÷ 2 $987,500 9-18 101,000 PROBLEM 9-2A (a) $33,000. (b) $44,000 ($2,200,000 X 2%). (c) $46,500 [($825,000 X 6%) – $3,000]. (d) $52,500 [($825,000 X 6%) + $3,000]. (e) The weakness of the direct write-off method is two-fold. First, it does not match expenses with revenues. Second, the accounts receivable are not stated at cash realizable value at the balance sheet date. 9-19 PROBLEM 9-3A (a) Dec. 31 Bad Debts Expense ........................................ Allowance for Doubtful Accounts........ ($42,610 – $12,000) 30,610 30,610 (a) & (b) Bad Debts Expense Date 2008 Dec. 31 Explanation Ref. Adjusting Debit Credit 30,610 Balance 30,610 Allowance for Doubtful Accounts Date 2008 Dec. 31 31 2009 Mar. 31 May 31 Explanation Ref. Debit Balance Adjusting Credit Balance 30,610 12,000 42,610 1,000 41,610 42,610 1,000 (b) Mar. 31 May 31 31 (c) Dec. 31 2009 (1) Allowance for Doubtful Accounts ............. Accounts Receivable ............................ (2) Accounts Receivable ..................................... Allowance for Doubtful Accounts........ Cash..................................................................... Accounts Receivable ............................ 2009 Bad Debts Expense ........................................ Allowance for Doubtful Accounts........ ($28,600 + $800) 9-20 1,000 1,000 1,000 1,000 1,000 1,000 29,400 29,400 PROBLEM 9-4A (a) Total estimated bad debts Total 0–30 Accounts receivable $375,000 $220,000 % uncollectible 1% Estimated Bad debts $ 10,100 $ 2,200 Number of Days Outstanding 31–60 61–90 91–120 Over 120 $90,000 $40,000 $10,000 $15,000 4% 5% 8% 10% $ 3,600 $ 2,000 $ 800 $ 1,500 (b) Bad Debts Expense ............................................................ Allowance for Doubtful Accounts........................ ($10,100 + $8,000) 18,100 (c) Allowance for Doubtful Accounts ................................. Accounts Receivable ............................................... 5,000 (d) Accounts Receivable ......................................................... Allowance for Doubtful Accounts........................ 5,000 Cash......................................................................................... Accounts Receivable ............................................... 5,000 18,100 5,000 5,000 5,000 (e) If Wall Inc. used 3% of total accounts receivable rather than aging the individual accounts the bad debt expense adjustment would be $19,250 [($375,000 X 3%) + $8,000]. The rest of the entries would be the same as they were when aging the accounts receivable. Aging the individual accounts rather than applying a percentage to the total accounts receivable should produce a more accurate allowance account and bad debts expense. 9-21 PROBLEM 9-5A (a) The allowance method. Since the balance in the allowance for doubtful accounts is given, they must be using this method because the account would not exist if they were using the direct write-off method. (b) (1) Dec. 31 Bad Debts Expense ............................... ($11,750 – $2,000) Allowance for Doubtful Accounts ..................................... 9,750 Bad Debts Expense ............................... ($950,000 X 1%) Allowance for Doubtful Accounts ..................................... 9,500 Bad Debts Expense ............................... ($11,750 + $2,000) Allowance for Doubtful Accounts ..................................... 13,750 Bad Debts Expense ............................... Allowance for Doubtful Accounts ..................................... 9,500 (d) Allowance for Doubtful Accounts.................................. Accounts Receivable................................................. 3,000 (2) Dec. 31 (c) (1) Dec. 31 (2) Dec. 31 9,750 9,500 13,750 9,500 3,000 Note: The entry is the same whether the amount of bad debts expense at the end of 2008 was estimated using the percentage of receivables or the percentage of sales method. (e) Bad Debts Expense............................................................. Accounts Receivable................................................. (f) 3,000 3,000 Allowance for Doubtful Accounts is a contra-asset account. It is subtracted from the gross amount of accounts receivable so that accounts receivable is reported at its cash realizable value. 9-22 PROBLEM 9-6A (a) Oct. 7 12 15 15 24 31 Accounts Receivable......................................... Sales............................................................... 6,900 Cash ($900 – $27)................................................ Service Charge Expense .................................. ($900 X 3%) Sales............................................................... 873 27 Accounts Receivable ......................................... Interest Revenue ........................................ 460 Cash ........................................................................ Notes Receivable ....................................... Interest Receivable.................................... ($8,000 X 8% X 45/360) Interest Revenue ........................................ ($8,000 X 8% X 15/360) 8,107 Accounts Receivable—Hughey...................... Notes Receivable ....................................... Interest Receivable.................................... ($9,000 X 10% X 36/360) Interest Revenue ........................................ ($9,000 X 10% X 24/360) 9,150 Interest Receivable............................................. ($16,000 X 9% X 1/12) Interest Revenue ........................................ 120 6,900 900 460 8,000 80 27 9,000 90 60 120 (b) Notes Receivable Date Explanation Oct. 1 Balance 15 24 Ref.
Debit Credit 8,000 9,000 9-23 Balance 33,000 25,000 16,000 PROBLEM 9-6A (Continued) Accounts Receivable Date Oct. Explanation Ref. Debit 6,900 460 9,150 Credit Balance 6,900 7,360 16,510 Ref.
Debit Credit Balance 170 90 0 120 7 15 24 Interest Receivable Date Oct. 1 15 24 31 Explanation Balance 80 90 120 (c) Current assets Notes receivable .......................................................................... Accounts receivable ................................................................... Interest receivable ....................................................................... Total receivables................................................................. 9-24 $16,000 16,510 120 $32,630 PROBLEM 9-7A Jan. 5 20 Feb. 18 Apr. 20 30 May 25 Aug. 18 25 Sept. 1 Accounts Receivable—Dedonder Company ........ Sales ...................................................................... 20,000 Notes Receivable........................................................ Accounts Receivable—Dedonder Company.......................................................... 20,000 Notes Receivable........................................................ Sales ...................................................................... 8,000 Cash ($20,000 + $450) ............................................... Notes Receivable............................................... Interest Revenue................................................ ($20,000 X 9% X 3/12) 20,450 Cash ($25,000 + $1,000)............................................ Notes Receivable............................................... Interest Revenue................................................ ($25,000 X 12% X 4/12) 26,000 Notes Receivable........................................................ Accounts Receivable—Jenks Inc. ............... 4,000 Cash ($8,000 + $360) ................................................. Notes Receivable............................................... Interest Revenue................................................ ($8,000 X 9% X 6/12) 8,360 Accounts Receivable—Jenks Inc. ........................ ($4,000 + $70) Notes Receivable............................................... Interest Revenue................................................ ($4,000 X 7% X 3/12) 4,070 Notes Receivable........................................................ Sales ...................................................................... 12,000 9-25 20,000 20,000 8,000 20,000 450 25,000 1,000 4,000 8,000 360 4,000 70 12,000 PROBLEM 9-1B (a) 1. 2. 3. 4. 5. Accounts Receivable.......................................... 2,570,000 Sales ............................................................... Sales Returns and Allowances ....................... Accounts Receivable................................. 2,570,000 40,000 40,000 Cash ......................................................................... 2,300,000 Accounts Receivable................................. Allowance for Doubtful Accounts.................. Accounts Receivable................................. 65,000 Accounts Receivable.......................................... Allowance for Doubtful Accounts................................................... 25,000 Cash ......................................................................... Accounts Receivable................................. 25,000 2,300,000 65,000 25,000 25,000 (b) Bal. (1) (5) Bal. Accounts Receivable 1,000,000 (2) 40,000 2,570,000 (3) 2,300,000 25,000 (4) 65,000 (5) 25,000 1,165,000 Allowance for Doubtful Accounts (4) 65,000 Bal. 60,000 (5) 25,000 Bal. 20,000 (c) Balance before adjustment [see (b)] ........................................... Balance needed.................................................................................. Adjustment required......................................................................... $20,000 90,000 $70,000 The journal entry would therefore be as follows: Bad Debts Expense................................................... Allowance for Doubtful Accounts ............... (d) $2,570,000 – $40,000 $2,530,000 = = 2.51 times ($1,075,000 + $940,000) ÷ 2 $1,007,500 9-26 70,000 70,000 PROBLEM 9-2B (a) $26,000. (b) $30,800 ($1,540,000 X 2%). (c) $22,000 [($520,000 X 5%) – $4,000]. (d) $28,000 [($520,000 X 5%) + $2,000]. (e) There are two major weaknesses with the direct write-off method. First, it does not match expenses with the associated revenues. Second, the accounts receivable are not stated at cash realizable value at the balance sheet date. 9-27 PROBLEM 9-3B (a) Dec. 31 Bad Debts Expense ........................................ Allowance for Doubtful Accounts........ ($35,790 – $10,000) 25,790 25,790 (a) & (b) Bad Debts Expense Date Explanation 2008 Dec. 31 Adjusting Ref. Debit Credit 25,790 Balance 25,790 Allowance for Doubtful Accounts Date Explanation 2008 Dec. 31 Balance 31 Adjusting 2009 Mar. 1 May 1 (b) Mar. 1 May 1 1 (c) Dec. 31 Ref. Debit Credit Balance 25,790 10,000 35,790 1,100 34,690 35,790 1,100 2009 (1) Allowance for Doubtful Accounts ............... Accounts Receivable .............................. (2) Accounts Receivable ....................................... Allowance for Doubtful Accounts.......... Cash....................................................................... Accounts Receivable .............................. 2009 Bad Debts Expense .......................................... Allowance for Doubtful Accounts.......... ($28,300 + $1,200) 9-28 1,100 1,100 1,100 1,100 1,100 1,100 29,500 29,500 PROBLEM 9-4B (a) Total estimated bad debts Total 0–30 Number of Days Outstanding 31–60 61–90 91–120 Over 120 Accounts receivable $260,000 $100,000 $60,000 % uncollectible 1% 5% Estimated Bad debts $ 13,750 $ 1,000 $ 3,000 $50,000 $30,000 7.5% 10% $20,000 15% $ 3,750 $ 3,000 $ 3,000 (b) Bad Debts Expense ............................................................ Allowance for Doubtful Accounts........................ [$13,750 – $10,000] 3,750 (c) Allowance for Doubtful Accounts ................................. Accounts Receivable ............................................... 2,000 (d) Accounts Receivable ......................................................... Allowance for Doubtful Accounts........................ 1,000 Cash......................................................................................... Accounts Receivable ............................................... 1,000 3,750 2,000 1,000 1,000 (e) When an allowance account is used, an adjusting journal entry is made at the end of each accounting period. This entry satisfies the matching principle by recording the bad debts expense in the period in which the sales occur. 9-29 PROBLEM 9-5B (a) (1) Dec. 31 Bad Debts Expense ................................ ($17,550 – $1,500) Allowance for Doubtful Accounts ...................................... 16,050 Bad Debts Expense ................................ ($850,000 X 2%) Allowance for Doubtful Accounts ...................................... 17,000 Bad Debts Expense ................................ ($17,550 + $1,500) Allowance for Doubtful Accounts ...................................... 19,050 Bad Debts Expense ................................ Allowance for Doubtful Accounts ...................................... 17,000 (c) Allowance for Doubtful Accounts................................... Accounts Receivable.................................................. 4,500 (2) Dec. 31 (b) (1) Dec. 31 (2) Dec. 31 16,050 17,000 19,050 17,000 4,500 Note: The entry is the same whether the amount of bad debts expense at the end of 2008 was estimated using the percentage of receivables or the percentage of sales method. (d) Bad Debts Expense............................................................. Accounts Receivable................................................. 4,500 4,500 (e) The advantages of the allowance method over the direct write-off method are: (1) It attempts to match bad debts expense related to uncollectible accounts receivable with sales revenues on the income statement. (2) It attempts to show the cash realizable value of the accounts receivable on the balance sheet. 9-30 PROBLEM 9-6B (a) July 5 14 14 15 25 31 Accounts Receivable....................................... Sales............................................................. 6,200 Cash ($700 – $21).............................................. Service Charge Expense ................................ ($700 X 3%) Sales............................................................. 679 21 Accounts Receivable ....................................... Interest Revenue ...................................... 440 Cash ...................................................................... Notes Receivable ..................................... Interest Receivable .................................. ($6,000 X 10% X 45/360) Interest Revenue ...................................... ($6,000 X 10% X 15/360) 6,100 Accounts Receivable ....................................... Notes Receivable ..................................... Interest Receivable.................................. ($25,000 X 9% X 36/360) Interest Revenue ...................................... ($25,000 X 9% X 24/360) 25,375 Interest Receivable........................................... ($15,000 X 8% X 1/12) Interest Revenue ...................................... 100 6,200 700 440 6,000 75 25 25,000 225 150 100 (b) Notes Receivable Date Explanation July 1 Balance 15 25 Ref.
Debit Credit 6,000 25,000 9-31 Balance 46,000 40,000 15,000 PROBLEM 9-6B (Continued) Accounts Receivable Date July Explanation Ref. Debit 6,200 440 25,375 Credit Balance 6,200 6,640 32,015 Ref.
Debit Credit Balance 300 225 0 100 5 14 25 Interest Receivable Date July 1 15 25 31 Explanation Balance 75 225 Adjusting 100 (c) Current assets Notes receivable .......................................................................... Accounts receivable .................................................................. Interest receivable ....................................................................... Total receivables................................................................. 9-32 $15,000 32,015 100 $47,115 PROBLEM 9-7B Jan. 5 Feb. 2 12 26 Apr. 5 12 June 2 July 5 15 Oct. 15 Accounts Receivable—Klostermann Company ................................................................. Sales ..................................................................... 6,300 6,300 Notes Receivable....................................................... Accounts Receivable—Klostermann Company......................................................... 6,300 Notes Receivable....................................................... Sales ..................................................................... 7,800 Accounts Receivable—Louk Co. ......................... Sales ..................................................................... 4,000 Notes Receivable....................................................... Accounts Receivable—Louk Co. ................ 4,000 Cash ($7,800 + $130) ................................................ Notes Receivable.............................................. Interest Revenue............................................... ($7,800 X 10% X 2/12) 7,930 Cash ($6,300 + $210) ................................................ Notes Receivable.............................................. Interest Revenue............................................... ($6,300 X 10% X 4/12) 6,510 Accounts Receivable—Louk Co. ......................... ($4,000 + $80) Notes Receivable.............................................. Interest Revenue................................................ ($4,000 X 8% X 3/12) 4,080 Notes Receivable....................................................... Sales ..................................................................... 7,000 Allowance for Doubtful Accounts........................ Notes Receivable............................................... 7,000 9-33 6,300 7,800 4,000 4,000 7,800 130 6,300 210 4,000 80 7,000 7,000 BYP 9-1 (a) FINANCIAL REPORTING PROBLEM SEK COMPANY Accounts Receivable Aging Schedule May 31, 2008 Not yet due Less than 30 days past due 30 to 60 days past due 61 to 120 days past due 121 to 180 days past due Over 180 days past due (b) Proportion of Total Amount in Category Probability of NonCollection Estimated Uncollectible Amount .620 .200 .090 .050 .025 .015 1.000 $ 868,000 280,000 126,000 70,000 35,000 21,000 $1,400,000 .02 .04 .06 .09 .25 .70 $17,360 11,200 7,560 6,300 8,750 14,700 $65,870 SEK COMPANY Analysis of Allowance for Doubtful Accounts May 31, 2008 June 1, 2007 balance .............................................................. Bad debts expense accrual ($2,900,000 X .045) ............ Balance before write-offs of bad accounts..................... Write-offs of bad accounts ................................................... Balance before year-end adjustment................................ Estimated uncollectible amount......................................... Additional allowance needed .............................................. Bad Debts Expense................................................................. Allowance for Doubtful Accounts ............................. 9-34 $ 29,500 130,500 160,000 102,000 58,000 65,870 $ 7,870 7,870 7,870 BYP 9-1 (Continued) (c) 1. Steps to Improve the 2. Risks and Costs Involved Accounts Receivable Situation Establish more selective creditgranting policies, such as more restrictive credit requirements or more thorough credit investigations. This policy could result in lost sales and increased costs of credit evaluation. The company may be all but forced to adhere to the prevailing credit-granting policies of the office equipment and supplies industry. Establish a more rigorous collection policy either through external collection agencies or by its own personnel. This policy may offend current customers and thus risk future sales. Increased collection costs could result from this policy. Charge interest on overdue accounts. Insist on cash on delivery (COD) or cash on order (COO) for new customers or poor credit risks. This policy could result in lost sales and increased administrative costs. 9-35 BYP 9-2 COMPARATIVE ANALYSIS PROBLEM (a) (1) Accounts receivable turnover ratio PepsiCo Coca-Cola $32,562 ($2,999* + $3,261) ÷ 2 *See note 14 $32,562 = 10.4 times $3,130 $23,104 ($2,244 + $2,281) ÷ 2 $23,104 = 10.2 times $2,262.5 (2) Average collection period 365 = 35.1 days 10.4 365 = 35.8 days 10.2 (b) Both companies have reasonable accounts receivable turnovers and collection periods of slightly greater than 30 days. This collection period probably approximates their credit terms that they provide to customers. 9-36 BYP 9-3 (a) EXPLORING THE WEB Benefits of Factoring Receivables Factoring is a flexible financial solution that can help your business be more competitive while improving your cash flow, credit rating, and supplier discounts. Unlike traditional bank financing, factoring relies on the financial strength and credit worthiness of your customers, not you. You can use factoring services as much as you want or as little as you want. There are no obligations, no minimums, and no maximums. Here are the most common reasons businesses use factoring services: Offer better terms to win more business. With factoring you can attract more business by offering better terms on your invoices. Most companies negotiate on price to win business in a competitive market, but with factoring you can negotiate with terms instead of price. To your customers, better terms can be more attractive than better prices. When using attractive terms to win business, you can build the cost of factoring into your costs of goods and services. Example: A new customer may choose to do business with your company because you can offer NET 30 or NET 45 terms while your competitor (who isn’t factoring) requires payment up front but has a 3% better price. If you factor the subsequent invoice at a discount of 3%, you have leveraged factoring services to win the business at no extra cost and improved your cash flow at the same time. Improve cash flow without additional debt. Eliminate long billing cycles. Receive cash for your outstanding invoices in 24 hours or less. No new debt is created. Factoring is not a loan. This allows you to preserve your financial leverage to take on new debt. Customer Credit Services. Reduce bad debt expense, streamline credit approvals for new customers, improve decision-making on new business, and reduce administrative costs. 9-37 BYP 9-3 (Continued) Accounts Receivable Management. Reduce administrative costs, improve customer relationships, improve receivable turns, improve accounting, and redirect critical resources to marketing and production. Flexibility. Factor as much as you want or as little as you want. You decide. No obligations. No binding contracts. There are no minimums and no maximums in the amount you can factor. Funding is based on the strength of your customers. (b) Factoring fees are based on a per Diem Rate. The factor will assess the risk of the particular situation and determine a discount rate. This usually ranges from 3% to 9% of the gross invoices sold, and is the fee for the duties the factor assumes and the cost of using their money. The sooner a receivable is paid, the lower the discount rate. (c) Upon approval, the factor will advance the manufacturer 70%–90% of the total value of their invoices. This percentage is called the Advance Rate, and the cash is often delivered within 24 hours after an application is received. The rest of the cash minus the factor’s fees is then returned to the manufacturer as the receivables are collected. If the manufacturer’s customers pay slowly, the discount rates that apply grow accordingly larger. 9-38 BYP 9-4 DECISION MAKING ACROSS THE ORGANIZATION (a) Net credit sales ........................................... Credit and collection expenses Collection agency fees .................. Salary of accounts receivable clerk ................................................. Uncollectible accounts .................. Billing and mailing costs............... Credit investigation fees ............... Total............................................. Total expenses as a percentage of net credit sales ....................................... 2008 2007 2006 $500,000 $600,000 $400,000 $ $ $ 2,450 4,100 9,600 3,000 900 $ 20,100 4,100 6,400 2,000 600 $ 15,500 3.56% 3.35% 3.88% $ 30,000 $ 20,000 $ $ $ 2,000 Total credit and collection expenses per above.................................................. $ 17,800 Add: Investment earnings* .................... 2,000 Net credit and collection expenses........... $ 19,800 Net expenses as a percentage of net credit sales ....................................... 2,400 4,100 8,000 2,500 750 $ 17,800 (b) Average accounts receivable (5%)............ $ 25,000 Investment earnings (8%)........................ 2,500 3.96% 2,400 1,600 $ 20,100 2,400 $ 22,500 $ 15,500 1,600 $ 17,100 3.75% 4.28% *The investment earnings on the cash tied up in accounts receivable is an additional expense of continuing the existing credit policies. (c) The analysis shows that the credit card fee of 4% of net credit sales will be higher than the percentage cost of credit and collection expenses in each year before considering the effect of earnings from other investment opportunities. However, after considering investment earnings, the credit card fee of 4% will be less than the company’s percentage cost if annual net credit sales are less than $500,000. 9-39 BYP 9-4 (Continued) Finally, the decision hinges on: (1) the accuracy of the estimate of investment earnings, (2) the expected trend in credit sales, and (3) the effect the new policy will have on sales. Nonfinancial factors include the effects on customer relationships of the alternative credit policies and whether the Maynes want to continue with the problem of handling their own accounts receivable. 9-40 BYP 9-5 COMMUNICATION ACTIVITY Of course, this solution will differ from student to student. Important factors to look for would be definitions of the methods, how they are similar and how they differ. Also, use of good sentence structure, correct spelling, etc. Example: Dear Rene, The three methods you asked about are methods of dealing with uncollectible accounts receivable. Two of them, percentage-of-sales and percentage-ofreceivables, are “allowance” methods used to estimate the amount uncollectible. Under the percentage-of-sales basis, management establishes a percentage relationship between the amount of credit sales and expected losses from uncollectible accounts. This is based on past experience and anticipated credit policy. The percentage is then applied to either total credit sales or net credit sales of the current year. This basis of estimating emphasizes the matching of expenses with revenues. Under the percentage-of-receivables basis, management establishes a percentage relationship between the amount of receivables and expected losses from uncollectible accounts. Customer accounts are classified by the length of time they have been unpaid. This basis emphasizes cash realizable value of receivables and is therefore deemed a “balance sheet” approach. The direct write-off method does not estimate losses and an allowance account is not used. Instead, when an account is determined to be uncollectible, it is written off directly to Bad Debts Expense. Unless bad debt losses are insignificant, this method is not acceptable for financial reporting purposes. Sincerely, 9-41 BYP 9-6 ETHICS CASE (a) The stakeholders in this situation are:
The president of Ruiz Co.
The controller of Ruiz Co.
The stockholders. (b) Yes. The controller is posed with an ethical dilemma—should he/she follow the president’s “suggestion” and prepare misleading financial statements (understated net income) or should he/she attempt to stand up to and possibly anger the president by preparing a fair (realistic) income statement. (c) Ruiz Co.’s growth rate should be a product of fair and accurate financial statements, not vice versa. That is, one should not prepare financial statements with the objective of achieving or sustaining a predetermined growth rate. The growth rate should be a product of management and operating results, not of creative accounting. 9-42 BYP 9-7 ALL ABOUT YOU ACTIVITY (a) There are a number of sources that compare features of credit cards. Here are three: www.creditcards.com/, www.federalreserve.gov/pubs/shop/, and www.creditorweb.com/. (b) Here are some of the features you should consider: annual percentage rate, credit limit, annual fees, billing and due dates, minimum payment, penalties and fees, premiums received (airlines miles, hotel discounts etc.), and cash rebates. (c) Answer depends on present credit card and your personal situation. 9-43 Chapter 10 Standard Costs and the Balanced Scorecard Solutions to Questions 10-1 A quantity standard indicates how much of an input should be used to make a unit of output. A price standard indicates how much the input should cost. 10-8 The materials price variance is usually the responsibility of the purchasing manager. The materials quantity and labor eff iciency variances are usually the responsibility of production managers and supervisors. 10-2 I deal standards assume perfection and do not allow for any ineff iciency. Thus, ideal standards are rarely, if ever, attained. Practical standards can be attained by employees working at a reasonable, though eff icient pace and allow for normal breaks and work interruptions. 10-3 Chronic inability to meet a standard is likely to be demoralizing and may result in decreased productivity. 10-4 A budget is usually expressed in terms of total dollars, whereas a standard is expressed on a per unit basis. A standard might be viewed as the budgeted cost for one unit. 10-5 A variance is the difference between what was planned or expected and what was actually accomplished. A standard cost system has at least two types of variances. A price variance focuses on the difference between standard and actual prices. A quantity variance is concerned with the difference between the standard quantity of input allowed for the actual output and the actual amount of the input used. 10-9 The materials price variance can be computed either when materials are purchased or when they are placed into production. I t is usually better to compute the variance when materials are purchased since that is when the purchasing manager, who has responsibility for this variance, has completed his or her work. I n addition, recognizing the price variance when materials are purchased allows the company to carry its raw materials in the inventory accounts at standard cost, which greatly simplif ies bookkeeping. 10-10 This combination of variances may indicate that inferior quality materials were purchased at a discounted price, but the low quality materials created production problems. 10-11 I f standards are used to f ind who to blame for problems, they can breed resentment and undermine morale. Standards should not be used to conduct witch-hunts, or as a means of f inding someone to blame for problems. 10-12 Several factors other than the contrac10-6 Under management by exception, managers focus their attention on results that deviate from expectations. I t is assumed that results that meet expectations do not require investigation. 10-7 Separating an overall variance into a price variance and a quantity variance provides more information. Moreover, price and quantity variances are usually the responsibilities of different managers. tual rate paid to workers can cause a labor rate variance. For example, skilled workers with high hourly rates of pay can be given duties that require little skill and that call for low hourly rates of pay, resulting in an unfavorable rate variance. Or unskilled or untrained workers can be assigned to tasks that should be f illed by more skilled workers with higher rates of pay, resulting in a favorable rate variance. Unfavorable rate variances can also arise from overtime work at premium rates. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 545 10-13 I f poor quality materials create produc- 10-17 A company’s balanced scorecard should tion problems, a result could be excessive labor time and therefore an unfavorable labor eff iciency variance. Poor quality materials would not ordinarily affect the labor rate variance. be derived from and support its strategy. Since different companies have different strategies, their balanced scorecards should be different. 10-18 The balanced scorecard is constructed 10-14 The variable overhead eff iciency variance and the direct labor eff iciency variance will always be favorable or unfavorable together if overhead is applied on the basis of direct laborhours. Both variances are computed by comparing the number of direct labor-hours actually worked to the standard hours allowed. That is, in each case the formula is: Eff iciency Variance = SR(AH – SH) Only the “SR” part of the formula differs between the two variances. to support the company’s strategy, which is a theory about what actions will further the company’s goals. Assuming that the company has f inancial goals, measures of f inancial performance must be included in the balanced scorecard as a check on the reality of the theory. I f the internal business processes improve, but the f inancial outcomes do not improve, the theory may be flawed and the strategy should be changed. aid that helps workers identify variances that should be investigated. Upper and lower limits are set on the control chart. Any variances falling between those limits are considered to be normal. Any variances falling outside of those limits are considered abnormal and are investigated. 10-19 The difference between the delivery cycle time and the throughput time is the waiting period between when an order is received and when production on the order is started. The throughput time is made up of process time, inspection time, move time, and queue time. These four elements can be classif ied between value-added time (process time) and non-valueadded time (inspection time, move time, and queue time). 10-16 I f labor is a f ixed cost and standards are 10-20 An MCE of less than 1 means that the tight, then the only way to generate favorable labor eff iciency variances is for every workstation to produce at capacity. However, the output of the entire system is limited by the capacity of the bottleneck. I f workstations before the bottleneck in the production process produce at capacity, the bottleneck will be unable to process all of the work in process. I n general, if every workstation is attempting to produce at capacity, then work in process inventory will build up in front of the workstations with the least capacity. production process includes non-value-added time. An MCE of 0.40, for example, means that 40% of throughput time consists of actual processing, and that the other 60% consists of moving, inspection, and other non-value-added activities. 10-15 A statistical control chart is a graphical 10-21 Formal entry tends to give variances more emphasis than off-the-record computations. And, the use of standard costs in the journals simplif ies the bookkeeping process by allowing all inventories to be carried at standard, rather than actual, cost. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 546 Managerial Accounting, 11th Edition Exercise 10-1 (20 minutes) 1. Cost per 15-gallon container .......................................... $115.00 Less 2% cash discount .................................................. 2.30 Net cost ....................................................................... 112.70 Add shipping cost per container ($130 ÷ 100) ................. 1.30 Total cost per 15-gallon container (a) ............................. $114.00 Number of quarts per container (15 gallons × 4 quarts per gallon) (b) .......................... 60 Standard cost per quart purchased (a) ÷ (b) ................... $1.90 2. Content per bill of materials .............................. Add allowance for evaporation and spillage (7.6 quarts ÷ 0.95 = 8.0 quarts; 8.0 quarts – 7.6 quarts = 0.4 quarts) ............. Total ............................................................... Add allowance for rejected units (8.0 quarts ÷ 40 bottles) ................................ Standard quantity per salable bottle of solvent ... I tem Standard Quantity Standard Price Echol 8.2 quarts $1.90 per quart 3. 7.6 quarts 0.4 quarts 8.0 quarts 0.2 quarts 8.2 quarts Standard Cost per Bottle $15.58 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 547 Exercise 10-2 (20 minutes) 1. Number of helmets ............................................. Standard kilograms of plastic per helmet .............. Total standard kilograms allowed ......................... Standard cost per kilogram .................................. Total standard cost ............................................. RM 35,000 × 0.6 21,000 × RM 8 168,000 Actual cost incurred (given) ................................. RM 171,000 Total standard cost (above) ................................. 168,000 Total material variance—unfavorable .................... RM 3,000 2. Actual Quantity of I nput, at Actual Price (AQ × AP) RM 171,000 ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 22,500 kilograms × RM 8 per kilogram = RM 180,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 21,000 kilograms* × RM 8 per kilogram = RM 168,000 Price Variance, Quantity Variance, RM 9,000 F RM 12,000 U Total Variance, RM 3,000 U ↑ * 35,000 helmets × 0.6 kilograms per helmet = 21,000 kilograms Alternatively: Materials price variance = AQ (AP – SP) 22,500 kilograms (RM 7.60 per kilogram* – RM 8.00 per kilogram) = RM 9,000 F * RM 171,000 ÷ 22,500 kilograms = RM 7.60 per kilogram Materials quantity variance = SP (AQ – SQ) RM 8 per kilogram (22,500 kilograms – 21,000 kilograms) = RM 12,000 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 548 Managerial Accounting, 11th Edition Exercise 10-3 (20 minutes) 1. Number of meals prepared ...................... 4,000 Standard direct labor-hours per meal........ × 0.25 Total direct labor-hours allowed ............... 1,000 Standard direct labor cost per hour .......... × $9.75 Total standard direct labor cost ................ $9,750 Actual cost incurred................................. Total standard direct labor cost (above) .... Total direct labor variance ....................... 2. Actual Hours of I nput, at the Actual Rate (AH × AR) 960 hours × $10.00 per hour = $9,600 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 960 hours × $9.75 per hour = $9,360 ↑ $9,600 9,750 $ 150 Favorable Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 1,000 hours × $9.75 per hour = $9,750 Rate Variance, Eff iciency Variance, $240 U $390 F Total Variance, $150 F ↑ Alternatively, the variances can be computed using the formulas: Labor rate variance = AH(AR – SR) = 960 hours ($10.00 per hour – $9.75 per hour) = $240 U Labor efficiency variance = SR(AH – SH) = $9.75 per hour (960 hours – 1,000 hours) = $390 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 549 Exercise 10-4 (20 minutes) 1. Number of items shipped .................................. 120,000 Standard direct labor-hours per item ................. × 0.02 Total direct labor-hours allowed ........................ 2,400 Standard variable overhead cost per hour .......... × $3.25 Total standard variable overhead cost................ $ 7,800 Actual variable overhead cost incurred............... Total standard variable overhead cost (above) ... Total variable overhead variance ....................... 2. Actual Hours of I nput, at the Actual Rate (AH × AR) 2,300 hours × $3.20 per hour* = $7,360 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 2,300 hours × $3.25 per hour = $7,475 ↑ $7,360 7,800 $ 440 Favorable Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 2,400 hours × $3.25 per hour = $7,800 Variable Overhead Variable Overhead Efficiency Variance, Spending Variance, $325 F $115 F Total Variance, $440 F ↑ * $7,360 ÷ 2,300 hours = $3.20 per hour Alternatively, the variances can be computed using the formulas: Variable overhead spending variance: AH(AR – SR) = 2,300 hours ($3.20 per hour – $3.25 per hour) = $115 F Variable overhead efficiency variance: SR(AH – SH) = $3.25 per hour (2,300 hours – 2,400 hours) = $325 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 550 Managerial Accounting, 11th Edition Exercise 10-5 (45 minutes) 1. MPC’s previous manufacturing strategy was focused on high-volume production of a limited range of paper grades. The goal of this strategy was to keep the machines running constantly to maximize the number of tons produced. Changeovers were avoided because they lowered equipment utilization. Maximizing tons produced and minimizing changeovers helped spread the high fixed costs of paper manufacturing across more units of output. The new manufacturing strategy is focused on low-volume production of a wide range of products. The goals of this strategy are to increase the number of paper grades manufactured, decrease changeover times, and increase yields across non-standard grades. While MPC realizes that its new strategy will decrease its equipment utilization, it will still strive to optimize the utilization of its high fixed cost resources within the confines of flexible production. I n an economist’s terms the old strategy focused on economies of scale while the new strategy focuses on economies of scope. 2. Employees focus on improving those measures that are used to evaluate their performance. Therefore, strategically-aligned performance measures will channel employee effort towards improving those aspects of performance that are most important to obtaining strategic objectives. I f a company changes its strategy but continues to evaluate employee performance using measures that do not support the new strategy, it will be motivating its employees to make decisions that promote the old strategy, not the new strategy. And if employees make decisions that promote the new strategy, their performance measures will suffer. Some performance measures that would be appropriate for MPC’s old strategy include: equipment utilization percentage, number of tons of paper produced, and cost per ton produced. These performance measures would not support MPC’s new strategy because they would discourage increasing the range of paper grades produced, increasing the number of changeovers performed, and decreasing the batch size produced per run. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 551 Exercise 10-5 (continued) 3. Students’ answers may differ in some details from this solution. Financial Sales + Contribution margin per ton + Customer Number of new customers acquired Time to fill an order Average changeover time Learning and Grow th Customer satisfaction with breadth of product offerings – I nternal Business Process + Number of different paper grades produced – + Average manufacturing yield Number of employees trained to support the flexibility strategy + + + © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 552 Managerial Accounting, 11th Edition Exercise 10-5 (continued) 4. The hypotheses underlying the balanced scorecard are indicated by the arrows in the diagram. Reading from the bottom of the balanced scorecard, the hypotheses are: ° I f the number of employees trained to support t he flexibility strategy increases, then the average changeover time will decrease and the number of different paper grades produced and the average manufacturing yield will increase. ° I f the average change-over time decreases, then the time to fill an order will decrease. ° I f the number of different paper grades produce d increases, then the customer satisfaction with breadth of product offerings will increase. ° I f the average manufacturing yield increases, t hen the contribution margin per ton will increase. ° I f the time to fill an order decreases, then th e number of new customers acquired, sales, and the contribution margin per ton will increase. ° I f the customer satisfaction with breadth of pr oduct offerings increases, then the number of new customers acquired, sales, and the contribution margin per ton will increase. ° I f the number of new customers acquired increas es, then sales will increase. Each of these hypotheses is questionable to some degree. For example, the time to fill an order is a function of additional factors above and beyond changeover times. Thus, MPC’s average changeover time could decrease while its time to fill an order increases if, for example, the shipping department proves to be incapable of efficiently handling greater product diversity, smaller batch sizes, and more frequent shipments. The fact that each of the hypotheses mentioned above can be questioned does not invalidate the balanced scorecard. I f the scorecard is used correctly, management will be able to identify which, if any, of the hypotheses are invalid and modify the balanced scorecard accordingly. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 553 Exercise 10-6 (20 minutes) 1. Throughput time = Process time + I nspection time + Move time + Queue time = 2.7 days + 0.3 days + 1.0 days + 5.0 days = 9.0 days 2. Only process time is value-added time; therefore the manufacturing cycle eff iciency (MCE) is: MCE = Value- added time 2.7 days = = 0.30 Throughput time 9.0 days 3. I f the MCE is 30% , then the complement of this f igure, or 70% of the time, was spent in non-value-added activities. 4. Delivery cycle time = Wait time + Throughput time = 14.0 days + 9.0 days = 23.0 days 5. I f all queue time in production is eliminated, then the throughput time drops to only 4 days (2.7 + 0.3 + 1.0). The MCE becomes: MCE = Value- added time 2.7 days = = 0.675 Throughput time 4.0 days Thus, the MCE increases to 67.5% . This exercise shows quite dramatically how the JI T approach can improve the eff iciency of operations and reduce throughput time. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 554 Managerial Accounting, 11th Edition Exercise 10-7 (20 minutes) 1. The general ledger entry to record the purchase of materials for the month is: Raw Materials (12,000 meters at $3.25 per meter) ..................... 39,000 Materials Price Variance (12,000 meters at $0.10 per meter F).......... Accounts Payable (12,000 meters at $3.15 per meter) ............ 1,200 37,800 2. The general ledger entry to record the use of materials for the month is: Work in Process (10,000 meters at $3.25 per meter) ..................... 32,500 Materials Quantity Variance (500 meters at $3.25 per meter U) ...................... 1,625 Raw Materials (10,500 meters at $3.25 per meter) ............ 34,125 3. The general ledger entry to record the incurrence of direct labor cost for the month is: Work in Process (2,000 hours at $12.00 per hour) ... 24,000 Labor Rate Variance (1,975 hours at $0.20 per hour U) ....................... 395 Labor Efficiency Variance (25 hours at $12.00 per hour F) .................. Wages Payable (1,975 hours at $12.20 per hour) ................ 300 24,095 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 555 Exercise 10-8 (20 minutes) 1. The standard price of a kilogram of white chocolate is determined as follows: Purchase price, finest grade white chocolate ........................ Less purchase discount, 8% of the purchase price of £7.50 ... Shipping cost from the supplier in Belgium ........................... Receiving and handling cost ................................................ Standard price per kilogram of white chocolate..................... £7.50 (0.60) 0.30 0.04 £7.24 2. The standard quantity, in kilograms, of white chocolate in a dozen truffles is computed as follows: Material requirements............................... Allowance for waste ................................. Allowance for rejects ................................ Standard quantity of white chocolate ......... 0.70 0.03 0.02 0.75 3. The standard cost of the white chocolate in a dozen truffles is determined as follows: Standard quantity of white chocolate (a) ....... 0.75 kilogram Standard price of white chocolate (b) ........... £7.24 per kilogram Standard cost of white chocolate (a) × (b) .... £5.43 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 556 Managerial Accounting, 11th Edition Exercise 10-9 (30 minutes) 1. a. Notice in the solution below that the materials price variance is computed on the entire amount of materials purchased, whereas the materials quantity variance is computed only on the amount of materials used in production. Actual Quantity of I nput, at Actual Price (AQ × AP) 25,000 microns × $0.48 per micron = $12,000 ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 25,000 microns × $0.50 per micron = $12,500 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 18,000 microns* × $0.50 per micron = $9,000 Price Variance, $500 F 20,000 microns × $0.50 per micron = $10,000 ↑ ↑ Quantity Variance, $1,000 U * 3,000 toys × 6 microns per toy = 18,000 microns Alternatively: Materials price variance = AQ (AP – SP) 25,000 microns ($0.48 per micron – $0.50 per micron) = $500 F Materials quantity variance = SP (AQ – SQ) $0.50 per micron (20,000 microns – 18,000 microns) = $1,000 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 557 Exercise 10-9 (continued) b. Direct labor variances: Actual Hours of I nput, at the Actual Rate (AH × AR) $36,000 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 4,000 hours × $8.00 per hour = $32,000 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 3,900 hours* × $8.00 per hour = $31,200 Rate Variance, Eff iciency Variance, $4,000 U $800 U Total Variance, $4,800 U ↑ * 3,000 toys × 1.3 hours per toy = 3,900 hours Alternatively: Labor rate variance = AH (AR – SR) 4,000 hours ($9.00 per hour* – $8.00 per hour) = $4,000 U * $36,000 ÷ 4,000 hours = $9.00 per hour Labor eff iciency variance = SR (AH – SH) $8.00 per hour (4,000 hours – 3,900 hours) = $800 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 558 Managerial Accounting, 11th Edition Exercise 10-9 (continued) 2. A variance usually has many possible explanations. I n particular, we should always keep in mind that the standards themselves may be incorrect. Some of the other possible explanations for the variances observed at Dawson Toys appear below: Materials Price Variance Since this variance is favorable, the actual price paid per unit for the material was less than the standard price. This could occur for a variety of reasons including the purchase of a lower grade material at a discount, buying in an unusually large quantity to take advantage of quantity discounts, a change in the market price of the material, or particularly sharp bargaining by the purchasing department. Materials Quantity Variance Since this variance is unfavorable, more materials were used to produce the actual output than were called for by the standard. This could also occur for a variety of reasons. Some of the possibilities include poorly trained or supervised workers, improperly adjusted machines, and defective materials. Labor Rate Variance Since this variance is unfavorable, the actual average wage rate was higher than the standard wage rate. Some of the possible explanations include an increase in wages that has not been reflected in the standards, unanticipated overtime, and a shift toward more highly paid workers. Labor Eff iciency Variance Since this variance is unfavorable, the actual number of labor hours was greater than the standard labor hours allowed for the actual output. As with the other variances, this variance could have been caused by any of a number of factors. Some of the possible explanations include poor supervision, poorly trained workers, low quality materials requiring more labor time to process, and machine breakdowns. In addition, if the direct labor force is essentially f ixed, an unfavorable labor eff iciency variance could be caused by a reduction in output due to decreased demand for the company’s products. I t is worth noting that all of these variances could have been caused by the purchase of low quality materials at a cut-rate price. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 559 Exercise 10-10 (20 minutes) 1. I f the total variance is $93 unfavorable, and the rate variance is $87 favorable, then the eff iciency variance must be $180 unfavorable, since the rate and eff iciency variances taken together always equal the total variance. Knowing that the eff iciency variance is $180 unfavorable, one approach to the solution would be: Eff iciency $9.00 per $9.00 per $9.00 per variance = SR (AH – SH) hour (AH – 125 hours* ) = $180 U hour × AH – $1,125 = $180* * hour × AH = $1,305 AH = $1,305 ÷ $9.00 per hour AH = 145 hours * 50 jobs × 2.5 hours per job = 125 hours * * When used with the formula, unfavorable variances are positive and favorable variances are negative. 2. Rate variance = AH (AR – SR) 145 hours (AR – $9.00 per hour) = $87 F 145 hours × AR – $1,305 = –$87* 145 hours × AR = $1,218 AR = $1,218 ÷ 145 hours AR = $8.40 per hour * When used with the formula, unfavorable variances are positive and favorable variances are negative. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 560 Managerial Accounting, 11th Edition Exercise 10-10 (continued) An alternative approach to each solution would be to work from known to unknown data in the columnar model for variance analysis: Actual Hours of I nput, at the Actual Rate (AH × AR) 145 hours × $8.40 per hour = $1,218 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 145 hours × $9.00 per hour* = $1,305 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 125 hours§ × $9.00 per hour* = $1,125 Rate Variance, Eff iciency Variance, $87 F* $180 U Total Variance, $93 U* ↑ § 50 tune-ups* × 2.5 hours per tune-up* = 125 hours * Given © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 561 Exercise 10-11 (30 minutes) 1. Number of units manufactured ............................... Standard labor time per unit .................................. Total standard hours of labor time allowed .............. Standard direct labor rate per hour ......................... Total standard direct labor cost .............................. 20,000 × 0.3* 6,000 × $12 $72,000 * 18 minutes ÷ 60 minutes per hour = 0.3 hours Actual direct labor cost .......................................... Standard direct labor cost ...................................... Total variance—unfavorable ................................... 2. Actual Hours of I nput, at the Actual Rate (AH × AR) $73,600 ↑ $73,600 72,000 $ 1,600 Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 6,000 hours* × $12.00 per hour = $72,000 Actual Hours of I nput, at the Standard Rate (AH × SR) 5,750 hours × $12.00 per hour = $69,000 ↑ Rate Variance, Eff iciency Variance, $4,600 U $3,000 F Total Variance, $1,600 U ↑ * 20,000 units × 0.3 hours per unit = 6,000 hours Alternative Solution: Labor rate variance = AH (AR – SR) 5,750 hours ($12.80 per hour* – $12.00 per hour) = $4,600 U * $73,600 ÷ 5,750 hours = $12.80 per hour Labor eff iciency variance = SR (AH – SH) $12.00 per hour (5,750 hours – 6,000 hours) = $3,000 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 562 Managerial Accounting, 11th Edition Exercise 10-11 (continued) 3. Actual Hours of I nput, at the Actual Rate (AH × AR) $21,850 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 5,750 hours × $4.00 per hour = $23,000 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 6,000 hours × $4.00 per hour = $24,000 Spending Variance, Eff iciency Variance, $1,150 F $1,000 F Total Variance, $2,150 F ↑ Alternative Solution: Variable overhead spending variance = AH (AR – SR) 5,750 hours ($3.80 per hour* – $4.00 per hour) = $1,150 F * $21,850 ÷ 5,750 hours = $3.80 per hour Variable overhead eff iciency variance = SR (AH – SH) $4.00 per hour (5,750 hours – 6,000 hours) = $1,000 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 563 Exercise 10-12 (20 minutes) 1. Actual Quantity of I nput, at Actual Price (AQ × AP) 20,000 pounds × $2.35 per pound = $47,000 ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 20,000 pounds × $2.50 per pound = $50,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 18,400 pounds* × $2.50 per pound = $46,000 Price Variance, Quantity Variance, $3,000 F $4,000 U Total Variance, $1,000 U ↑ * 4,000 units × 4.6 pounds per unit = 18,400 pounds Alternatively: Materials price variance = AQ (AP – SP) 20,000 pounds ($2.35 per pound – $2.50 per pound) = $3,000 F Materials quantity variance = SP (AQ – SQ) $2.50 per pound (20,000 pounds – 18,400 pounds) = $4,000 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 564 Managerial Accounting, 11th Edition Exercise 10-12 (continued) 2. Actual Hours of I nput, at the Actual Rate (AH × AR) $10,425 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 750 hours × $12.00 per hour = $9,000 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 800 hours* × $12.00 per hour = $9,600 Rate Variance, Eff iciency Variance, $1,425 U $600 F Total Variance, $825 U ↑ * 4,000 units × 0.2 hours per unit = 800 hours Alternatively: Labor rate variance = AH (AR – SR) 750 hours ($13.90 per hour* – $12.00 per hour) = $1,425 U * 10,425 ÷ 750 hours = $13.90 per hour Labor eff iciency variance = SR (AH – SH) $12.00 per hour (750 hours – 800 hours) = $600 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 565 Exercise 10-13 (15 minutes) Notice in the solution below that the materials price variance is computed for the entire amount of materials purchased, whereas the materials quantity variance is computed only for the amount of materials used in production. Actual Quantity of I nput, at Actual Price (AQ × AP) 20,000 pounds × $2.35 per pound = $47,000 ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 20,000 pounds × $2.50 per pound = $50,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 13,800 pounds* × $2.50 per pound = $34,500 Price Variance, $3,000 F 14,750 pounds × $2.50 per pound = $36,875 ↑ ↑ Quantity Variance, $2,375 U * 3,000 units × 4.6 pounds per unit = 13,800 pounds Alternatively: Materials price variance = AQ (AP – SP) 20,000 pounds ($2.35 per pound – $2.50 per pound) = $3,000 F Materials quantity variance = SP (AQ – SQ) $2.50 per pound (14,750 pounds – 13,800 pounds) = $2,375 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 566 Managerial Accounting, 11th Edition Exercise 10-14 (45 minutes) 1. Students’ answers may differ in some details from this solution. Financial + Profit margin + Revenue per employee Customer Customer satisfaction with effectiveness Sales Number of new customers acquired + I nternal Business Processes Ratio of billable hours to total hours Customer satisfaction with efficiency + + + Average number of errors per tax return Customer satisfaction with service quality + – Average time needed to prepare a return + – Learning And Grow th Percentage of job offers accepted Employee morale + Amount of compensation paid above industry average + + Average number of years to be promoted – © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 567 Exercise 10-14 (continued) 2. The hypotheses underlying the balanced scorecard are indicated by the arrows in the diagram. Reading from the bottom of the balanced scorecard, the hypotheses are: ° I f the amount of compensation paid above the in dustry average increases, then the percentage of job offers accepted and the level of employee morale will increase. ° I f the average number of years to be promoted d ecreases, then the percentage of job offers accepted and the level of employee morale will increase. ° I f the percentage of job offers accepted increa ses, then the ratio of billable hours to total hours should increase while the average number of errors per tax return and the average time needed to prepare a return should decrease. ° I f employee morale increases, then the ratio of billable hours to total hours should increase while the average number of errors per tax return and the average time needed to prepare a return should decrease. ° I f employee morale increases, then the customer satisfaction with service quality should increase. ° I f the ratio of billable hours to total hours i ncreases, then the revenue per employee should increase. ° I f the average number of errors per tax return decreases, then the customer satisfaction with effectiveness should increase. ° I f the average time needed to prepare a return decreases, then the customer satisfaction with efficiency should increase. ° I f the customer satisfaction with effectiveness, efficiency and service quality increases, then the number of new customers acquired should increase. ° I f the number of new customers acquired increas es, then sales should increase. ° I f revenue per employee and sales increase, the n the profit margin should increase. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 568 Managerial Accounting, 11th Edition Exercise 10-14 (continued) Each of these hypotheses is questionable to some degree. For example, Ariel’s customers may define effectiveness as a function of minimizing their tax liability which is not necessarily the same as minimizing the number of errors in a tax return. I f some of Ariel’s customers became aware through a knowledgeable third party that Ariel overlooked legal tax minimizing opportunities, it is likely that the “customer satisfaction with effectiveness” measure would decline. This decline would probably puzzle Ariel because, although the firm prepared what it believed to be error-free returns, it overlooked important tax minimization strategies. I n this example, Ariel’s internal business process measure related to the average number of errors per tax return does not capture all of the factors that drive the customers’ satisfaction with effectiveness. The fact that each of the hypotheses mentioned above can be questioned does not invalidate the balanced scorecard. I f the scorecard is used correctly, management will be able to identify which, if any, of the hypotheses are invalid and then modify the balanced scorecard accordingly. 3. The performance measure “total dollar amount of tax refunds generated” would motivate Ariel’s employees to aggressively search for tax minimization opportunities for its clients. However, employees may be too aggressive and recommend questionable or illegal tax practices to clients. This undesirable behavior could generate unfavorable publicity and lead to major problems for the company as well as its customers. Overall, it would probably be unwise to use this performance measure in Ariel’s scorecard. However, if Ariel wanted to create a scorecard measure to capture this aspect of its client service responsibilities, it may make sense to focus the performance measure on its training process. Properly trained employees are more likely to recognize viable tax minimization opportunities. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 569 Exercise 10-14 (continued) 4. Each office’s individual performance should be based on the scorecard measures only if the measures are controllable by those employed at the branch offices. I n other words, it would not make sense to attempt to hold branch office managers responsible for measures such as the percent of job offers accepted or the amount of compensation paid above industry average. Recruiting and compensation decisions are not typically made at the branch offices. On the other hand, it would make sense to measure the branch offices with respect to internal business process, customer, and financial performance. Gathering this type of data would be useful for evaluating the performance of employees at each office. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 570 Managerial Accounting, 11th Edition Exercise 10-15 (45 minutes) 1. a. Actual Quantity of I nput, at Actual Price (AQ × AP) 10,000 yards × $13.80 per yard = $138,000 ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 10,000 yards × $14.00 per yard = $140,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 7,500 yards* × $14.00 per yard = $105,000 Price Variance, $2,000 F 8,000 yards × $14.00 per yard = $112,000 ↑ ↑ Quantity Variance, $7,000 U * 3,000 units × 2.5 yards per unit = 7,500 yards Alternatively: Materials price variance = AQ (AP – SP) 10,000 yards ($13.80 per yard – $14.00 per yard) = $2,000 F Materials quantity variance = SP (AQ – SQ) $14.00 per yard (8,000 yards – 7,500 yards) = $7,000 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 571 Exercise 10-15 (continued) b. The journal entries would be: Raw Materials (10,000 yards × 14.00 per yard) .................... Materials Price Variance (10,000 yards × $0.20 per yard F) ......... Accounts Payable (10,000 yards × $13.80 per yard) .......... Work in Process (7,500 yards × $14.00 per yard) .................... Materials Quantity Variance (500 yards U × $14.00 per yard) .................... Raw Materials (8,000 yards × $14.00 per yard) ............ 2. a. Actual Hours of I nput, at the Actual Rate (AH × AR) $43,000 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 5,000 hours × $8.00 per hour = $40,000 ↑ 140,000 2,000 138,000 105,000 7,000 112,000 Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 4,800 hours* × $8.00 per hour = $38,400 Rate Variance, Eff iciency Variance, $3,000 U $1,600 U Total Variance, $4,600 U ↑ * 3,000 units × 1.6 hours per unit = 4,800 hours © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 572 Managerial Accounting, 11th Edition Exercise 10-15 (continued) Alternative Solution: Labor rate variance = AH (AR – SR) 5,000 hours ($8.60 per hour* – $8.00 per hour) = $3,000 U * $43,000 ÷ 5,000 hours = $8.60 per hour Labor eff iciency variance = SR (AH – SH) $8.00 per hour (5,000 hours – 4,800 hours) = $1,600 U b. The journal entry would be: Work in Process (4,800 hours × $8.00 per hour) ....................... 38,400 Labor Rate Variance (5,000 hours × $0.60 per hour U) .................... 3,000 Labor Eff iciency Variance (200 hours U × $8.00 per hour) ....................... 1,600 Wages Payable (5,000 hours × $8.60 per hour) ............... 43,000 3. The entries are: entry (a), purchase of materials; entry (b), issue of materials to production; and entry (c), incurrence of direct labor cost. (a) Bal.* Raw Materials 140,000 112,000 28,000 Accounts Payable 138,000 Materials Price Variance 2,000 (c) Labor Rate Variance 3,000 (b) (b) (c) Wages Payable 43,000 (a) (a) Work in Process 105,000 38,400 (c) Materials Quantity Variance (b) 7,000 (c) Labor Eff iciency Variance 1,600 * 2,000 yards of material at a standard cost of $14.00 per yard © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 573 Problem 10-16 (45 minutes) 1. The standard quantity of plates allowed for tests performed during the month would be: Blood tests..................................... Smears.......................................... Total.............................................. Plates per test ................................ Standard quantity allowed............... 1,800 2,400 4,200 × 2 8,400 The variance analysis for plates would be: Actual Quantity of I nput, at Actual Price (AQ × AP) $28,200 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 8,400 plates × $2.50 per plate = $21,000 Actual Quantity of I nput, at Standard Price (AQ × SP) 12,000 plates × $2.50 per plate = $30,000 ↑ Price Variance, $1,800 F 10,500 plates × $2.50 per plate = $26,250 ↑ ↑ Quantity Variance, $5,250 U Alternative Solution: Materials price variance = AQ (AP – SP) 12,000 plates ($2.35 per plate* – $2.50 per plate) = $1,800 F * $28,200 ÷ 12,000 plates = $2.35 per plate. Materials quantity variance = SP (AQ – SQ) $2.50 per plate (10,500 plates – 8,400 plates) = $5,250 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 574 Managerial Accounting, 11th Edition Problem 10-16 (continued) Note that all of the price variance is due to the hospital’s 6% quantity discount. Also note that the $5,250 quantity variance for the month is equal to 25% of the standard cost allowed for plates. 2. a. The standard hours allowed for tests performed during the month would be: Blood tests: 0.3 hour per test × 1,800 tests ........... 540 hours Smears: 0.15 hour per test × 2,400 tests ............... 360 hours Total standard hours allowed ................................. 900 hours The variance analysis would be: Actual Hours of I nput, at the Actual Rate (AH × AR) $13,800 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 1,150 hours × $14.00 per hour = $16,100 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 900 hours × $14.00 per hour = $12,600 Rate Variance, Eff iciency Variance, $2,300 F $3,500 U Total Variance, $1,200 U ↑ Alternative Solution: Labor rate variance = AH (AR – SR) 1,150 hours ($12.00 per hour* – $14.00 per hour) = $2,300 F * $13,800 ÷ 1,150 hours = $12.00 per hour Labor eff iciency variance = SR (AH – SH) $14.00 per hour (1,150 hours – 900 hours) = $3,500 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 575 Problem 10-16 (continued) b. The policy probably should not be continued. Although the hospital is saving $2 per hour by employing more assistants than senior technicians, this savings is more than offset by other factors. Too much time is being taken in performing lab tests, as indicated by the large unfavorable labor eff iciency variance. And, it seems likely that most (or all) of the hospital’s unfavorable quantity variance for plates is traceable to inadequate supervision of assistants in the lab. 3. The variable overhead variances follow: Actual Hours of I nput, at the Actual Rate (AH × AR) $7,820 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 1,150 hours × $6.00 per hour = $6,900 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 900 hours × $6.00 per hour = $5,400 Spending Variance, Eff iciency Variance, $920 U $1,500 U Total Variance, $2,420 U ↑ Alternative Solution: Variable overhead spending variance = AH (AR – SR) 1,150 hours ($6.80 per hour* – $6.00 per hour) = $920 U * $7,820 ÷ 1,150 hours = $6.80 per hour Variable overhead eff iciency variance = SR (AH – SH) $6.00 per hour (1,150 hours – 900 hours) = $1,500 U Yes, the two variances are closely related. Both are computed by comparing actual labor time to the standard hours allowed for the output of the period. Thus, if the labor eff iciency variance is favorable (or unfavorable), then the variable overhead eff iciency variance will also be favorable (or unfavorable). © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 576 Managerial Accounting, 11th Edition Problem 10-17 (45 minutes) 1. a. I n the solution below, the materials price variance is computed on the entire amount of materials purchased whereas the materials quantity variance is computed only on the amount of materials used in production: Actual Quantity of I nput, at Actual Price (AQ × AP) $225,000 ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 12,000 ounces × $20.00 per ounce = $240,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 9,375 ounces* × $20.00 per ounce = $187,500 Price Variance, $15,000 F 9,500 ounces × $20.00 per ounce = $190,000 ↑ ↑ Quantity Variance, $2,500 U * 3,750 units × 2.5 ounces per unit = 9,375 ounces Alternatively: Materials price variance = AQ (AP – SP) 12,000 ounces ($18.75 per ounce* – $20.00 per ounce) = $15,000 F * $225,000 ÷ 12,000 ounces = $18.75 per ounce Materials quantity variance = SP (AQ – SQ) $20.00 per ounce (9,500 ounces – 9,375 ounces) = $2,500 U b. Yes, the contract probably should be signed. The new price of $18.75 per ounce is substantially lower than the old price of $20.00 per ounce, resulting in a favorable price variance of $15,000 for the month. Moreover, the material from the new supplier appears to cause little or no problem in production as shown by the small materials quantity variance for the month. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 577 Problem 10-17 (continued) 2. a. Actual Hours of I nput, at the Actual Rate (AH × AR) 5,600 hours* × $12.00 per hour = $67,200 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 5,600 hours × $12.50 per hour = $70,000 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 5,250 hours* * × $12.50 per hour = $65,625 Rate Variance, Eff iciency Variance, $2,800 F $4,375 U Total Variance, $1,575 U ↑ * 35 technicians × 160 hours per technician = 5,600 hours * * 3,750 units × 1.4 hours per technician = 5,250 hrs Alternatively: Labor rate variance = AH (AR – SR) 5,600 hours ($12.00 per hour – $12.50 per hour) = $2,800 F Labor eff iciency variance = SR (AH – SH) $12.50 per hour (5,600 hours – 5,250 hours) = $4,375 U b. No, the new labor mix probably should not be continued. Although it decreases the average hourly labor cost from $12.50 to $12.00, thereby causing a $2,800 favorable labor rate variance, this savings is more than offset by a large unfavorable labor eff iciency variance for the month. Thus, the new labor mix increases overall labor costs. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 578 Managerial Accounting, 11th Edition Problem 10-17 (continued) 3. Actual Hours of I nput, at the Actual Rate (AH × AR) $18,200 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 5,600 hours* × $3.50 per hour = $19,600 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 5,250 hours* * × $3.50 per hour = $18,375 Spending Variance, Eff iciency Variance, $1,400 F $1,225 U Total Variance, $175 F ↑ * Based on direct labor hours: 35 technicians × 160 hours per technician = 5,600 hours * * 3,750 units × 1.4 hours per unit = 5,250 hours Alternatively: Variable overhead spending variance = AH (AR – SR) 5,600 hours ($3.25 per hour* – $3.50 per hour) = $1,400 F * $18,200 ÷ 5,600 hours = $3.25 per hour Variable overhead eff iciency variance = SR (AH – SH) $3.50 per hour (5,600 hours – 5,250 hours) = $1,225 U Both the labor eff iciency variance and the variable overhead eff iciency variance are computed by comparing actual labor-hours to standard labor-hours. Thus, if the labor eff iciency variance is unfavorable, then the variable overhead eff iciency variance will be unfavorable as well. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 579 Problem 10-18 (60 minutes) 1. a. Actual Quantity of I nput, at Actual Price (AQ × AP) 32,000 feet × $4.80 per foot = $153,600 ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 32,000 feet × $5.00 per foot = $160,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 29,600 feet* × $5.00 per foot = $148,000 Price Variance, Quantity Variance, $6,400 F $12,000 U Total Variance, $5,600 U ↑ * 8,000 footballs × 3.7 ft. per football = 29,600 feet Alternative Solution: Materials price variance = AQ (AP – SP) 32,000 feet ($4.80 per foot – $5.00 per foot) = $6,400 F Materials quantity variance = SP (AQ – SQ) $5.00 per foot (32,000 feet – 29,600 feet) = $12,000 U b. Raw Materials (32,000 feet × $5.00 per foot) ... 160,000 Materials Price Variance (32,000 feet × $0.20 per foot F) .......... Accounts Payable (32,000 feet × $4.80 per foot) ............. 153,600 Work in Process (29,600 feet × $5.00 per foot) ...................... 148,000 Materials Quantity Variance (2,400 feet U × $5.00 per foot) .................... 12,000 Raw Materials (32,000 feet × $5.00 per foot) ............. 160,000 6,400 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 580 Managerial Accounting, 11th Edition Problem 10-18 (continued) 2. a. Actual Hours of I nput, at the Actual Rate (AH × AR) 6,400 hours* × $8.00 per hour = $51,200 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 6,400 hours × $7.50 per hour = $48,000 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 7,200 hours* * × $7.50 per hour = $54,000 Rate Variance, Eff iciency Variance, $3,200 U $6,000 F Total Variance, $2,800 F ↑ * 8,000 footballs × 0.8 hours per football = 6,400 hours * * 8,000 footballs × 0.9 hours per football = 7,200 hours Alternative Solution: Labor rate variance = AH (AR – SR) 6,400 hours ($8.00 per hour – $7.50 per hour) = $3,200 U Labor eff iciency variance = SR (AH – SH) $7.50 per hour (6,400 hours – 7,200 hours) = $6,000 F b. Work in Process (7,200 hours × $7.50 per hour) ... 54,000 Labor Rate Variance (6,400 hours × $0.50 per hour U) ..................... 3,200 Labor Eff iciency Variance (800 hours F × $7.50 per hour) ............... 6,000 Wages Payable (6,400 hours × $8.00 per hour)................ 51,200 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 581 Problem 10-18 (continued) 3. Actual Hours of I nput, at the Actual Rate (AH × AR) 6,400 hours × $2.75 per hour = $17,600 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 6,400 hours × $2.50 per hour = $16,000 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 7,200 hours × $2.50 per hour = $18,000 Spending Variance, Eff iciency Variance, $1,600 U $2,000 F Total Variance, $400 F ↑ Alternative Solution: Variable overhead spending variance = AH (AR – SR) 6,400 hours ($2.75 per hour – $2.50 per hour) = $1,600 U Variable overhead eff iciency variance = SR (AH – SH) $2.50 per hour (6,400 hours – 7,200 hours) = $2,000 F 4. No. He is not correct in his statement. The company has a large, unfavorable materials quantity variance that should be investigated. Also, the overhead spending variance equals 10% of standard, which should also be investigated. I t appears that the company’s strategy to increase output by giving raises was effective. Although the raises resulted in an unfavorable rate variance, this variance was more than offset by a large, favorable eff iciency variance. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 582 Managerial Accounting, 11th Edition Problem 10-18 (continued) 5. The variances have many possible causes. Some of the more likely causes include the following: Materials variances: Favorable price variance: Fortunate purchase, inferior quality materials, unusual discount due to quantity purchased, drop in market price, less costly method of freight, outdated or inaccurate standards. Unfavorable quantity variance: Carelessness, poorly adjusted machines, unskilled workers, inferior quality materials, outdated or inaccurate standards. Labor variances: Unfavorable rate variance: Use of highly skilled workers, change in pay scale, overtime, outdated or inaccurate standards. Favorable eff iciency variance: Use of highly skilled workers, high quality materials, new equipment, outdated or inaccurate standards. Variable overhead variances: Unfavorable spending variance: I ncrease in costs, waste, theft, spillage, purchases in uneconomical lots, outdated or inaccurate standards. Favorable eff iciency variance: Same as for labor eff iciency variance. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 583 Problem 10-19 (45 minutes) 1. a. Actual Quantity of I nput, at Actual Price (AQ × AP) 60,000 pounds × $1.95 per pound = $117,000 ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 60,000 pounds × $2.00 per pound = $120,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 45,000 pounds* × $2.00 per pound = $90,000 Price Variance, $3,000 F 49,200 pounds × $2.00 per pound = $98,400 ↑ ↑ Quantity Variance, $8,400 U * 15,000 pools × 3.0 pounds per pool = 45,000 pounds Alternative Solution: Materials price variance = AQ (AP – SP) 60,000 pounds ($1.95 per pound – $2.00 per pound) = $3,000 F Materials quantity variance = SP (AQ – SQ) $2.00 per pound (49,200 pounds – 45,000 pounds) = $8,400 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 584 Managerial Accounting, 11th Edition Problem 10-19 (continued) b. Actual Hours of I nput, at the Actual Rate (AH × AR) 11,800 hours × $7.00 per hour = $82,600 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 11,800 hours × $6.00 per hour = $70,800 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 12,000 hours* × $6.00 per hour = $72,000 Rate Variance, Eff iciency Variance, $11,800 U $1,200 F Total Variance, $10,600 U ↑ * 15,000 pools × 0.8 hours per pool = 12,000 hours Alternative Solution: Labor rate variance = AH (AR – SR) 11,800 hours ($7.00 per hour – $6.00 per hour) = $11,800 U Labor eff iciency variance = SR (AH – SH) $6.00 per hour (11,800 hours – 12,000 hours) = $1,200 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 585 Problem 10-19 (continued) c. Actual Hours of I nput, at the Actual Rate (AH × AR) $18,290 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 5,900 hours × $3.00 per hour = $17,700 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 6,000 hours* × $3.00 per hour = $18,000 Spending Variance, Eff iciency Variance, $590 U $300 F Total Variance, $290 U ↑ * 15,000 pools × 0.4 hours per pool = 6,000 hours Alternative Solution: Variable overhead spending variance = AH (AR – SR) 5,900 hours ($3.10 per hour* – $3.00 per hour) = $590 U * $18,290 ÷ 5,900 hours = $3.10 per hour Variable overhead eff iciency variance = SR (AH – SH) $3.00 per hour (5,900 hours – 6,000 hours) = $300 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 586 Managerial Accounting, 11th Edition Problem 10-19 (continued) 2. Summary of variances: Material price variance ........................... $ 3,000 Material quantity variance ...................... 8,400 Labor rate variance................................ 11,800 Labor eff iciency variance........................ 1,200 Variable overhead spending variance ...... 590 Variable overhead eff iciency variance...... 300 Net variance ......................................... $16,290 F U U F U F U The net unfavorable variance of $16,290 for the month caused the plant’s variable cost of goods sold to increase from the budgeted level of $180,000 to $196,290: Budgeted cost of goods sold at $12 per pool .......... $180,000 Add the net unfavorable variance, as above............ 16,290 Actual cost of goods sold ...................................... $196,290 This $16,290 net unfavorable variance also accounts for the difference between the budgeted net operating income and the actual net operating income for the month. Budgeted net operating income .............................. Deduct the net unfavorable variance added to cost of goods sold for the month................................. Net operating income ............................................ $36,000 16,290 $19,710 3. The two most signif icant variances are the materials quantity variance and the labor rate variance. Possible causes of the variances include: Materials quantity variance: Outdated standards, unskilled workers, poorly adjusted machines, carelessness, poorly trained workers, inferior quality materials. Labor rate variance: Outdated standards, change in pay scale, overtime pay. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 587 Problem 10-20 (60 minutes) 1. Both companies view training as important; both companies need to leverage technology to succeed in the marketplace; and both companies are concerned with minimizing defects. There are numerous differences between the two companies. For example, Applied Pharmaceuticals is a product-focused company and Destination Resorts I nternational (DRI ) is a service-focused company. Applied Pharmaceuticals’ training resources are focused on their engineers because they hold the key to the success of the organization. DRI ’s training resources are focused on their frontline employees because they hold the key to the success of their organization. Applied Pharmaceuticals’ technology investments are focused on supporting the innovation that is inherent in the product development side of the business. DRI ’s technology investments are focused on supporting the day-to-day execution that is inherent in the customer interface side of the business. Applied Pharmaceuticals defines a defect from an internal manufacturing standpoint, while DRI defines a defect from an external customer interaction standpoint. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 588 Managerial Accounting, 11th Edition Problem 10-20 (continued) 2. Students’ answers may differ in some details from this solution. Applied Pharmaceuticals Financial Return on Stockholders’ Equity + Customer Customer perception of first-to-market capability I nternal Business Process + R&D Yield Learning and Grow th Customer perception of product quality + Defect rates Percentage of job offers accepted Dollars invested in engineering technology + + – + Dollars invested in engineering training per engineer + © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 589 Problem 10-20 (continued) Destination Resorts I nternational Financial Sales + Customer + Number of repeat customers I nternal Business Process Percentage of error-free repeat customer check-ins Learning and Grow th + Room cleanliness Employee turnover Average time to resolve customer complaint + – Survey of employee morale Number of employees receiving database training – + + © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 590 Managerial Accounting, 11th Edition Problem 10-20 (continued) 3. The hypotheses underlying the balanced scorecards are indicated by the arrows in each diagram. Reading from the bottom of each balanced scorecard, the hypotheses are: Applied Pharmaceuticals o I f the dollars invested in engineering technology increase, then the o o o o o o R&D yield will increase. I f the percentage of job offers accepted increases, then the R&D yield will increase. I f the dollars invested in engineering training per engineer increase, then the R&D yield will increase. I f the R&D yield increases, then customer perception of first-tomarket capability will increase. I f the defects per million opportunities decrease, then the customer perception of product quality will increase. I f the customer perception of first-to-market capability increases, then the return on stockholders’ equity will increase. I f the customer perception of product quality increases, then the return on stockholders’ equity will increase. Destination Resort I nternational o I f the employee turnover decreases, then the percentage of error- o o o o o o free repeat customer check-ins and room cleanliness will increase and the average time to resolve customer complaints will decrease. I f the number of employees receiving database training increases, then the percentage of error-free repeat customer check-ins will increase. I f employee morale increases, then the percentage of error-free repeat customer check-ins and room cleanliness will increase and the average time to resolve customer complaints will decrease. I f the percentage of error-free repeat customer check-ins increases, then the number of repeat customers will increase. I f the room cleanliness increases, then the number of repeat customers will increase. I f the average time to resolve customer complaints decreases, then the number of repeat customers will increase. I f the number of repeat customers increases, then sales will increase. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 591 Problem 10-20 (continued) Each of these hypotheses is questionable to some degree. For example, in the case of Applied Pharmaceuticals, R&D yield is not the sole driver of the customers’ perception of first-to-market capability. More specifically, if Applied Pharmaceuticals experimented with nine possible drug compounds in year one and three of those compounds proved to be successful in the marketplace it would result in an R&D yield of 33% . I f in year two, it experimented with four possible drug compounds and two of those compounds proved to be successful in the marketplace it would result in an R&D yield of 50% . While the R&D yield has increased from year one to year two, it is quite possible that the customer’s perception of first-to-market capability would decrease. The fact that each of the hypotheses mentioned above can be questioned does not invalidate the balanced scorecard. I f the scorecard is used correctly, management will be able to identify which, if any, of the hypotheses are invalid and the balanced scorecard can then be appropriately modified. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 592 Managerial Accounting, 11th Edition Problem 10-21 (30 minutes) 1. a., b., and c. Month 1 2 3 4 2.1 0.6 0.4 4.3 7.4 2.0 0.7 0.3 5.0 8.0 1.9 0.7 0.4 5.8 8.8 1.8 0.6 0.4 6.7 9.5 Manufacturing cycle eff iciency (MCE): Process time (x) ÷ Throughput time (y) ......................... 28.4% 25.0% 21.6% 18.9% Throughput time—days: Process time (x) ................................. I nspection time................................... Move time .......................................... Queue time ........................................ Total throughput time (y) .................... Delivery cycle time—days: Wait time from order to start of production ........................................ Throughput time.................................. Total delivery cycle time ....................... 16.0 7.4 23.4 17.5 8.0 25.5 19.0 8.8 27.8 20.5 9.5 30.0 2. All of the performance measures display unfavorable trends. Throughput time per unit is increasing—largely because of an increase in queue time. Manufacturing cycle eff iciency is declining and delivery cycle time is increasing. I n addition, the percentage of on-time deliveries has dropped as has the total throughput. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 593 Problem 10-21 (continued) 3. a. and b. Month 5 Throughput time—days: Process time (x) ............................................... I nspection time................................................. Move time ........................................................ Queue time ...................................................... Total throughput time (y) .................................. Manufacturing cycle eff iciency (MCE): Process time (x) ÷ Throughput time (y).............. 1.8 0.6 0.4 0.0 2.8 64.3% 6 1.8 0.0 0.4 0.0 2.2 81.8% As a company reduces non-value-added activities, the manufacturing cycle eff iciency increases rapidly. The goal, of course, is to have an eff iciency of 100% . This will be achieved when all non-value-added activities have been eliminated and process time is equal to throughput time. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 594 Managerial Accounting, 11th Edition Problem 10-22 (30 minutes) 1. Salex quantity standard: Required per 10-liter batch (9.6 liters ÷ 0.8) .......... Loss from rejected batches (1/ 5 × 12 liters) .......... Total quantity per good batch ............................... 12.0 liters 2.4 liters 14.4 liters Nyclyn quantity standard: Required per 10-liter batch (12 kilograms ÷ 0.8) .... Loss from rejected batches (1/ 5 × 15 kilograms).... Total quantity per good batch ............................... 15.0 kilograms 3.0 kilograms 18.0 kilograms Protet quantity standard: Required per 10-liter batch ................................... Loss from rejected batches (1/ 5 × 5 kilograms) ..... Total quantity per good batch ............................... 5.0 kilograms 1.0 kilograms 6.0 kilograms 2. Total minutes per 8-hour day .................................. Less rest breaks and cleanup .................................. Productive time each day ........................................ 480 minutes 60 minutes 420 minutes Productive time each day 420 minutes per day = = 12 batches per day Time required per batch 35 minutes per batch Time required per batch ......................................... Rest breaks and clean up time (60 minutes ÷ 12 batches) ................................... Total ..................................................................... Loss from rejected batches (1/ 5 × 40 minutes) ........ Total time per good batch ....................................... 35 minutes 5 40 8 48 minutes minutes minutes minutes © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 595 Problem 10-22 (continued) 3. Standard cost card: Salex ..................... Nyclyn ................... Protet .................... Labor time ............. Standard Quantity or Time Standard Price or Rate Standard Cost 14.4 liters 18.0 kilograms 6.0 kilograms 48 minutes, or 0.8 hour $1.50 per liter $2.80 per kilogram $3.00 per kilogram $21.60 50.40 18.00 $9.00 per hour Total standard cost per acceptable batch ........... 7.20 $97.20 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 596 Managerial Accounting, 11th Edition Problem 10-23 (45 minutes) 1. Materials price variance = (AQ × AP) – (AQ × SP) ($424,800) – (180,000 yards × $2.40 per yard) = $7,200 F 2. a. and b. 48 Lot Number 49 Standard yards: 950 Units in lot (dozen) ................ 1,500 × 32 Standard yards per dozen ....... × 32 30,400 Total yards allowed ................ 48,000 30,140 Actual yards used ..................... 48,300 300 U 260 F Quantity variance in yards ......... Quantity variance in dollars @ $2.40 per yard ................... $720 U $624 F 50 Total 2,100 4,550 × 32 × 32 67,200 145,600 67,250 145,690 50 U 90 U $120 U $216 U 3. Labor rate variance = (AH × AR) – (AH × SR) ($192,280) – (25,300 hours* × $7.50 per hour) = $2,530 U * 8,900 hours + 6,130 hours + 10,270 hours = 25,300 hours 4. a. and b. 48 Standard hours: ................... Units in lot (dozen) ............ Standard hours per dozen... Total standard hours .......... 1,500 × 6 9,000 Lot Number 49 950 × 6 5,700 50 Total 2,100 × 6 12,600 4,550 × 6 27,300 × 80% Percentage completed ........ × 100% × 100% Total standard hours 9,000 5,700 10,080 24,780 allowed........................... 8,900 6,130 10,270 25,300 Actual hours worked ............. Labor eff iciency variance in hours ................................ 100 F 430 U 190 U 520 U Labor eff iciency variance in dollars @ $7.50 per hour .... $750 F $3,225 U $1,425 U $3,900 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 597 Problem 10-23 (continued) 5. Some supervisors and managers rarely deal with, or think in terms of, dollars in their daily work. I nstead they think in terms of hours, units, eff iciency, and so on. For these managers, it may be better to express quantity variances in units (hours, yards, etc.) rather than in dollars. For other managers, quantity variances expressed in terms of dollars may be more useful—particularly to convey a notion of the materiality of the variance. I n some cases, managers may prefer that the variances be expressed in terms of both dollars and units. On the other hand, price variances expressed in units (hours, yards) would make little sense. Such variances should always be expressed in dollars. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 598 Managerial Accounting, 11th Edition Problem 10-24 (45 minutes) 1. a. Materials quantity variance = SP (AQ – SQ) $5.00 per foot (AQ – 9,600 feet* ) = $4,500 U $5.00 per foot × AQ – $48,000 = $4,500* * $5.00 per foot × AQ = $52,500 AQ = 10,500 feet * $3,200 units × 3 foot per unit * * When used with the formula, unfavorable variances are positive and favorable variances are negative. Therefore, $55,650 ÷ 10,500 feet = $5.30 per foot b. Materials price variance = AQ (AP – SP) 10,500 feet ($5.30 per foot – $5.00 per foot) = $3,150 U The total variance for materials would be: Materials price variance.................... Materials quantity variance ............... Total variance.................................. $3,150 U 4,500 U $7,650 U Alternative approach to parts (a) and (b): Actual Quantity of I nput, at Actual Price (AQ × AP) 10,500 feet × $5.30 per foot = $55,650* ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 10,500 feet × $5.00 per foot* = $52,500 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 9,600 feet* * × $5.00 per foot* = $48,000 Price Variance, Quantity Variance, $3,150 U $4,500 U* Total Variance, $7,650 U ↑ * Given * * 3,200 units × 3 foot per unit = 9,600 feet © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 599 Problem 10-24 (continued) 2. a. Labor rate variance = AH (AR – SR) 4,900 hours ($7.50 per hour* – SR) = $2,450 F* * $36,750 – 4,900 hours × SR = –$2,450* * * 4,900 hours × SR = $39,200 SR = $8.00 * $36,750 ÷ 4,900 hours * * $1,650 F + $800 U. * * * When used with the formula, unfavorable variances are positive and favorable variances are negative. b. Labor eff iciency variance = SR (AH – SH) $8 per hour (4,900 hours – SH) = $800 U $39,200 – $8 per hour × SH = $800* $8 per hour × SH = $38,400 SH = 4,800 hours * When used with the formula, unfavorable variances are positive and favorable variances are negative. Alternative approach to parts (a) and (b): Actual Hours of I nput, at the Actual Rate (AH × AR) $36,750* ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 4,900 hours* × $8.00 per hour = $39,200 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 4,800 hours × $8.00 per hour = $38,400 Rate Variance, Eff iciency Variance, $2,450 F $800 U* Total Variance, $1,650 F* ↑ * Given. c. The standard hours allowed per unit of product would be: 4,800 hours ÷ 3,200 units = 1.5 hours per unit © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 600 Managerial Accounting, 11th Edition Problem 10-25 (75 minutes) 1. a. Before the variances can be computed, we must first compute the standard and actual quantities of material per hockey stick. The computations are: Direct materials added to work in process (a) ... $115,200 Standard direct materials cost per foot (b) ........ $3.00 Standard quantity of direct materials (a) ÷ (b) .. 38,400 feet Standard quantity of direct materials (a) ........... Number of sticks produced (b) ......................... Standard quantity per stick (a) ÷ (b) ................ 38,400 feet 8,000 4.8 feet Actual quantity of direct materials used per stick last year: 4.8 feet + 0.2 feet = 5.0 feet. With these figures, the variances can be computed as follows: Actual Quantity of I nput, at Actual Price (AQ × AP) $174,000 ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 60,000 feet × $3.00 per foot = $180,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 38,400 feet × $3.00 per foot = $115,200 Price Variance, $6,000 F 40,000 feet* × $3.00 per foot = $120,000 ↑ ↑ Quantity Variance, $4,800 U * 8,000 units × 5.0 feet per unit = 40,000 feet © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 601 Problem 10-25 (continued) Alternative Solution: Materials price variance = AQ (AP – SP) 60,000 feet ($2.90 per foot* – $3.00 per foot) = $6,000 F * $174,000 ÷ 60,000 feet = $2.90 per foot Materials quantity variance = SP (AQ – SQ) $3.00 per foot (40,000 feet – 38,400 feet) = $4,800 U b. Raw Materials (60,000 feet × $3.00 per foot) ....... 180,000 Materials Price Variance (60,000 feet × $0.10 per foot F).................. 6,000 Accounts Payable (60,000 feet × $2.90 per foot) .................... 174,000 Work in Process (38,400 feet × $3.00 per foot) .... 115,200 Materials Quantity Variance (1,600 feet U × $3.00 per foot) ........................ 4,800 Raw Materials (40,000 feet × $3.00 per foot) .. 120,000 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 602 Managerial Accounting, 11th Edition Problem 10-25 (continued) 2. a. Before the variances can be computed, we must first determine the actual direct labor hours worked for last year. This can be done through the variable overhead efficiency variance, as follows: Variable overhead eff iciency variance = SR (AH – SH) $1.30 per hour × (AH – 16,000 hours* ) = $650 U $1.30 per hour × AH – $20,800 = $650* * $1.30 per hour × AH = $21,450 AH = $21,450 ÷ $1.30 per hour AH = 16,500 hours * 8,000 units × 2.0 hours per unit = 16,000 hours * * When used in the formula, an unfavorable variance is positive. We must also compute the standard rate per direct labor hour. The computation is: Labor rate variance = (AH × AR) – (AH × SR) $79,200 – (16,500 hours × SR) = $3,300 F $79,200 – 16,500 hours × SR = –$3,300* 16,500 hours × SR = $82,500 SR = $82,500 ÷ 16,500 hours SR = $5.00 per hour * When used in the formula, a favorable variance is negative. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 603 Problem 10-25 (continued) Given these figures, the variances are: Actual Hours of I nput, at the Actual Rate (AH × AR) $79,200 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 16,500 hours × $5.00 per hour = $82,500 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 16,000 hours × $5.00 per hour = $80,000 Rate Variance, Eff iciency Variance, $3,300 F $2,500 U Total Variance, $800 F ↑ Alternative Solution: Labor rate variance = AH (AR – SR) 16,500 hours ($4.80 per hour* – $5.00 per hour) = $3,300 F * 79,200 ÷ 16,500 hours = $4.80 per hour Labor eff iciency variance = SR (AH – SH) $5.00 per hour (16,500 hours – 16,000 hours) = $2,500 U b. Work in Process (16,000 hours × $5.00 per hour) ...................... 80,000 Labor Eff iciency Variance (500 hours U × $5.00 per hour)........................ 2,500 Labor Rate Variance (16,500 hours × $0.20 per hour F) .............. Wages Payable (16,500 hours × $4.80 per hour) ................. 3,300 79,200 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 604 Managerial Accounting, 11th Edition Problem 10-25 (continued) 3. Actual Hours of I nput, at the Actual Rate (AH × AR) $19,800 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 16,500 hours × $1.30 per hour = $21,450 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 16,000 hours × $1.30 per hour = $20,800 Spending Variance, Eff iciency Variance, $1,650 F $650 U Total Variance, $1,000 F ↑ Alternative Solution: Variable overhead spending variance = AH (AR – SR) 16,500 hours ($1.20 per hour* – $1.30 per hour) = $1,650 F * $19,800 ÷ 16,500 hours = $1.20 per hour Variable overhead eff iciency variance = SR (AH – SH) $1.30 per hour (16,500 hours – 16,000 hours) = $650 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 605 Problem 10-25 (continued) 4. For materials: Favorable price variance: Decrease in outside purchase price; fortunate buy; inferior quality materials; unusual discounts due to quantity purchased; less costly method of freight; inaccurate standards. Unfavorable quantity variance: I nferior quality materials; carelessness; poorly adjusted machines; unskilled workers; inaccurate standards. For labor: Favorable rate variance: Unskilled workers (paid lower rates); piecework; inaccurate standards. Unfavorable eff iciency variance: Poorly trained workers; poor quality materials; faulty equipment; work interruptions; f ixed labor and insuff icient demand to f ill capacity; inaccurate standards. For variable overhead: Favorable spending variance: Decrease in supplier prices; less usage of lubricants or indirect materials than planned; inaccurate standards. Unfavorable eff iciency variance: See comments under direct labor eff iciency variance above. 5. Direct materials............... Direct labor ..................... Variable overhead............ Total standard cost .......... Standard Quantity or Hours Standard Price or Rate Standard Cost 4.8 feet 2.0 hours 2.0 hours $3.00 per foot $5.00 per hour $1.30 per hour $14.40 10.00 2.60 $27.00 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 606 Managerial Accounting, 11th Edition Problem 10-26 (60 minutes) 1. Standard cost for March production: Materials.......................................................................... Direct labor...................................................................... Variable manufacturing overhead ...................................... Total standard cost (a) ..................................................... $16,800 10,500 4,200 $31,500 Number of backpacks produced (b)................................... 1,000 Standard cost of a single backpack (a) ÷ (b) .................... $31.50 2. Standard cost of a single backpack (above) ....................... Deduct difference between standard and actual cost.......... Actual cost per backpack .................................................. $31.50 0.15 $31.35 3. Total standard cost of materials used during March (a) .... Number of backpacks produced during March (b)............ Standard materials cost per backpack (a) ÷ (b) .............. $16,800 1,000 $16.80 Standard materials cost per backpack $16.80 per backpack = Standard materials cost per yard $6.00 per yard = 2.8 yards per backpack 4. Standard cost of material used .............. $16,800 Actual cost of material used .................. 15,000 Total variance ...................................... $ 1,800 F The price and quantity variances together equal the total variance. I f the quantity variance is $1,200 U, then the price variance must be $3,000 F: Price variance ...................................... $ 3,000 F Quantity variance ................................. 1,200 U Total variance ...................................... $ 1,800 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 607 Problem 10-26 (continued) Alternative Solution: Actual Quantity of I nput, at Actual Price (AQ × AP) 3,000 yards × $5.00 per yard = $15,000* ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 3,000 yards × $6.00 per yard* = $18,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 2,800 yards* * × $6.00 per yard* = $16,800* Price Variance, Quantity Variance, $3,000 F $1,200 U* Total Variance, $1,800 F ↑ * Given. * * 1,000 units × 2.8 yards per unit = 2,800 yards 5. The f irst step in computing the standard direct labor rate is to determine the standard direct labor-hours allowed for the month’s production. The standard direct labor-hours can be computed by working with the variable manufacturing overhead costs, since they are based on direct labor-hours worked: Standard variable manufacturing overhead cost for March (a) ... $4,200 Standard variable manufacturing overhead rate per direct laborhour (b).............................................................................. $3.00 Standard direct labor-hours for March (a) ÷ (b)........................ 1,400 Total standard direct labor cost for March $10,500 = Total standard direct labor-hours for March 1,400 DLHs = $7.50 per DLH © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 608 Managerial Accounting, 11th Edition Problem 10-26 (continued) 6. Before the labor variances can be computed, it is necessary to compute the actual direct labor cost for the month: Actual cost per backpack produced (part 2) .......... Number of backpacks produced ........................... Total actual cost of production ............................. Less: Actual cost of materials .............................. $15,000 Actual cost of variable manufacturing overhead ................................................ 3,600 Actual cost of direct labor ................................... $ 31.35 × 1,000 $31,350 18,600 $12,750 With this information, the variances can be computed: Actual Hours of I nput, at the Actual Rate (AH × AR) $12,750 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 1,500 hours* × $7.50 per hour = $11,250 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) $10,500* Rate Variance, Eff iciency Variance, $1,500 U $750 U Total Variance, $2,250 U ↑ * Given. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 609 Problem 10-26 (continued) 7. Actual Hours of I nput, at the Actual Rate (AH × AR) $3,600* ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 1,500 hours* × $3.00 per hour* = $4,500 Standard Hours Allowed for Output, at the Standard Rate (SH × SR) $4,200* ↑ Spending Variance, Eff iciency Variance, $900 F $300 U Total Variance, $600 F ↑ * Given. 8. Direct materials................. Direct labor....................... Variable manufacturing overhead ....................... Total standard cost ............ Standard Quantity or Hours Standard Price or Rate Standard Cost 2.8 yards1 1.4 hours2 $6 per yard $7.50 per hour 3 $16.80 10.50 1.4 hours $3 per hour 4.20 $31.50 1 From part 3. 1,400 standard hours (from part 5) ÷ 1,000 backpacks = 1.4 hours per backpack. 3 From part 5. 2 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 610 Managerial Accounting, 11th Edition Problem 10-27 (75 minutes) 1. Actual Quantity of I nput, at Actual Price (AQ × AP) 510,000 feet × $3.20 per foot = $1,632,000 ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 510,000 feet × $3.00 per foot = $1,530,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 540,000 feet* × $3.00 per foot = $1,620,000 Price Variance, Quantity Variance, $102,000 U $90,000 F Total Variance, $12,000 U ↑ * 30,000 units × 18 feet per unit = 540,000 feet Alternative Solution: Materials price variance = AQ (AP – SP) 510,000 feet ($3.20 per foot – $3.00 per foot) = $102,000 U Materials quantity variance = SP (AQ – SQ) $3 per foot (510,000 feet – 540,000 feet) = $90,000 F Yes, the decrease in waste is apparent because of the $90,000 favorable quantity variance. I f the company wants to continue to compute the material price variance, then the standard price per foot should be changed to reflect current JI T purchase costs. The old standard price of $3.00 per foot is no longer relevant. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 611 Problem 10-27 (continued) 2. Actual Hours of I nput, at the Actual Rate (AH × AR) 90,000 hours × $7.85 per hour = $706,500 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 90,000 hours × $8.00 per hour = $720,000 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 75,000 hours* × $8.00 per hour = $600,000 Rate Variance, Eff iciency Variance, $13,500 F $120,000 U Total Variance, $106,500 U ↑ * 30,000 units × 2.5 hours per unit = 75,000 hours Alternative Solution: Labor rate variance = AH (AR – SR) 90,000 hours ($7.85 per hour – $8.00 per hour) = $13,500 F Labor eff iciency variance = SR (AH – SH) $8.00 per hour (90,000 hours – 75,000 hours) = $120,000 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 612 Managerial Accounting, 11th Edition Problem 10-27 (continued) No, the labor eff iciency variance is not appropriate as a measure of performance in this situation. The reasons are: • Labor is largely a fixed cost rather than a variable cost since the company maintains a stable workforce to operate its flow line. Thus, the variance is not an effective measure of efficiency. • I n a JI T environment the goal is to produce onlyas needed to meet demand. This often conflicts with the goal of having high labor eff iciency, which requires that labor be fully utilized producing output. I f that output is not really demanded by customers, the result of fully utilizing labor is a buildup of excess work in process and f inished goods inventories. This is anathema in a JI T environment. Unfortunately, the situation posed in the problem is a common one as companies switch from a traditional system to JI T, and sometimes JI T doesn’t work because of misplaced emphasis on eff iciency variances. I n a JI T setting, it is an interesting paradox that one of the “costs” of greater eff iciency on the production line is greater “ineff iciency” on the part of labor as it is occasionally idle or as it spends time at various tasks other than producing goods. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 613 Problem 10-27 (continued) 3. Actual Hours of I nput, at the Actual Rate (AH × AR) $207,000 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 90,000 hours × $2.80 per hour = $252,000 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 75,000 hours* × $2.80 per hour = $210,000 Spending Variance, Eff iciency Variance, $45,000 F $42,000 U Total Variance, $3,000 F ↑ * 30,000 units × 2.5 hours per unit = 75,000 hours Alternative Solution: Variable overhead spending variance = AH × AR – AH × SR $207,000 – 90,000 hours × $2.80 per hour = $45,000 F Variable overhead eff iciency variance = SR (AH – SH) $2.80 per hour (90,000 hours – 75,000 hours) = $42,000 U I t is doubtful that a correlation still exists between direct labor and variable manufacturing overhead cost. Direct labor time is now largely a f ixed cost. Variable manufacturing overhead, however, will tend to rise and fall with actual changes in production. I f variable manufacturing overhead cost was indeed correlated with direct labor, then the actual variable manufacturing overhead cost for June should have been about $252,000 (90,000 hours × $2.80 per hour). But actual variable manufacturing overhead cost was far below this f igure, as shown by the large favorable spending variance for the month. I ndeed, the actual variable manufacturing overhead cost of $207,000 is very near the $210,000 standard cost allowed for the month’s output. Thus, it appears that as production has been cut back, variable manufacturing overhead cost has also decreased, even though direct labor time has remained quite stable. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 614 Managerial Accounting, 11th Edition Problem 10-27 (continued) 4. a. and b. April Throughput time—hours: Processing time (x) ..................................... 2.6 I nspection time........................................... 1.3 Move time .................................................. 1.9 Queue time ................................................ 8.2 Total throughput time (y) ............................ 14.0 Manufacturing cycle eff iciency (MCE): Processing time (x) ÷ Throughput time (y) ... 18.6% Month May June 2.5 0.9 1.4 5.2 10.0 2.4 0.1 0.6 1.9 5.0 25. 0% 48.0% Note that the manufacturing cycle eff iciency has improved dramatically over the last three months. This means that non-value-added time is being eliminated. 5. Under JI T the goal of the company is to produce to meet demand rather than to just f ill labor time. Thus, the traditional labor variances are often unfavorable. Throughput time and MCE focus on all elements of manufacturing—not just labor time. These other elements, which are independent of labor time, are showing greater eff iciency each month as the company eliminates non-value-added activities. Throughput time and MCE are more appropriate in this situation since they focus on those elements that are of greatest importance in a JI T environment. The labor eff iciency variance has little or no signif icance in such an environment. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 615 Problem 10-28 (45 minutes) 1. Students’ answers may differ in some details from this solution. Financial Weekly profit + Weekly sales + Customer Customer satisfaction with service I nternal Business Processes Dining area cleanliness + Customer satisfaction with menu choices + Average time to take an order Learning and Growth Percentage of dining room staff completing hospitality course Average time to prepare an order – + + – Number of menu items Percentage of kitchen staff completing cooking course + + © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 616 Managerial Accounting, 11th Edition Problem 10-28 (continued) 2. The hypotheses underlying the balanced scorecard are indicated by the arrows in the diagram. Reading from the bottom of the balanced scorecard, the hypotheses are: o I f the percentage of dining room staff who complete the basic hospitality course increases, then the average time to take an order will decrease. o I f the percentage of dining room staff who complete the basic hospitality course increases, then dining room cleanliness will improve. o I f the percentage of kitchen staff who complete the basic cooking course increases, then the average time to prepare an order will decrease. o I f the percentage of kitchen staff who complete the basic cooking course increases, then the number of menu items will increase. o I f the dining room cleanliness improves, then customer satisfaction with service will increase. o I f the average time to take an order decreases, then customer satisfaction with service will increase. o I f the average time to prepare an order decreases, then customer satisfaction with service will increase. o I f the number of menu items increases, then customer satisfaction with menu choices will increase. o I f customer satisfaction with service increases, weekly sales will increase. o I f customer satisfaction with menu choices increases, weekly sales will increase. o I f sales increase, weekly profits for the Lodge will increase. Each of these hypotheses is questionable to some degree. For example, the items added to the menu may not appeal to customers. So even if the number of menu items increases, customer satisfaction with the menu choices may not increase. The fact that each of the hypotheses can be questioned does not, however, invalidate the balanced scorecard. I f the scorecard is used correctly, management will be able to identify which, if any, of the hypotheses are incorrect. [ See below.] © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 617 Problem 10-28 (continued) 3. Management will be able to tell if a hypothesis is false if an improvement in a performance measure at the bottom of an arrow does not, in fact, lead to improvement in the performance measure at the tip of the arrow. For example, if the number of menu items is increased, but customer satisfaction with the menu choices does not increase, management will immediately know that something was wrong with that particular hypothesis. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 618 Managerial Accounting, 11th Edition Problem 10-29 (45 minutes) The answers below are not the only possible answers. I ngenious people can f igure out many different ways of making performance look better even though it really isn’t. This is one of the reasons for a balanced scorecard . By having a number of different measures that ultimately are linked to overall f inancial goals, “gaming” the system is more diff icult. 1. Speed-to-market can be improved by taking on less ambitious projects. I nstead of working on major product innovations that require a great deal of time and effort, R&D may choose to work on small, incremental improvements in existing products. There is also a danger that in the rush to push products out the door, the products will be inadequately tested and developed. 2. Performance measures that are ratios or percentages present special dangers. A ratio can be increased either by increasing the numerator or by decreasing the denominator. Usually, the intention is to increase the numerator in the ratio, but a manager may react by decreasing the denominator instead. I n this case (which actually happened), the managers pulled telephones out of the high-crime areas. This eliminated the problem for the managers, but was not what the CEO or the city off icials had intended. They wanted the phones f ixed, not eliminated. 3. I n real life, the production manager simply added several weeks to the delivery cycle time. I n other words, instead of promising to deliver an order in four weeks, the manager promised to deliver in six weeks. This increase in delivery cycle time did not, of course, please customers and drove some business away, but it dramatically improved the percentage of orders delivered on time. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 619 Problem 10-29 (continued) 4. As stated above, ratios can be improved by changing either the numerator or the denominator. Managers who are under pressure to increase the revenue per employee may f ind it easier to eliminate employees than to increase revenues. Of course, eliminating employees may reduce total revenues and total prof its, but the revenue per employee will increase as long as the percentage decline in revenues is less than the percentage cut in number of employees. Suppose, for example, that a manager is responsible for business units with a total of 1,000 employees, $120 million in revenues, and prof its of $2 million. Further suppose that a manager can eliminate one of these business units that has 200 employees, revenues of $10 million, and prof its of $1.2 million. Before eliminating After eliminating the business unit the business unit Total revenue ................ Total employees............. Revenue per employee ... Total prof its................... $120,000,000 1,000 $120,000 $2,000,000 $110,000,000 800 $137,500 $800,000 As these examples illustrate, performance measures should be selected with a great deal of care and managers should avoid placing too much emphasis on any one performance measure. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 620 Managerial Accounting, 11th Edition Problem 10-30 (30 minutes) 1. a., b., and c. Month Throughput time in days: Process time .................................... I nspection time................................ Move time ....................................... Queue time during production ........... Total throughput time....................... 1 2 3 4 2.1 0.8 0.3 2.8 6.0 2.0 0.7 0.4 4.4 7.5 1.9 0.7 0.4 6.0 9.0 1.8 0.7 0.5 7.0 10.0 Manufacturing cycle eff iciency (MCE): Process time ÷ Throughput time ....... 35.0% Delivery cycle time in days: Wait time to start of production......... 9.0 Throughput time .............................. 6.0 Total delivery cycle time.................... 15.0 26.7% 21.1% 18.0% 11.5 7.5 19.0 12.0 9.0 21.0 14.0 10.0 24.0 2. a. Areas where the company is improving: Quality control. The number of defects has decreased by over 50% in the last four months. Moreover, both warranty claims and customer complaints are down sharply. I n short, overall quality appears to have signif icantly improved. Material control. The purchase order lead time is only half of what it was four months ago, which indicates that purchases are arriving in less time. This trend may be a result of the company’s move toward JI T purchasing. Delivery performance. The process time has decreased from 2.1 days to 1.8 days over the last four months. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 621 Problem 10-30 (continued) b. Areas of deterioration: Material control. Scrap as a percentage of total cost has tripled over the last four months. Machine performance. Machine downtime has doubled over the last four months. This may be a result of the greater setup time, or it may just reflect efforts to get the new equipment operating properly. Also note that use of the machines as a percentage of availability is declining rapidly. The use of the machines may be declining as a consequence of the shift to JI T. Machines may be utilized less because they are not being used to build excess inventories. Delivery performance. All delivery performance measures are moving in the wrong direction. Throughput time and delivery cycle time are both increasing, and the manufacturing cycle eff iciency is decreasing. 3. a. and b. Month Throughput time in days: Process time............................................ I nspection time........................................ Move time ............................................... Queue time during production .................. Total throughput time .............................. 5 6 1.8 0.7 0.5 0.0 3.0 1.8 0.0 0.5 0.0 2.3 Manufacturing cycle eff iciency (MCE): Process time ÷ Throughput time ............... 60.0% 78.3% As non-value-added activities are eliminated, the manufacturing cycle eff iciency improves. The goal, of course, is to have an eff iciency of 100% . This is achieved when all non-value-added activities have been eliminated and process time equals throughput time. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 622 Managerial Accounting, 11th Edition Problem 10-31 (45 minutes) This problem is more diff icult than it looks. Allow ample time for discussion. 1. Actual Quantity of I nput, at Actual Price (AQ × AP) $45,600 ↑ Actual Quantity of I nput, at Standard Price (AQ × SP) 12,000 yards × $4.00 per yard* = $48,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 11,200 yards* * × $4.00 per yard* = $44,800 Price Variance, Quantity Variance, $2,400 F $3,200 U Total Variance, $800 U ↑ * $22.40 ÷ 5.6 yards = $4.00 per yard * * 2,000 sets × 5.6 yards per set = 11,200 yards Alternative Solution: Materials price variance = AQ (AP – SP) 12,000 yards ($3.80 per yard* – $4.00 per yard) = $2,400 F * $45,600 ÷ 12,000 yards = $3.80 per yard Materials quantity variance = SP (AQ – SQ) $4.00 per yard (12,000 yards – 11,200 yards) = $3,200 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 623 Problem 10-31 (continued) 2. Many students will miss parts 2 and 3 because they will try to use product costs as if they were hourly costs. Pay particular attention to the computation of the standard direct labor time per unit and the standard direct labor rate per hour. Actual Hours of I nput, at the Actual Rate (AH × AR) $18,200 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 2,800 hours × $6.00 per hour* = $16,800 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 3,000 hours* * × $6.00 per hour* = $18,000 Rate Variance, Eff iciency Variance, $1,400 U $1,200 F Total Variance, $200 U ↑ * 2,850 standard hours ÷ 1,900 sets = 1.5 standard hours per set, $9.00 standard cost per set ÷ 1.5 standard hours per set = $6.00 standard rate per hour. * * 2,000 sets × 1.5 standard hours per set = 3,000 standard hours. Alternative Solution: Labor rate variance = AH (AR – SR) 2,800 hours ($6.50 per hour* – $6.00 per hour) = $1,400 U * $18,200 ÷ 2,800 hours = $6.50 per hour Labor eff iciency variance = SR (AH – SH) $6.00 per hour (2,800 hours – 3,000 hours) = $1,200 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 624 Managerial Accounting, 11th Edition Problem 10-31 (continued) 3. Actual Hours of I nput, at the Actual Rate (AH × AR) $7,000 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 2,800 hours × $2.40 per hour* = $6,720 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 3,000 hours × $2.40 per hour* = $7,200 Spending Variance, Eff iciency Variance, $280 U $480 F Total Variance, $200 F ↑ * $3.60 standard cost per set ÷ 1.5 standard hours per set = $2.40 standard rate per hour Alternative Solution: Variable overhead spending variance = AH (AR – SR) 2,800 hours ($2.50 per hour* – $2.40 per hour) = $280 U * $7,000 ÷ 2,800 hours = $2.50 per hour Variable overhead eff iciency variance = SR (AH – SH) $2.40 per hour (2,800 hours – 3,000 hours) = $480 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 625 Problem 10-32 (45 minutes) 1. Standard cost for a ten-gallon batch of raspberry sherbet. Direct material: Raspberries (7.5 quarts1 × $0.80 per quart) ................ $6.00 Other ingredients (10 gallons × $0.45 per gallon) ....... 4.50 $10.50 Direct labor: Sorting (18 minutes2 ÷ 60 minutes per hour) × $9.00 per hour ....................................................... 2.70 Blending (12 minutes ÷ 60 minutes per hour) × $9.00 per hour ....................................................... 1.80 4.50 3 Packing (40 quarts × $0.38 per quart) ...................... 15.20 Standard cost per ten-gallon batch ............................... $30.20 1 6 quarts × (5 ÷ 4) = 7.5 quarts required to obtain 6 acceptable quarts. 3 minutes per quart × 6 quarts. 3 4 quarts per gallon × 10 gallons = 40 quarts. 2 2. a. I n general, the purchasing manager is held responsible for unfavorable material price variances. Causes of these variances include the following: • I ncorrect standards. • Failure to correctly forecast price increases. • Purchasing in nonstandard or uneconomical lots. • Failure to take available purchase discounts. • Failure to control transportation costs. • Purchasing from suppliers other than those offering the most favorable terms. However, failure to meet price standards may be caused by a rush of orders or changes in production schedules. I n this case, the responsibility for unfavorable material price variances should rest with the sales manager or the manager of production planning. Variances may also be caused by external events that are uncontrollable, e.g., a strike at a supplier’s plant. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 626 Managerial Accounting, 11th Edition Problem 10-32 (continued) b. I n general, the production manager or foreman is held responsible for unfavorable labor eff iciency variances. Causes of these variances include the following: • I ncorrect standards. • Poorly trained labor. • Substandard or ineff icient equipment. • I nadequate supervision. • Machine breakdowns from poor maintenance. • Poorly motivated employees. • Fixed labor force with demand less than capacity. Failure to meet labor eff iciency standards may also be caused by the use of inferior materials or poor production planning. I n these cases, responsibility should rest with the purchasing manager or the manager of production planning. Variances may also be caused by external events that are uncontrollable, e.g., low unemployment leading to the inability to hire and retain skilled workers. (Unoff icial CMA Solution, adapted) © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 627 Case 10-33 (60 minutes) 1. Student answers may differ concerning which category—learning and growth, internal business processes, customers, or f inancial—a particular performance measure belongs to. Financial Total profit Average age of accounts receivable Customer I nternal Business Processes Learning and Growth Customer satisfaction with accuracy of charge account bills Percentage of charge account bills containing errors + Written-off accounts receivable as a percentage of sales − − + − Percentage of sales clerks trained to correctly enter data on charge account slips Unsold inventory at end of season as a percentage of total cost of sales − Percentage of suppliers making just-in-time deliveries + + © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 628 Managerial Accounting, 11th Edition Case 10-33 (continued) A number of the performance measures suggested by managers have not been included in the above balanced scorecard. The excluded performance measures may have an impact on total profit, but they are not linked in any obvious way with the two key problems that have been identified by management—accounts receivables and unsold inventory. I f every performance measure that potentially impacts profit is included in a company’s balanced scorecard, it would become unwieldy and focus would be lost. 2. The results of operations can be exploited for information about the company’s strategy. Each link in the balanced scorecard should be regarded as a hypothesis of the form “I f ..., then ...”. For example, the balanced scorecard on the previous page contains the hypothesis “I f customers express greater satisfaction with the accuracy of their charge account bills, then the average age of accounts receivable will improve.” I f customers in fact do express greater satisfaction with the accuracy of their charge account bills, but the average age of accounts receivable does not improve, this would have to be considered evidence that is inconsistent with the hypothesis. Management should try to figure out why the average age of receivables has not improved. (See the answer below for possible explanations.) The answer may suggest a shift in strategy. I n general, the most important results are those that provide evidence inconsistent with the hypotheses embedded in the balanced scorecard. Such evidence suggests that the company’s strategy needs to be reexamined. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 629 Case 10-33 (continued) 3. a. This evidence is inconsistent with two of the hypotheses underlying the balanced scorecard. The first of these hypotheses is “I f customers express greater satisfaction with the accuracy of their charge account bills, then the average age of accounts receivable will improve.” The second of these hypotheses is “I f customers express greater satisfaction with the accuracy of their charge account bills, then there will be improvement in bad debts.” There are a number of possible explanations. Two possibilities are that the company’s collection efforts are ineffective and that the company’s credit reviews are not working properly. I n other words, the problem may not be incorrect charge account bills at all. The problem may be that the procedures for collecting overdue accounts are not working properly. Or, the problem may be that the procedures for reviewing credit card applications let through too many poor credit risks. I f so, this would suggest that efforts should be shifted from reducing charge account billing errors to improving the internal business processes dealing with collections and credit screening. And in that case, the balanced scorecard should be modified. b. This evidence is inconsistent with three hypotheses. The first of these is “I f the average age of receivables declines, then profits will increase.” The second hypothesis is “I f the written-off accounts receivable decrease as a percentage of sales, then profits will increase.” The third hypothesis is “I f unsold inventory at the end of the season as a percentage of cost of sales declines, then profits will increase.” Again, there are a number of possible explanations for the lack of results consistent with the hypotheses. Managers may have decreased the average age of receivables by simply writing off old accounts earlier than was done previously. This would actually decrease reported profits in the short term. Bad debts as a percentage of sales could be decreased by drastically cutting back on extensions of credit to customers—perhaps even canceling some charge accounts. (Bad debts would be zero if there were no credit sales.) This would have the effect of reducing bad debts, but might irritate otherwise loyal credit customers and reduce sales and profits. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 630 Managerial Accounting, 11th Edition Case 10-33 (continued) The reduction in unsold inventories at the end of the season as a percentage of cost of sales could have occurred for a number of reasons that are not necessarily good for profits. For example, managers may have been too cautious about ordering goods to restock low inventories—creating stockouts and lost sales. Or, managers may have cut prices drastically on excess inventories in order to eliminate them before the end of the season. This may have reduced the willingness of customers to pay the store’s normal prices. Or, managers may have gotten rid of excess inventories by selling them to discounters before the end of the season. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 631 Case 10-34 (30 minutes) This case may be diff icult for some students to grasp since it requires looking at standard costs from an entirely different perspective. I n this case, standard costs have been inappropriately used as a means to manipulate reported earnings rather than as a way to control costs. 1. Lansing has evidently set very loose standards in which the standard prices and standard quantities are far too high. This guarantees that favorable variances will ordinarily result from operations. I f the standard costs are set artif icially high, the standard cost of goods sold will be artif icially high and thus the division’s net operating income will be depressed until the favorable variances are recognized. I f Lansing saves the favorable variances, he can release just enough in the second and third quarters to show some improvement and then he can release all of the rest in the last quarter, creating the annual “Christmas present.” 2. Lansing should not be permitted to continue this practice for several reasons. First, it distorts the quarterly earnings for both the division and the company. The distortions of the division’s quarterly earnings are troubling because the manipulations may mask real signs of trouble. The distortions of the company’s quarterly earnings are troubling because they may mislead external users of the f inancial statements. Second, Lansing should not be rewarded for manipulating earnings. This sets a moral tone in the company that is likely to lead to even deeper trouble. I ndeed, the permissive attitude of top management toward the manipulation of earnings may indicate the existence of other, even more serious, ethical problems in the company. Third, a clear message should be sent to division managers like Lansing that their job is to manage their operations, not their earnings. I f they keep on top of operations and manage well, the earnings should take care of themselves. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 632 Managerial Accounting, 11th Edition Case 10-34 (continued) 3. Stacy Cummins does not have any easy alternatives available. She has already taken the problem to the President, who was not interested. I f she goes around the President to the Board of Directors, she will be putting herself in a politically diff icult position with little likelihood that it will do much good if, in fact, the Board of Directors already knows what is going on. On the other hand, if she simply goes along, she will be violating the “Objectivity” standard of ethical conduct for management accountants. The Home Security Division’s manipulation of quarterly earnings does distort the entire company’s quarterly reports. And the Objectivity standard clearly stipulates that “management accountants have a responsibility to disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented.” Apart from the ethical issue, there is also a very practical consideration. I f Merced Home Products becomes embroiled in controversy concerning questionable accounting practices, Stacy Cummins will be viewed as a responsible party by outsiders and her career is likely to suffer dramatically and she may even face legal problems. We would suggest that Ms. Cummins quietly bring the manipulation of earnings to the attention of the audit committee of the Board of Directors, carefully laying out in a non-confrontational manner the problems created by Lansing’s practice of manipulating earnings. I f the President and the Board of Directors are still not interested in dealing with the problem, she may reasonably conclude that the best alternative is to start looking for another job. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 633 Case 10-35 (90 minutes) This is a very rigorous case; be sure that students understand variances and journal entries before it is assigned. 1. Standard cost of Material A used in production (a) .......... $5,760 Standard cost of Material A per batch (6 gallons × $8.00 per gallon) (b) ............................... $48 Number of batches produced last week (a) ÷ (b) ............ 120 2. a. Standard cost of last week’s purchases (1,000 gallons × $8.00 per gallon) ........................... $8,000 Deduct favorable price variance ................................. 300 Actual cost of last week’s purchases ........................... $7,700 Alternative Solution: Materials price variance = (AQ × AP) – (AQ × SP) (1,000 gallons × AP) – (1,000 gallons × $8.00 per gallon) = $300 F (1,000 gallons × AP) – $8,000 = –$300* (1,000 gallons × AP) = $7,700 * When used in the formula, a favorable variance is negative. b. The number of gallons of Material A used in production can be computed through analysis of the raw materials inventory account: Balance, Material A, 3/ 1 ........................................... Add purchases (1,000 gallons × $8.00 per gallon) ...... Total Material A available .......................................... Less balance, Material A, 3/ 7 .................................... Total Material A used (at standard cost) ..................... $ 0 8,000 8,000 2,000 $6,000 Total cost of material A used $6,000 = = 750 gallons used Standard cost per gallon $8.00 per gallon © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 634 Managerial Accounting, 11th Edition Case 10-35 (continued) c. Materials quantity variance = SP (AQ – SQ) $8.00 per gallon (750 gallons – 720 gallons* ) = $240 U * 120 batches × 6 gallons per batch = 720 gallons d. Raw materials (1,000 gallons × $8.00 per gallon) ...... 8,000 Materials price variance (1,000 gallons × $0.30 per gallon F) ................. Accounts payable (1,000 gallons × $7.70 per gallon* ) .................. 300 7,700 * $7,700 ÷ 1,000 gallons = $7.70 per gallon Work in process (720 gallons × $8.00 per gallon) ...... Materials quantity variance (30 gallons U × $8.00 per gallon) .......................... Raw materials (750 gallons × $8.00 per gallon) ....................... 5,760 240 6,000 3. a. The standard cost per pound of Material B can be computed by analyzing the raw materials inventory account: Material B used in production ........................................ Add balance, Material B, 3/ 7.......................................... Total Material B available last week ................................ Deduct balance, Material B, 3/ 1 ..................................... Purchases of Material B (at standard cost) ...................... $2,500 1,400 3,900 700 $3,200 Purchases of Material B $3,200 = = $4.00 per pound Number of pounds purchased 800 lbs. b. Material B drawn from inventory ...... $2,500 ÷ $4.00/ pound = 625 pounds used Deduct unfavorable quantity variance ... 100 Standard cost of material used ........ $2,400 ÷ $4.00/ pound = 600 pounds allowed © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 635 Case 10-35 (continued) Alternative solution for standard quantity: Materials quantity variance = (AQ × SP) – (SQ × SP) $2,500 – (SQ × $4.00 per pound) = $100 U $2,500 – $4 per pound × SQ = $100* $4 per pound × SQ = $2,400 SQ = 600 pounds * When used with the formula, an unfavorable variance is positive. c. 600 pounds ÷ 120 batches = 5 pounds per batch d. Total cost of purchases of materials (accounts payable) ......................................... Less cost of Material A purchases (Part 2) ........... Cost of Material B purchases .............................. $11,460 7,700 $ 3,760 Materials price variance = (AQ × AP) – (AQ × SP) $3,760 – (800 pounds × $4.00 per pound) = $3,760 – $3,200 = $560 U e. Raw materials (800 pounds × $4.00 per pound) ......... 3,200 Materials price variance (800 pounds × $0.70 per pound U) ......................... 560 Accounts payable (800 pounds × $4.70 per pound* ) ..................... 3,760 * $3,760 ÷ 800 pounds = $4.70 per pound Work in process (600 pounds × $4.00 per pound)....... 2,400 Materials quantity variance (25 pounds U × $4.00 per pound) ........................... 100 Raw materials (625 pounds × $4.00 per pound) .... 2,500 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 636 Managerial Accounting, 11th Edition Case 10-35 (continued) 4. a. Labor rate variance = ($4,100) – (400 hours* × SR) = $4,100 – 400 hours × SR = 400 hours × SR = SR = (AH × AR) – (AH × SR) $500 U $500* * $3,600 $9.00 per hour * 10 workers × 40 hours per worker = 400 hours * * When used with the formula, an unfavorable variance is positive. b. The standard hours per batch can be obtained by working through the standard cost card for Maxitol. Standard cost per batch (given) ................... Less standard materials cost: Material A standard cost (6 gallons × $8.00 per gallon) ................ $48.00 Material B standard cost (5 pounds × $4.00 per pound) ............... 20.00 Direct labor standard cost per batch............. $99.50 68.00 $31.50 Direct labor standard cost per batch $31.50 per batch = Standard rate per direct labor-hour $9.00 per DLH = 3.5 DLHs per batch c. 120 batches × 3.5 hours per batch = 420 hours d. Labor eff iciency variance = (AH × SR) – (SH × SR) (400 hours × $9.00 per hour) – (420 hours × $9.00 per hour) = $180 F e. Work in process (420 hours × $9.00 per hour) ........... 3,780 Labor rate variance (400 hours × $1.25 per hour U) ... 500 Labor eff iciency variance (20 hours F × $9.00 per hour) ........................... 180 Wages payable (400 hours × $10.25 per hour* ) .... 4,100 * $4,100 ÷ 400 hours = $10.25 per hour © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 637 Case 10-35 (continued) Standard Quantity or Hours 5. Standard Price or Rate Material A ........................... 6 gal. $8.00 per gallon Material B ........................... 5 pounds $4.00 per pound Direct labor .........................3.5 hours $9.00 per hour Standard cost per batch ....... Standard Cost $48.00 20.00 31.50 $99.50 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 638 Managerial Accounting, 11th Edition Case 10-36 (30 minutes) 1. Based on the conversation between Terry Travers and Sally Christensen, it seems likely that their motivation would be stifled by the variance reporting system at Aurora Manufacturing Company. Their behavior may include any of the following: • Suboptimization, a condition in which individual managers disregard major company goals and focus their attention solely on their own division’s activities. • Frustration from untimely reports and formats that are not useful in their daily activities. 2. a. The benef its that can be derived by both the company and its employees from a properly implemented variance reporting system include the following: • Variance analysis can provide standards and measures for incentive and performance evaluation programs. • Variance reporting can emphasize teamwork and interdepartmental dependence. • Timely reporting provides useful feedback, helpsto identify problems, and aids in solving these problems. Responsibility can be assigned for the resolution of problems. b. Aurora Manufacturing Company could improve its variance reporting system, so as to increase employee motivation, by implementing the following: • I ntroduce a flexible budgeting system that relates actual expenditures to actual levels of production on a monthly basis. I n addition, the budgeting process should be participative rather than imposed. • Only those costs that are controllable by managers should be included in the variance analysis. • Distribute reports on a timelier basis to allow quick resolution of problems. • Reports should be stated in terms that are most understandable to the users, i.e., units of output, hours, etc. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 639 Group Exercise 10-37 The answers to the questions in this group exercise will depend on the particular auto repair company that is investigated. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 640 Managerial Accounting, 11th Edition Group Exercise 10-38 The answers to the questions in this group exercise will depend on the particular company that is investigated. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 10 641 Chapter 11 Flexible Budgets and Overhead Analysis Solutions to Questions 11-1 A static budget is a budget prepared for a single level of activity that remains unchanged even if the activity level subsequently changes. 11-2 A flexible budget can be adjusted to reflect any level of activity. By contrast, a static budget is prepared for a single level of activity and is not subsequently adjusted. 11-3 Criteria for choosing an activity base: 1. The activity base and overhead cost should be causally related. 2. The activity base should not be expressed in dollars. 3. The activity base should be simple and easy to understand. 11-7 The overhead eff iciency variance does not really measure eff iciency in the use of overhead. I t actually measures eff iciency in the use of the base underlying the flexible budget. This base could be direct labor-hours, machinehours, or some other measure of activity. 11-8 A flexible budget provides the cost and activity data needed to compute the predetermined overhead rate, which is used in product costing. 11-9 The denominator level of activity is the denominator in the predetermined overhead rate. 11-10 A normal costing system was used in 11-4 I f the flexible budget is based on actual hours worked, then only a spending variance will be produced on the performance report. Both a spending and an eff iciency variance will be produced if the flexible budget is based on both actual hours and standard hours. Chapter 3, whereas in Chapter 11 a standard cost system is used. Standard costing ensures that the same amount of overhead is applied to a product regardless of the actual amount of the application base (such as machine-hours or direct labor-hours) that is used during a period. 11-5 Standard hours allowed means the time that should have been taken to complete the actual output of the period. 11-11 I n a standard cost system both a budget 11-6 11-12 The f ixed overhead budget variance is The materials price variance consists entirely of differences in price paid from standard. The variable overhead spending variance consists of two elements. One element is like a price variance and results from differences between actual and standard prices for variable overhead inputs. The other element is like a quantity variance and results from differences between the amount of variable overhead inputs that should have been used and the amounts that were actually used. Ordinarily these two elements are not separated. variance and a volume variance are computed for f ixed manufacturing overhead cost. the difference between total budgeted f ixed overhead cost and the total amount of f ixed overhead cost incurred. I f actual costs exceed budgeted costs, the variance is labeled unfavorable. 11-13 The volume variance is favorable when the activity level for a period, at standard, is greater than the denominator activity level. Conversely, if the activity level, at standard, is less than the denominator level of activity, the volume variance is unfavorable. The variance does not measure deviations in spending. I t © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 643 measures deviations in actual activity from the denominator level of activity. 11-14 I f f ixed costs are expressed on a per unit basis, managers may be misled into thinking that they are really variable. This can lead to faulty predictions concerning cost behavior and to bad decisions and erroneous performance evaluations. 11-15 Under- or overapplied overhead can be factored into variable overhead spending and eff iciency variances and the f ixed overhead budget and volume variances. 11-16 The total of the overhead variances would be favorable, since overapplied overhead is equivalent to a favorable variance. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 644 Managerial Accounting, 11th Edition Exercise 11-1 (15 minutes) Emory Corporation Flexible Budget Cost Formula (per MH) Variable costs: Utilities........................ I ndirect labor ............... Supplies ...................... Maintenance ................ Total variable cost........... Fixed costs: I ndirect labor ............... Maintenance ................ Depreciation ................ Total f ixed cost ............... Total overhead cost ........ $0.30 1.40 0.20 0.10 $2.00 Machine-Hours 15,000 20,000 25,000 $ 4,500 $ 6,000 $ 7,500 21,000 28,000 35,000 3,000 4,000 5,000 1,500 2,000 2,500 30,000 40,000 50,000 52,000 18,000 90,000 160,000 52,000 18,000 90,000 160,000 52,000 18,000 90,000 160,000 $190,000 $200,000 $210,000 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 645 Exercise 11-2 (15 minutes) 1. Orcas Boat Charter Service Flexible Budget Performance Report For the Month Ended July 31 Cost Formula (per charter) Actual Costs I ncurred for 160 Charters Budget Based on 160 Charters $ 60.50 35.25 15.75 $111.50 $ 9,440 5,980 2,670 18,090 $ 9,680 5,640 2,520 17,840 $ 240 340 150 250 F U U U Fixed overhead costs: Salaries and wages .............. Depreciation ........................ Utilities................................ Moorage.............................. Total fixed overhead costs ........ 9,200 12,800 835 5,360 28,195 9,150 12,100 860 4,980 27,090 50 700 25 380 1,105 U U F U U Total overhead costs ................ $46,285 $44,930 Variable overhead costs: Cleaning .............................. Maintenance ........................ Port fees ............................. Total variable overhead costs .... Variance $1,355 U 2. The addition of a new boat to the charter fleet apparently increased depreciation and moorage charges for the month above what had been anticipated. (A new boat adds to depreciation charges and a new boat needs to be moored, hence the higher moorage charges.) These two items are responsible for most of the $1,355 unfavorable total variance for the month. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 646 Managerial Accounting, 11th Edition Exercise 11-3 (15 minutes) Yung Corporation Variable Overhead Performance Report For the Year Ended December 31 Budgeted direct labor-hours ................................ Actual direct labor-hours ..................................... Standard direct labor-hours allowed ..................... Overhead Costs I ndirect labor ............... Supplies....................... Electricity ..................... Total variable overhead cost .................. 38,000 34,000 35,000 Actual Costs Budget Cost I ncurred Based on Formula 34,000 DLHs 34,000 DLHs Spending (per DLH) (AH × AR) (AH × SR) Variance $0.60 0.10 0.05 $21,200 3,200 1,600 $20,400 3,400 1,700 $800 U 200 F 100 F $0.75 $26,000 $25,500 $500 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 647 Exercise 11-4 (20 minutes) Yung Corporation Variable Overhead Performance Report For the Year Ended December 31 Budgeted direct labor-hours ............................ Actual direct labor-hours................................. Standard direct labor-hours allowed................. Overhead Costs I ndirect labor .............. Supplies ..................... Electricity.................... Total variable overhead cost ................. 38,000 34,000 35,000 (1) (2) (3) Actual Budget Budget Costs Based on Based on (4) I ncurred Cost 34,000 35,000 Total Spending Efficiency 34,000 DLHs Formula DLHs Variance Variance Variance DLHs (per DLH) (AH × AR) (AH × SR) (SH × SR) (1)-(3) (1)-(2) (2)-(3) $0.60 0.10 0.05 $21,200 3,200 1,600 $20,400 3,400 1,700 $21,000 3,500 1,750 $200 U 300 F 150 F $800 U 200 F 100 F $600 F 100 F 50 F $0.75 $26,000 $25,500 $26,250 $250 F $500 U $750 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 648 Managerial Accounting, 11th Edition Exercise 11-5 (15 minutes) 1. The total overhead cost at the denominator level of activity must be determined before the predetermined overhead rate can be computed. Total Total ($2 Total fixed overhead cost per year .................................. $250,000 variable overhead cost per DLH × 40,000 DLHs) ........................................ 80,000 overhead cost at the denominator level of activity .... $330,000 Predetermined = Overhead at the denominator level of activity overhead rate Denominator level of activity = $330,000 = $8.25 per DLH 40,000 DLHs 2. Standard direct labor-hours allowed for the actual output (a) ............................. 38,000 DLHs Predetermined overhead rate (b) ............. $8.25 per DLH Overhead applied (a) × (b) ...................... $313,500 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 649 Exercise 11-6 (15 minutes) 1. Fixed overhead Fixed portion of the = predetermined overhead rate Denominator level of activity $250,000 25,000 DLHs = = $10.00 per DLH 2. Budget = Actual fixed - Budgeted fixed variance overhead cost overhead cost = $254,000 - $250,000 = $4,000 U Fixed portion of Volume = the predetermined× Denominator - Standard hours variance hours allowed overhead rate ( ) = $10.00 per DLH (25,000 DLHs - 26,000 DLHs) = $10,000 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 650 Managerial Accounting, 11th Edition Exercise 11-7 (15 minutes) Note: With the exception of the number of cars, all amounts below are in Swiss francs. Lavage Rapide Flexible Budget For the Month Ended August 31 Overhead Costs Cost Formula (per car) Activity (cars) 8,000 9,000 10,000 Variable overhead costs: Cleaning supplies ......................... Electricity ................................... Maintenance ................................ Total variable overhead cost ............ 0.80 0.30 0.20 1.30 6,400 7,200 8,000 2,400 2,700 3,000 1,600 1,800 2,000 10,400 11,700 13,000 Fixed overhead costs: Operator wages ........................... Depreciation ................................ Rent............................................ Total fixed overhead cost ................ 9,000 9,000 9,000 6,000 6,000 6,000 8,000 8,000 8,000 23,000 23,000 23,000 Total overhead cost ........................ 33,400 34,700 36,000 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 651 Exercise 11-8 (10 minutes) Lavage Rapide Static Budget For the Month Ended August 31 Budgeted number of cars .......................... 8,800 Budgeted variable overhead costs: Cleaning supplies (@ 0.80 SFr per car) .... Electricity (@ 0.30 SFr per car) ............... Maintenance (@ 0.20 SFr per car) ........... Total variable overhead cost ...................... 7,040 SFr 2,640 1,760 11,440 Budgeted fixed overhead costs: Operator wages .................................... Depreciation ......................................... Rent...................................................... Total fixed overhead cost .......................... 9,000 6,000 8,000 23,000 Total budgeted overhead cost ................... 34,440 SFr © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 652 Managerial Accounting, 11th Edition Exercise 11-9 (15 minutes) Note: With the exception of the number of cars, all amounts below are in Swiss francs. Lavage Rapide Flexible Budget Performance Report For the Month Ended August 31 Budgeted number of cars............. Actual number of cars.................. 8,800 8,900 Actual Budget Costs Cost I ncurred Based on 8,900 Formula for 8,900 Cars Variance Cars (per car) Overhead Costs Variable overhead costs: Cleaning supplies .................... Electricity ............................... Maintenance ........................... Total variable overhead cost ....... 0.80 0.30 0.20 1.30 7,080 2,460 1,550 11,090 7,120 2,670 1,780 11,570 40 210 230 480 F F F F Fixed overhead costs: Operator wages ...................... Depreciation ........................... Rent....................................... Total fixed overhead cost ........... 9,100 7,000 8,000 24,100 9,000 6,000 8,000 23,000 100 U 1,000 U 0 1,100 U Total overhead cost ................... 35,190 34,570 620 U Students may question the variances for fixed costs. Operator wages can differ from what was budgeted for a variety of reasons including an unanticipated increase in the wage rate; changes in the mix of workers between those earning lower and higher wages; changes in the number of operators on duty; and overtime. Depreciation may have increased because of the acquisition of new equipment or because of a loss on equipment that must be scrapped—perhaps due to poor maintenance. (This assumes that the loss flows through the depreciation account on the performance report.) © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 653 Exercise 11-10 (20 minutes) 1. Murray Company Variable Overhead Performance Report Budgeted machine-hours ............. Actual machine-hours worked....... 12,000 11,500 Actual Budget 11,500 hours 11,500 hours Variable overhead costs: Supplies ...................... Maintenance................ Utilities ....................... Rework time................ Total variable overhead cost ................. Spending Variance $ 2,400 8,000 1,100 5,300 $ 2,300 9,200 1,150 4,600 $ 100 1,200 50 700 U F F U $16,800 $17,250 $ 450 F 2. Favorable variances can be as much a matter of concern as unfavorable variances. I n particular, the favorable maintenance variance should be investigated. I s scheduled preventative maintenance being carried out? I n terms of percentage deviation from budgeted allowances, the rework time variance is even more signif icant (equal to 15% of the budget allowance). This unfavorable rework time variance may be a result of poor maintenance of machines. Some may say that if the two variances are related, then the trade-off is a good one, since the savings in maintenance cost is greater than the added cost of rework time. But this is shortsighted reasoning. Poor maintenance can reduce the life of equipment, as well as decrease overall output, thereby costing far more in the long run than any short-run savings. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 654 Managerial Accounting, 11th Edition Exercise 11-11 (15 minutes) Columbia National Bank Check Clearing Office Variable Overhead Performance Report For the Month Ended September 30 Budgeted labor-hours ................................................................................ Actual labor-hours ..................................................................................... Standard labor-hours allowed for the actual number of checks processed ...... Overhead Costs Variable overhead costs: Office supplies................ Staff coffee lounge ......... I ndirect labor ................. Total variable overhead cost ............................ 3,080 3,100 3,200 (3) (2) (1) Actual Budget Breakdown of the Budget Costs Total Variance Based on I ncurred Based on 3,200 3,100 for 3,100 Cost Total Spending Efficiency LaborLaborLaborFormula Hours Variance Variance Variance Hours (per labor- Hours (AH × AR) (AH × SR) (SH × SR) (1) – (3) (1) – (2) (2) – (3) hour) $0.10 0.20 0.90 $ 365 520 2,710 $ 310 620 2,790 $ 320 640 2,880 $ 45 U 120 F 170 F $ 55 U 100 F 80 F $ 10 F 20 F 90 F $1.20 $3,595 $3,720 $3,840 $245 F $125 F $120 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 655 Exercise 11-12 (15 minutes) 1. Total overhead from the flexible Predetermined = budget at the denominator activity overhead rate Denominator activity = $225,000 30,000 DLHs = $7.50 per DLH Variable element: $57,000 ÷ 30,000 DLHs = $1.90 per DLH Fixed element: $168,000 ÷ 30,000 DLHs = $5.60 per DLH 2. Direct materials, 2.5 yards @ $8.60 per yard ........... $21.50 Direct labor, 3 DLHs* @ $12.00 per DLH ................. 36.00 Variable overhead, 3 DLHs @ $1.90 per DLH ........... 5.70 Fixed overhead, 3 DLHs @ $5.60 per DLH............... 16.80 Total standard cost per unit ................................... $80.00 * 30,000 DLHs ÷ 10,000 units = 3 DLHs per unit. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 656 Managerial Accounting, 11th Edition Exercise 11-13 (15 minutes) 1. 9,500 units × 4 hours per unit = 38,000 hours. 2. and 3. Actual Fixed Overhead Cost $198,700* ↑ Budgeted Fixed Overhead Cost $200,000 ↑ Budget Variance, $1,300 F Fixed Overhead Cost Applied to Work in Process 38,000 hours × $5 per hour* = $190,000 Volume Variance, $10,000 U* ↑ * Given. 4. Budgeted fixed overhead cost Fixed element of the = predetermined overhead rate Denominator activity = $200,000 Denominator activity = $5 per hour Therefore, the denominator activity is: $200,000 ÷ $5 per hour = 40,000 hours. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 657 Exercise 11-14 (20 minutes) 1. Total rate: $480,000 = $8 per MH 60,000 MHs Variable rate: $180,000 = $3 per MH 60,000 MHs Fixed rate: $300,000 = $5 per MH 60,000 MHs 2. The standard hours per unit of product are: 60,000 hours ÷ 40,000 units = 1.5 hours per unit Given this f igure, the standard hours allowed for the actual production would be: 42,000 units × 1.5 hours per unit = 63,000 standard hours allowed. 3. Variable overhead spending variance: Variable overhead spending variance = (AH × AR) – (AH × SR) ($185,600) – (64,000 hours × $3 per hour) = $6,400 F Variable overhead eff iciency variance: Variable overhead eff iciency variance = SR (AH – SH) $3 per hour (64,000 hours – 63,000 hours) = $3,000 U The f ixed overhead variances would be as follows: Actual Fixed Overhead Cost $302,400 ↑ Budgeted Fixed Overhead Cost $300,000* Budget Variance, $2,400 U ↑ Fixed Overhead Cost Applied to Work in Process 63,000 hours × $5 per hour = $315,000 Volume Variance, $15,000 F ↑ * As originally budgeted. This f igure can be expressed as: 60,000 denominator hours × $5 per hour = $300,000. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 658 Managerial Accounting, 11th Edition Exercise 11-14 (continued) Alternative approach to the budget variance: Budget = Actual fixed - Budgeted fixed variance overhead cost overhead cost = $302,400 - $300,000 = $2,400 U Alternative approach to the volume variance: Fixed portion of ⎛ Standard⎞ Volume = the predetermined ⎜⎜Denominator - hours ⎟⎟ ⎟⎟ ⎜ Variance hours overhead rate ⎜⎜⎝ allowed ⎠⎟ = $5 per hour (60,000 hours - 63,000 hours) = $15,000 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 659 Exercise 11-15 (15 minutes) 1. 14,000 units produced × 3 MHs per unit = 42,000 MHs 2. Actual f ixed overhead costs incurred.......... $267,000 Add: Favorable budget variance................. 3,000 Budgeted f ixed overhead cost ................... $270,000 Budgeted fixed overhead cost Fixed element of the = predetermined overhead rate Denominator activity $270,000 45,000 MHs = = $6 per MH 3. Fixed portion of ⎛ Standard⎞ Volume = the predetermined ⎜⎜Denominator - hours ⎟⎟ ⎟⎟ ⎜ Variance hours overhead rate ⎜⎜⎝ allowed ⎠⎟ = $6 per MH (45,000 MHs - 42,000 MHs) = $18,000 U Alternative solution to parts 1-3: Actual Fixed Overhead Cost $267,000* ↑ 1 2 3 Budgeted Fixed Overhead Cost 1 $270,000 Budget Variance, $3,000 F* ↑ Fixed Overhead Cost Applied to Work in Process 3 42,000 MHs2 × $6 per MH = $252,000 Volume Variance, $18,000 U ↑ $267,000 + $3,000 = $270,000. 14,000 units × 3 MHs per unit = 42,000 MHs $270,000 ÷ 45,000 denominator MHs = $6 per MH * Given. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 660 Managerial Accounting, 11th Edition Exercise 11-16 (10 minutes) Company A: This company has a favorable volume variance since the standard hours allowed for the actual production are greater than the denominator hours. Company B: This company has an unfavorable volume variance since the standard hours allowed for the actual production are less than the denominator hours. Company C: This company has no volume variance since the standard hours allowed for the actual production and the denominator hours are the same. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 661 Problem 11-17 (30 minutes) 1. The cost formulas in the flexible budget below report were obtained by dividing the costs on the static budget in the problem statement by the budgeted level of activity (500 liters). The fixed costs are carried over from the static budget. St. Lucia Blood Bank Flexible Budget Performance Report For the Month Ended September 30 Budgeted activity (in liters) ............... Actual activity (in liters) .................... Costs Variable costs: Medical supplies .............. Lab tests......................... Refreshments for donors.. Administrative supplies .... Total variable cost .............. 500 620 Actual Costs Budget Cost Formula I ncurred Based on (per 620 for 620 Liters Liters liter) $15.00 12.00 2.00 0.50 $29.50 Variance $ 9,350 6,180 1,340 400 17,270 $ 9,300 7,440 1,240 310 18,290 $ 50 1,260 100 90 1,020 U F U U F Fixed costs: Staff salaries ................... Equipment depreciation ... Rent ............................... Utilities ........................... Total fixed cost .................. 10,000 2,800 1,000 570 14,370 10,000 2,500 1,000 500 14,000 0 300 U 0 70 U 370 U Total cost .......................... $31,640 $32,290 $ 650 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 662 Managerial Accounting, 11th Edition Problem 11-17 (continued) 2. The overall variance is favorable and none of the unfavorable variances is particularly large. Nevertheless, the large favorable variance for lab tests is worrisome. Perhaps the blood bank has not been doing all of the lab tests for HI V, hepatitis, and other blood-transmittable diseases that it should be doing. This is well worth investigating; favorable variances may warrant attention as much as unfavorable variances. Some may wonder why depreciation has a variance. Fixed costs can change; they just don’t vary with the level of activity. Depreciation may have increased because of the acquisition of new equipment or because of a loss on equipment that must be scrapped. (This assumes that the loss flows through the depreciation account on the performance report.) © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 663 Problem 11-18 (45 minutes) 1. Direct materials price and quantity variances: Materials price variance = AQ (AP – SP) 64,000 feet ($8.55 per foot – $8.45 per foot) = $6,400 U Materials quantity variance = SP (AQ – SQ) $8.45 per foot (64,000 feet – 60,000 feet* ) = $33,800 U * 30,000 units × 2 feet per unit = 60,000 feet 2. Direct labor rate and eff iciency variances: Labor rate variance = AH (AR – SR) 43,500 DLHs ($15.80 per DLH – $16.00 per DLH) = $8,700 F Labor eff iciency variance = SR (AH – SH) $16.00 per DLH (43,500 DLHs – 42,000 DLHs* ) = $24,000 U * 30,000 units × 1.4 DLHs per unit = 42,000 DLHs 3. a. Variable overhead spending and eff iciency variances: Actual Hours of I nput, at the Actual Rate (AH × AR) $108,000 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 43,500 DLHs × $2.50 per DLH = $108,750 Spending Variance, $750 F ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 42,000 DLHs × $2.50 per DLH = $105,000 Eff iciency Variance, $3,750 U ↑ Alternative solution: Variable overhead spending variance = (AH × AR) – (AH × SR) ($108,000) – (43,500 DLHs × $2.50 per DLH) = $750 F Variable overhead eff iciency variance = SR (AH – SH) $2.50 per DLH (43,500 DLHs – 42,000 DLHs) = $3,750 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 664 Managerial Accounting, 11th Edition Problem 11-18 (continued) b. Fixed overhead budget and volume variances: Actual Fixed Overhead Cost $211,800 ↑ Budgeted Fixed Overhead Cost $210,000* Budget Variance, $1,800 U ↑ Fixed Overhead Cost Applied to Work in Process 42,000 DLHs × $6 per DLH = $252,000 Volume Variance, $42,000 F ↑ * As originally budgeted. This f igure can also be expressed as: 35,000 denominator DLHs × $6 per DLH = $210,000. Alternative solution: Budget variance: Budget = Actual fixed - Budgeted fixed variance overhead cost overhead cost = $211,800 - $210,000 = $1,800 U Volume variance: Fixed portion of ⎛ Standard⎞ Volume = the predetermined ⎜⎜Denominator - hours ⎟⎟ ⎟⎟ ⎜⎜ Variance hours ⎜ overhead rate ⎝ allowed ⎠⎟ = $6.00 per DLH (35,000 DLHs - 42,000 DLHs) = $42,000 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 665 Problem 11-18 (continued) 4. The total of the variances would be: Direct materials variances: Price variance ..................................................... $ 6,400 U Quantity variance................................................ 33,800 U Direct labor variances: Rate variance ..................................................... 8,700 F Eff iciency variance .............................................. 24,000 U Variable manufacturing overhead variances: Spending variance .............................................. 750 F Eff iciency variance .............................................. 3,750 U Fixed manufacturing overhead variances: Budget variance.................................................. 1,800 U Volume variance ................................................. 42,000 F Total variance........................................................ $18,300 U Note that the total of the variances agrees with the $18,300 variance mentioned by the president. I t appears that not everyone should be given a bonus for good cost control. The materials quantity variance and the labor eff iciency variance are 6.7% and 3.6% , respectively, of the standard cost allowed and thus would warrant investigation. The company’s large unfavorable variances (for materials quantity and labor eff iciency) do not show up more clearly because they are offset for the most part by the favorable volume variance. This favorable volume variance is a result of the company operating at an activity level that is well above the denominator activity level used to set predetermined overhead rates. (The company operated at an activity level of 42,000 standard hours; the denominator activity level set at the beginning of the year was 35,000 hours.) As a result of the large favorable volume variance, the unfavorable quantity and eff iciency variances have been concealed in a small “net” f igure. The large favorable volume variance may have been achieved by building up inventories. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 666 Managerial Accounting, 11th Edition Problem 11-19 (30 minutes) 1. Direct materials, 3 yards at $4.40 per yard ............................... $13.20 Direct labor, 1 DLH at $12.00 per DLH ..................................... 12.00 Variable manufacturing overhead, 1 DLH at $5.00 per DLH* ...... 5.00 Fixed manufacturing overhead, 1 DLH at $11.80 per DLH* * ...... 11.80 Standard cost per unit ............................................................ $42.00 * $25,000 ÷ 5,000 DLHs = $5.00 per DLH. * * $59,000 ÷ 5,000 DLHs = $11.80 per DLH. 2. Materials variances: Materials price variance = AQ (AP – SP) 24,000 yards ($4.80 per yard – $4.40 per yard) = $9,600 U Materials quantity variance = SP (AQ – SQ) $4.40 per yard (18,500 yards – 18,000 yards* ) = $2,200 U * 6,000 units × 3 yards per unit = 18,000 yards Labor variances: Labor rate variance = AH (AR – SR) 5,800 DLHs ($13.00 per DLH – $12.00 per DLH) = $5,800 U Labor eff iciency variance = SR (AH – SH) $12.00 per DLH (5,800 DLHs – 6,000 DLHs* ) = $2,400 F * 6,000 units × 1 DLH per unit = 6,000 DLHs © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 667 Problem 11-19 (continued) 3. Variable overhead variances: Actual DLHs of I nput, at the Actual Rate (AH × AR) $29,580 ↑ Actual DLHs of I nput, at the Standard Rate (AH × SR) 5,800 DLHs × $5.00 per DLH = $29,000 ↑ Standard DLHs Allowed for Output, at the Standard Rate (SH × SR) 6,000 DLHs × $5.00 per DLH = $30,000 Spending Variance, Eff iciency Variance, $580 U $1,000 F Total Variance, $420 F ↑ Alternative solution for the variable overhead variances: Variable overhead spending variance = (AH × AR) – (AH × SR) ($29,580) – (5,800 DLHs × $5.00 per DLH) = $580 U Variable overhead eff iciency variance = SR (AH – SH) $5.00 per DLH (5,800 DLHs – 6,000 DLHs) = $1,000 F Fixed overhead variances: Actual Fixed Overhead Cost $60,400 ↑ Budgeted Fixed Overhead Cost $59,000 Budget Variance, $1,400 U ↑ Fixed Overhead Cost Applied to Work in Process 6,000 DLHs × $11.80 per DLH = $70,800 Volume Variance, $11,800 F ↑ © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 668 Managerial Accounting, 11th Edition Problem 11-19 (continued) Alternative approach to the budget variance: Budget = Actual fixed - Budgeted fixed variance overhead cost overhead cost = $60,400 - $59,000 = $1,400 U Alternative approach to the volume variance: Fixed portion of ⎛ Standard⎞ Volume = the predetermined ⎜⎜Denominator - hours ⎟⎟ ⎟⎟ ⎜ Variance hours overhead rate ⎜⎜⎝ allowed ⎠⎟ = $11.80 per DLH (5,000 DLHs - 6,000 DLHs) = $11,800 F 4. The choice of a denominator activity level affects standard unit costs in that the higher the denominator activity level chosen, the lower standard unit costs will be. The reason is that the f ixed portion of overhead costs is spread over more units as the denominator activity rises. The volume variance cannot be controlled by controlling spending. The volume variance simply reflects whether actual activity was greater than or less than the denominator activity. Thus, the volume variance is controllable only through activity. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 669 Problem 11-20 (30 minutes) 1. The reports as presently prepared are of little use to the company. The problem is that the company is using a static budget to compare budgeted performance at one level of activity to actual performance at another level of activity. Although the reports do a good job of showing whether or not the budgeted level of activity was attained, they do not tell whether costs were controlled for the activity level that was actually worked during the period. 2. The company should use a flexible budget approach to evaluate control over costs. Under the flexible budget approach, the actual costs incurred during the quarter in working 35,000 machine-hours should be compared to budgeted costs at that activity level. 3. Westmont Company Overhead Performance Report—Assembly Department For the Quarter Ended March 31 Budgeted machine-hours ......... 40,000 Actual machine-hours .............. 35,000 Cost Formula (per MH) Variable costs: I ndirect materials......... Rework time ................ Utilities........................ Machine setup ............. Total variable cost........... Fixed costs: Maintenance ................ I nspection ................... Total f ixed cost ............... Total overhead cost ........ $0.80 0.20 1.40 0.30 $2.70 Actual 35,000 hours Budget 35,000 hours Spending or Budget Variance $ 29,700 $ 28,000 $1,700 U 7,900 7,000 900 U 51,800 49,000 2,800 U 11,600 10,500 1,100 U 101,000 94,500 6,500 U 79,200 60,000 139,200 80,000 60,000 140,000 800 F 0 800 F $240,200 $234,500 $5,700 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 670 Managerial Accounting, 11th Edition Problem 11-21 (45 minutes) 1. Total rate: PZ297,500 = PZ8.50 per hour 35,000 hours Variable rate: PZ87,500 = PZ2.50 per hour 35,000 hours Fixed rate: PZ210,000 = PZ6.00 per hour 35,000 hours 2. 32,000 standard hours × PZ8.50 per hour = PZ272,000. 3. Variable overhead variances: Actual Hours of I nput, at the Actual Rate (AH × AR) PZ78,000 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 30,000 hours × PZ2.50 per hour = PZ75,000 Spending Variance, PZ3,000 U ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 32,000 hours × PZ2.50 per hour = PZ80,000 Eff iciency Variance, PZ5,000 F ↑ Alternative solution: Variable overhead spending variance = (AH × AR) – (AH × SR) (PZ78,000) – (30,000 hours × PZ2.50 per hour) = PZ3,000 U Variable overhead eff iciency variance = SR (AH – SH) PZ2.50 per hour (30,000 hours – 32,000 hours) = PZ5,000 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 671 Problem 11-21 (continued) Fixed overhead variances: Actual Fixed Overhead Cost PZ209,400 ↑ Budgeted Fixed Overhead Cost PZ210,000 Budget Variance, PZ600 F ↑ Fixed Overhead Cost Applied to Work in Process 32,000 hours × PZ6 per hour = PZ192,000 Volume Variance, PZ18,000 U ↑ Alternative solution: Budget variance: Budget = Actual fixed - Budgeted fixed variance overhead cost overhead cost = PZ209,400 - PZ210,000 = PZ600 F Volume variance: Fixed portion of ⎛ Standard⎞ Volume = the predetermined ⎜⎜Denominator - hours ⎟⎟ ⎟⎟ ⎜ Variance hours overhead rate ⎜⎜⎝ allowed ⎠⎟ = PZ6.00 per hour (35,000 hours - 32,000 hours) = PZ18,000 U Verif ication: Variable overhead: Spending variance ................ PZ 3,000 Eff iciency variance ............... 5,000 Fixed overhead: Budget variance ................... 600 Volume variance................... 18,000 Underapplied overhead ........... PZ15,400 U F F U U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 672 Managerial Accounting, 11th Edition Problem 11-21 (continued) 4. Variable overhead Spending variance: This variance includes both price and quantity elements. The overhead spending variance reflects differences between actual and standard prices for variable overhead items. I t also reflects differences between the amounts of variable overhead inputs that were actually used and the amounts that should have been used for the actual output of the period. Since the variable overhead spending variance is unfavorable, either too much was paid for variable overhead items or too many of them were used. Eff iciency variance: The term “variable overhead eff iciency variance” is a misnomer, since the variance does not measure eff iciency in the use of overhead items. I t measures the indirect effect on variable overhead of the eff iciency or ineff iciency with which the activity base is utilized. I n this company, the activity base is labor-hours. I f variable overhead is really proportional to labor-hours, then more effective use of labor-hours has the indirect effect of reducing variable overhead. Since 2,000 fewer labor-hours were required than indicated by the labor standards, the indirect effect was presumably to reduce variable overhead spending by about PZ 5,000 (PZ 2.50 per hour × 2,000 hours). Fixed overhead Budget variance: This variance is simply the difference between the budgeted f ixed cost and the actual f ixed cost. I n this case, the variance is favorable which indicates that actual f ixed costs were lower than anticipated in the budget. Volume variance: This variance occurs as a result of actual activity being different from the denominator activity in the predetermined overhead rate. I n this case, the variance is unfavorable, so actual activity was less than the denominator activity. I t is diff icult to place much of a meaningful economic interpretation on this variance. I t tends to be large, so it often swamps the other, more meaningful variances if they are simply netted against each other. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 673 Problem 11-22 (45 minutes) 1. Harper Company Flexible Budget—Assembly Department Budgeted direct labor-hours ............. Overhead Costs Variable costs: Utilities ....................... I ndirect labor............... Supplies ...................... Total variable cost .......... Fixed costs: I nsurance.................... Supervisory salaries ..... Depreciation ................ Equipment rental ......... Total f ixed cost .............. Total overhead cost ........ 2. Cost Formula (per DLH) $0.60 0.90 0.30 $1.80 75,000 Direct Labor-Hours 60,000 75,000 90,000 $ 36,000 $ 45,000 $ 54,000 54,000 67,500 81,000 18,000 22,500 27,000 108,000 135,000 162,000 8,000 90,000 160,000 42,000 300,000 8,000 90,000 160,000 42,000 300,000 $408,000 $435,000 $462,000 Total rate: $435,000 = $5.80 per DLH 75,000 DLHs Variable rate: $135,000 = $1.80 per DLH 75,000 DLHs Fixed rate: $300,000 = $4.00 per DLH 75,000 DLHs 3. a. 8,000 90,000 160,000 42,000 300,000 Manufacturing Overhead Actual costs 425,700 406,000* Underapplied overhead 19,700 Applied costs * 70,000 standard hours × 5.80 per hour = $406,000. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 674 Managerial Accounting, 11th Edition Problem 11-22 (continued) b. Variable overhead variances: Actual Hours of I nput, at the Standard Rate (AH × SR) 73,000 hours × $1.80 per hour = $131,400 Actual Hours of I nput, at the Actual Rate (AH × AR) $124,100 ↑ Spending Variance, $7,300 F ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 70,000 hours × $1.80 per hour = $126,000 Eff iciency Variance, $5,400 U ↑ Alternative solution: Variable overhead spending variance = (AH × AR) – (AH × SR) ($124,100) – (73,000 hours × $1.80 per hour) = $7,300 F Variable overhead eff iciency variance = SR (AH – SH) $1.80 per hour (73,000 hours – 70,000 hours) = $5,400 U Fixed overhead variances: Actual Fixed Overhead Cost $301,600 ↑ Budgeted Fixed Overhead Cost $300,000* Budget Variance, $1,600 U ↑ Fixed Overhead Cost Applied to Work in Process 70,000 hours × $4 per hour = $280,000 Volume Variance, $20,000 U ↑ * As originally budgeted. 75,000 denominator hours × $4 per hour = $300,000. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 675 Problem 11-22 (continued) Alternative solution: Budget variance: Budget = Actual fixed - Budgeted fixed variance overhead cost overhead cost = $301,600 - $300,000 = $1,600 U Volume variance: Fixed portion of ⎛ Standard⎞ Volume = the predetermined ⎜⎜Denominator - hours ⎟⎟ ⎟⎟ ⎜ Variance hours overhead rate ⎜⎜⎝ allowed ⎠⎟ = $4 per hour (75,000 hours - 70,000 hours) = $20,000 U The overhead variances can be summarized as follows: Variable overhead: Spending variance ................................. $ 7,300 F Eff iciency variance ................................. 5,400 U Fixed overhead: Budget variance..................................... 1,600 U Volume variance .................................... 20,000 U Underapplied overhead for the year ........... $19,700 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 676 Managerial Accounting, 11th Edition Problem 11-23 (30 minutes) 1. The company is using a static budget approach in which budgeted performance at one level of activity is compared to actual performance at a higher level of activity. The variable overhead variances are all unfavorable because of this mismatching of activity levels. The report in this format is not useful for measuring either operating eff iciency or cost control. The only accurate piece of information it gives is that the department worked more than the 35,000 machine-hours budgeted for the month. I t does not tell whether the actual output for the month was produced eff iciently, nor does it tell whether overhead spending has been controlled during the month. 2. See the next page. 3. The stolen supplies would be included as part of the variable overhead spending variance for the month. Unlike the price variance for materials and the rate variance for labor, the spending variance measures both price and quantity (waste, theft) elements. This is why the variance is called a “spending” variance; total spending can be affected as much by waste or theft as by greater (or lesser) prices paid for items. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 677 Problem 11-23 (continued) 2. Freemont Company Overhead Performance Report—Machining Department Budgeted machine-hours .......... 35,000 Actual machine-hours ............... 38,000 Standard machine-hours ........... 40,000 * Overhead Costs Variable costs: Utilities.................. I ndirect labor ......... Supplies ................ Maintenance .......... Total variable cost..... Fixed costs: Supervision............ Maintenance .......... Depreciation .......... Total f ixed cost ......... Total cost ................. Budget Based on 38,000 MHs (2) Budget Based on 40,000 MHs (3) Cost Formula (per MH) Actual Costs I ncurred (1) $0.40 2.30 0.60 1.20 $4.50 $ 15,700 86,500 26,000 44,900 173,100 $ 15,200 87,400 22,800 45,600 171,000 $ 16,000 92,000 24,000 48,000 180,000 38,000 92,400 80,000 210,400 $383,500 38,000 92,000 80,000 210,000 $381,000 38,000 0 92,000 400 U 80,000 0 210,000 400 U $390,000 $6,500 F Total Spending Eff iciency Variance Variance Variance (1) – (3) (1) – (2) (2) – (3) $ 300 F $ 500 U $ 800 5,500 F 900 F 4,600 2,000 U 3,200 U 1,200 3,100 F 700 F 2,400 6,900 F $2,100 U $9,000 F F F F F * 16,000 units × 2.5 hours per unit = 40,000 hours © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 678 Managerial Accounting, 11th Edition Problem 11-24 (20 minutes) Budgeted machine-hours ..................... Actual machine-hours .......................... Standard machine-hours allowed .......... Overhead I tem Power ................... Setup time ............ Polishing wheels .... Maintenance ......... Total variable cost.. Cost Formula (per MH) $0.30 0.20 0.16 0.18 $0.84 11,250 9,250 9,000 (1) Actual Costs I ncurred 9,250 MHs $2,405 2,035 1,110 925 $6,475 (2) (3) Budget Budget Based on Based on 9,250 MHs 9,000 MHs $2,775 $2,700 1,850 1,800 1,480 1,440 1,665 1,620 $7,770 $7,560 Total Variance (1) – (3) $ 295 F 235 U 330 F 695 F $1,085 F Breakdown of the Total Variance Spending Eff iciency Variance Variance (1) – (2) (2) – (3) $ 370 F $ 75 U 185 U 50 U 370 F 40 U 740 F 45 U $1,295 F $210 U © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 679 Problem 11-25 (45 minutes) 1. Total rate: Variable rate: Fixed rate: $432,000 = $10.80 per DLH 40,000 DLHs $72,000 = $1.80 per DLH 40,000 DLHs $360,000 = $9 per DLH 40,000 DLHs 2. Direct materials: 8 yards at $4.50 per yard .............. $36.00 Direct labor: 2.5 DLHs at $12.00 per DLH ............... 30.00 Variable overhead: 2.5 DLHs at $1.80 per DLH ........ 4.50 Fixed overhead: 2.5 DLHs at $9 per DLH................. 22.50 Standard cost per unit ........................................... $93.00 3. See the graph at the end of this solution. 4. a. Fixed overhead variances: Actual Fixed Overhead Cost $361,800 ↑ Budgeted Fixed Overhead Cost $360,000 Budget Variance, $1,800 U ↑ Fixed Overhead Cost Applied to Work in Process 35,000 DLHs* × $9 per DLH = $315,000 Volume Variance, $45,000 U ↑ * 14,000 units × 2.5 DLHs per unit = 35,000 DLHs © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 680 Managerial Accounting, 11th Edition Problem 11-25 (continued) Alternative approach: Budget variance: Budget = Actual fixed - Budgeted fixed variance overhead cost overhead cost = $361,800 - $360,000 = $1,800 U Volume variance: Fixed portion of ⎛ Standard⎞ Volume = the predetermined ⎜⎜Denominator - hours ⎟⎟ ⎟⎟ ⎜⎜ Variance hours ⎜ overhead rate ⎝ allowed ⎠⎟ = $9 per DLH (40,000 DLHs - 35,000 DLHs) = $45,000 U b. See the graph at the end of this solution. 5. a. The f ixed overhead budget variance will not change. The f ixed overhead volume variance will be: Actual Fixed Overhead Cost $361,800 ↑ Budgeted Fixed Overhead Cost $360,000 Budget Variance, $1,800 U ↑ Fixed Overhead Cost Applied to Work in Process 50,000 DLHs* × $9 per DLH = $450,000 Volume Variance, $90,000 F ↑ * 20,000 units × 2.5 DLHs per unit = 50,000 DLHs © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 681 Problem 11-25 (continued) Alternative solution to the volume variance: Fixed portion of ⎛ Standard⎞ Volume = the predetermined ⎜⎜Denominator - hours ⎟⎟ ⎟⎟ ⎜ Variance hours overhead rate ⎜⎜⎝ allowed ⎠⎟ = $9 per DLH (40,000 DLHs - 50,000 DLHs) = $90,000 F b. See the graph on the following page. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 682 Managerial Accounting, 11th Edition Problem 11-25 (continued) Denominator Hours $450,000 Fixed Overhead Cost Applied at $9 per DLH Favorable Volume Variance, $90,000 (Part 5) Unfavorable Volume Variance, $45,000 (Part 4) $360,000 $315,000 $250,000 30,000 35,000 40,000 50,000 Standard Direct Labor-Hours © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 683 Problem 11-26 (45 minutes) 1. A flexible budget is clearer if the variable and f ixed costs are shown separately, as illustrated in the text, and if individual cost formulas are given. Fixed and variable costs can be separated (and cost formulas determined) by the high-low method. I ncorporating these ideas, the revised flexible budget would be: Gant Products, I nc. Flexible Budget Overhead Costs Machine-hours .................... Variable costs: Maintenance .................... Supplies........................... Utilities ............................ Machine setup .................. Total variable cost ............... Cost Formula (per MH) $0.10 0.40 0.30 0.20 $1.00 Percentage of Capacity 80% 90% 100% 4,800 5,400 6,000 $ 480 1,920 1,440 960 4,800 $ 540 2,160 1,620 1,080 5,400 $ 600 2,400 1,800 1,200 6,000 Fixed costs: Maintenance .................... Utilities ............................ Supervision ...................... Total f ixed cost ................... 1,000 500 3,000 4,500 1,000 500 3,000 4,500 1,000 500 3,000 4,500 Total overhead cost ............. $9,300 $9,900 $10,500 2. The cost formula for all overhead costs would be $4,500 plus $1.00 per machine-hour. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 684 Managerial Accounting, 11th Edition Problem 11-26 (continued) 3. Gant Products, I nc. Overhead Performance Report For the Month of April Budgeted machine-hours ......... 6,000 Standard machine-hours .......... 5,600 Actual machine-hours .............. 5,700 * Overhead Costs Variable overhead: Maintenance ............... Supplies ..................... Utilities....................... Machine setup ............ Total variable cost.......... Cost Formula (per MH) $0.10 0.40 0.30 0.20 $1.00 Actual 5,700 MH Budgeted Spending 5,700 MH Variance $ 1,083 * * 3,420 2,166 * * 855 7,524 $ 570 2,280 1,710 1,140 5,700 $ 513 1,140 456 285 1,824 Fixed overhead: Maintenance ............... Utilities....................... Supervision................. Total f ixed cost .............. 1,000 500 3,000 4,500 1,000 500 3,000 4,500 0 0 0 0 Total overhead cost ....... $12,024 $10,200 U U U F U $1,824 U * 95% × 6,000 MHs = 5,700 MHs * * $2,083 less $1,000 f ixed = $1,083. $2,666 less $500 f ixed = $2,166. 4. a. Assuming that the variable overhead really should be proportional to actual machine-hours, the unfavorable spending variance in this situation could be the result of either higher prices or waste. Unlike the price variance for materials and the rate variance for labor, the spending variance for variable overhead measures both price and waste elements. This is why the variance is called a “spending” variance. Total spending can be affected as much by waste as it can by greater (or lesser) prices paid for items. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 685 Problem 11-26 (continued) b. Eff iciency variance = SR (AH – SH) $1 per MH (5,700 MHs – 5,600 MHs) = $100 U The overhead eff iciency variance is misnamed, since it does not measure eff iciency (waste) in use of variable overhead items. The variance arises solely because of ineff iciency in the base underlying the incurrence of variable overhead cost. I f the incurrence of variable overhead costs is directly tied to the actual machine-hours worked, then the excessive number of machine-hours worked during April has caused the incurrence of an additional $100 in variable overhead costs. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 686 Managerial Accounting, 11th Edition Problem 11-27 (45 minutes) 1. Total rate: $600,000 = $10 per DLH 60,000 DLHs Variable rate: $120,000 = $2 per DLH 60,000 DLHs Fixed rate: $480,000 = $8 per DLH 60,000 DLHs 2. Direct materials: 3 pounds at $7 per pound............. Direct labor: 1.5 DLHs at $12 per DLH .................... Variable overhead: 1.5 DLHs at $2 per DLH............. Fixed overhead: 1.5 DLHs at $8 per DLH................. Standard cost per unit ........................................... $21 18 3 12 $54 3. a. 42,000 units × 1.5 DLHs per unit = 63,000 standard DLHs. b. Actual costs Manufacturing Overhead 606,500 630,000 * Applied costs 23,500 Overapplied overhead * 63,000 standard DLHs × $10 per DLH = $630,000. 4. Variable overhead variances: Actual Hours of I nput, at the Actual Rate (AH × AR) $123,500 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 65,000 DLHs × $2 per DLH = $130,000 Spending Variance, $6,500 F ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 63,000 DLHs × $2 per DLH = $126,000 Eff iciency Variance, $4,000 U ↑ © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 687 Problem 11-27 (continued) Alternative solution: Variable overhead spending variance = (AH × AR) – (AH × SR) ($123,500) – (65,000 DLHs × $2 per DLH) = $6,500 F Variable overhead eff iciency variance = SR (AH – SH) $2 per DLH (65,000 DLHs – 63,000 DLHs) = $4,000 U Fixed overhead variances: Actual Fixed Overhead Cost $483,000 ↑ Budgeted Fixed Overhead Cost $480,000* Budget Variance, $3,000 U ↑ Fixed Overhead Cost Applied to Work in Process 63,000 DLHs × $8 per DLH = $504,000 Volume Variance, $24,000 F ↑ * Can be expressed as: 60,000 denominator DLHs × $8 per DLH = $480,000 Alternative solution: Budget variance: Budget = Actual fixed - Budgeted fixed variance overhead cost overhead cost = $483,000 - $480,000 = $3,000 U Volume variance: Fixed portion of ⎛ Standard⎞ Volume = the predetermined ⎜⎜Denominator - hours ⎟⎟ ⎟⎟ ⎜⎜ Variance hours ⎜ overhead rate ⎝ allowed ⎠⎟ = $8 per DLH (60,000 DLHs - 63,000 DLHs) = $24,000 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 688 Managerial Accounting, 11th Edition Problem 11-27 (continued) The company’s overhead variances can be summarized as follows: Variable overhead: Spending variance ........................... $ 6,500 F Eff iciency variance .......................... 4,000 U Fixed overhead: Budget variance .............................. 3,000 U Volume variance.............................. 24,000 F Overapplied overhead—see part 3....... $23,500 F 5. Only the volume variance would have changed. I t would have been unfavorable since the standard DLHs allowed for the year’s production (63,000 DLHs) would have been less than the denominator DLHs (65,000 DLHs). © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 689 Problem 11-28 (30 minutes) 1. FAB COMPANY Flexible Budget For the Month Ended March 31 Overhead Costs Variable costs: Utilities ......................... Maintenance.................. Machine setup ............... I ndirect labor ................ Total variable cost ............ Fixed costs: Maintenance.................. I ndirect labor ................ Depreciation .................. Total f ixed cost ................ Total overhead cost .......... Cost Formula (per MH) $0.90 1.60 0.30 0.70 $3.50 Machine-Hours 20,000 25,000 30,000 $ 18,000 $ 22,500 32,000 40,000 6,000 7,500 14,000 17,500 70,000 87,500 40,000 130,000 70,000 240,000 40,000 130,000 70,000 240,000 $ 27,000 48,000 9,000 21,000 105,000 40,000 130,000 70,000 240,000 $310,000 $327,500 $345,000 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 690 Managerial Accounting, 11th Edition Problem 11-28 (continued) 2. FAB Company Overhead Performance Report For the Month Ended March 31 Budgeted machine-hours ......... Actual machine-hours .............. Overhead Costs Variable costs: Utilities .................. Maintenance* ......... Machine setup ........ I ndirect labor ......... Total variable cost ..... Fixed costs: Maintenance .......... I ndirect labor ......... Depreciation........... Total f ixed cost ......... Total overhead cost ... Cost Formula (per MH) $0.90 1.60 0.30 0.70 $3.50 30,000 26,000 Actual 26,000 Hours Budget 26,000 Hours $ 24,200 $ 23,400 38,100 41,600 8,400 7,800 19,600 18,200 90,300 91,000 40,000 130,000 71,500 241,500 Spending or Budget Variance $ 800 3,500 600 1,400 700 U F U U F 40,000 130,000 70,000 240,000 0 0 1,500 U 1,500 U $331,800 $331,000 $ 800 U * $78,100 total maintenance cost, less $40,000 f ixed maintenance cost, equals $38,100 variable maintenance cost. The variable element of other costs is computed in the same way. 3. I n order to compute an overhead eff iciency variance, it would be necessary to know the standard hours allowed for the 15,000 units produced during March. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 691 Problem 11-29 (45 minutes) Per Direct Labor-Hour Variable Fixed Total 1. and 2. Denominator of 30,000 DLHs: $135,000 ÷ 30,000 DLHs ................... $270,000 ÷ 30,000 DLHs ................... Total predetermined rate ...................... Denominator of 40,000 DLHs: $180,000 ÷ 40,000 DLHs ................... $270,000 ÷ 40,000 DLHs ................... Total predetermined rate ...................... $4.50 $9.00 $ 4.50 9.00 $13.50 $6.75 $ 4.50 6.75 $11.25 $4.50 3. Denominator Activity: 30,000 DLHs Direct materials, 4 feet @ $8.75 per foot ................ $35.00 Direct labor, 2 DLHs @ $15 per DLH................... 30.00 Variable overhead, 2 DLHs @ $4.50 per DLH ... 9.00 Fixed overhead, 2 DLHs @ $9 per DLH ................ 18.00 Standard cost per unit ....... $92.00 Denominator Activity: 40,000 DLHs Same .......................... $35.00 Same .......................... 30.00 Same .......................... 9.00 Fixed overhead, 2 DLHs @ $6.75 per DLH ....... 13.50 Standard cost per unit .. $87.50 4. a. 18,000 units × 2 DLHs per unit = 36,000 standard DLHs. b. Actual costs Manufacturing Overhead 446,400 486,000 * Applied costs 39,600 Overapplied overhead * 36,000 standard DLHs × $13.50 predetermined rate per DLH = $486,000. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 692 Managerial Accounting, 11th Edition Problem 11-29 (continued) c. Variable overhead variances: Actual DLHs of I nput, at the Actual Rate (AH × AR) $174,800 ↑ Actual DLHs of I nput, at the Standard Rate (AH × SR) 38,000 DLHs × $4.50 per DLH = $171,000 ↑ Spending Variance, $3,800 U Standard DLHs Allowed for Output, at the Standard Rate (SH × SR) 36,000 DLHs × $4.50 per DLH = $162,000 ↑ Eff iciency Variance, $9,000 U Alternative solution: Variable overhead spending variance = (AH × AR) – (AH × SR) ($174,800) – (38,000 DLHs × $4.50 per DLH) = $3,800 U Variable overhead eff iciency variance = SR (AH – SH) $4.50 per DLH (38,000 DLHs – 36,000 DLHs) = $9,000 U Fixed overhead variances: Actual Fixed Overhead Cost $271,600 ↑ Budgeted Fixed Overhead Cost $270,000* Budget Variance, $1,600 U ↑ Fixed Overhead Cost Applied to Work in Process 36,000 DLHs × $9 per DLH = $324,000 Volume Variance, $54,000 F ↑ * Can be expressed as: 30,000 denominator DLHs × $9 per DLH = $270,000. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 693 Problem 11-29 (continued) Alternative solution: Budget variance: Budget = Actual fixed - Budgeted fixed variance overhead cost overhead cost = $271,600 - $270,000 = $1,600 U Volume variance: Fixed portion of ⎛ Standard⎞ Volume = the predetermined ⎜⎜Denominator - hours ⎟⎟ ⎟⎟ ⎜⎜ Variance hours ⎜ overhead rate ⎝ allowed ⎠⎟ = $9.00 per DLH (30,000 DLHs - 36,000 DLHs) = $54,000 F Summary of variances: Variable overhead spending variance ........... $ 3,800 U Variable overhead eff iciency variance .......... 9,000 U Fixed overhead budget variance.................. 1,600 U Fixed overhead volume variance ................. 54,000 F Overapplied overhead ................................ $39,600 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 694 Managerial Accounting, 11th Edition Problem 11-29 (continued) 5. The major disadvantage of using normal activity is the large volume variance that ordinarily results. This occurs because the denominator activity used to compute the predetermined overhead rate is different from the activity level that is anticipated for the period. I n the case at hand, the company has used a long-run normal activity f igure of 30,000 DLHs to compute the predetermined overhead rate, whereas activity for the period was expected to be 40,000 DLHs. This has resulted in a huge favorable volume variance that may be diff icult for management to interpret. I n addition, the large favorable volume variance in this case has masked the fact that the company did not achieve the budgeted level of activity for the period. The company had planned to work 40,000 DLHs, but managed to work only 36,000 DLHs (at standard). This unfavorable result is concealed due to using a denominator f igure that is out of step with current activity. On the other hand, using long-run normal activity as the denominator results in unit costs that are stable from year to year. Thus, management’s decisions are not clouded by unit costs that jump up and down as the activity level rises and falls. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 695 Problem 11-30 (60 minutes) 1. The computations of the cost formulas appear below. Actors and directors’ wages ................................ Stagehands’ wages ............................................ Ticket booth personnel and ushers’ wages........... Scenery, costumes, and props ............................ Theater hall rent ................................................ Printed programs............................................... Publicity ............................................................ Administrative expenses (15% ) .......................... Administrative expenses (10% ) .......................... Fixed administrative expenses (75% ) .................. Cost £216,000 £32,400 £16,200 £108,000 £54,000 £27,000 £12,000 £6,480 £4,320 £32,400 Variable with respect to performances performances performances productions performances performances productions productions performances — Activity level 108 108 108 6 108 108 6 6 108 — Cost per unit of activity £ 2,000 £300 £150 £18,000 £500 £250 £2,000 £1,080 £40 — 2. The performance report is clearest when it is organized by cost behavior. The costs that are variable with respect to the number of productions come first, then the costs that are variable with respect to performances, then the administrative expenses as a special category. The Little Theatre Flexible Budget Performance Report Actual number of productions ................................. Actual number of performances per production ........ Actual total number of performances....................... 7 24 168 The performance report is continued on the next page. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 696 Managerial Accounting, 11th Edition Problem 11-30 (continued) Cost Formula Per Unit of Activity Costs Variable costs of productions: (Flexible budget based on 7 productions) Scenery, costumes, and props....................... £18,000 Publicity ...................................................... 2,000 Total variable cost per production* .................. £20,000 Variable costs of performances: (Flexible budget based on 168 performances) Actors and directors’ wages .......................... £2,000 Stagehands’ wages ...................................... 300 Ticket booth personnel and ushers’ wages ..... 150 Theater hall rent .......................................... 500 Printed programs ......................................... 250 Total variable cost per performance* ............... £3,200 Administrative expenses: Variable per production ................................ £1,080 Variable per performance.............................. £40 Fixed........................................................... Total administrative expenses.......................... Total cost ....................................................... * Excluding variable portion of administrative expenses Actual Costs I ncurred Budget Based on Actual Activity Variance £130,600 15,100 145,700 £126,000 14,000 140,000 £ 4,600 U 1,100 U 5,700 U 341,800 49,700 25,900 78,000 38,300 533,700 336,000 50,400 25,200 84,000 42,000 537,600 5,800 700 700 6,000 3,700 3,900 47,500 £726,900 7,560 6,720 32,400 46,680 £724,280 820 U £ 2,620 U U F U F F F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 697 Problem 11-30 (continued) 3. The overall unfavorable variance is a very small percentage of the total cost, less than 0.4% . That suggests that costs are well under control. I n addition, the pattern of the variances may reflect good management. The largest unfavorable variances are for value-added activities (scenery, costumes, props, actors and directors) that may warrant additional spending. These unfavorable variances are offset by favorable variances for theater hall rent and the printed programs. Assuming that the quality of the printed programs has not noticeably declined and that the favorable variance for the rent reflects a lower negotiated rental fee, management should be congratulated. They have saved in some areas and have apparently transferred the funds to other areas that may favorably impact the quality of the theater’s productions. 4. The average costs may not be very good indicators of the additional costs of any particular production or performance. The averages gloss over considerable variations in costs. For example, a production of Peter the Rabbit may require only half a dozen actors and actresses and fairly simple costumes and props. On the other hand, a production of Cinderella may require dozens of actors and actresses and very elaborate and costly costumes and props. Consequently, both the production costs and the cost per performance will be much higher for Cinderella than for Peter the Rabbit. Managers of theater companies know that they must estimate the costs of each new production individually—the average costs are of little use for this purpose. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 698 Managerial Accounting, 11th Edition Case 11-31 (30 minutes) I t is diff icult to imagine how Tom Kemper could ethically agree to go along with reporting the favorable $21,000 variance for industrial engineering on the f inal report, even if the bill were not actually received by the end of the year. I t would be misleading to include all of the original contract price of $210,000 on the report, but to exclude part of the f inal cost of the contract. Collaborating in this attempt to mislead corporate headquarters would appear to be a violation of three of the Standards of Ethical Conduct for Management Accountants: Competence, I ntegrity, and Objectivity. These three violations are discussed below: Competence The competence standard requires that management accountants “prepare complete and clear reports and recommendations after appropriate analyses of relevant and reliable information.” A report that omits mentioning the entire amount owed on the industrial engineering contract could hardly be called complete. I ntegrity The integrity standard requires that management accountants “communicate unfavorable as well as favorable information...” Withholding unfavorable information such as the entire amount owed on the industrial engineering contract violates this standard. Objectivity The objectivity standard requires that management accountants “disclose fully all relevant information that could reasonably be expected to influence the user's understanding of the reports, comments, and recommendations presented.” Failing to disclose the entire amount owed on the industrial engineering contract violates this standard. I ndividuals will differ in how they think Tom Kemper should handle this situation. I n our opinion, he should f irmly state that he is willing to call Laura, but even if the bill does not arrive, he is ethically bound to properly accrue the expenses on the report—which will mean an unfavorable variance for industrial engineering and an overall unfavorable variance. This would require a great deal of personal courage. I f the general manager insists on keeping the misleading $21,000 favorable variance on the report, Kemper would have little choice under the Standards of Ethical Conduct. He would have to take the dispute to the next higher managerial level in the company. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 699 Case 11-31 (continued) I t is important to note that the problem may be a consequence of inappropriate use of performance reports by corporate headquarters. I f the performance report is being used as a way of “beating up” managers, corporate headquarters may be creating a climate in which managers such as the general manager at the Wichita plant will feel like they must always turn in positive reports. This creates pressure to bend the truth since reality isn’t always positive. Some students may suggest that Kemper redo the performance report to recognize eff iciency variances. This might make the performance look better, or it might make the performance look worse; we cannot tell from the data in the case. Moreover, it is unlikely that corporate headquarters would permit a performance report that does not follow the usual format, which apparently does not recognize eff iciency variances. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 700 Managerial Accounting, 11th Edition Case 11-32 (45 minutes) 1. Performance report: University Motor Pool Budget Report for March Gasoline .................................. Oil, minor repairs, and parts...... Outside repairs......................... I nsurance ................................ Salaries and benef its ................ Depreciation of vehicles ............ Total cost ................................. March Actual $ 4,300 380 50 525 2,500 2,310 $10,065 Flexible Budget $ 4,410 378 236 525 2,500 2,310 $10,359 Variance $110 F 2U 186 F 0 0 0 $294 F Number of automobiles in use ... Actual miles ............................. Cost per mile ........................... 21 63,000 $0.1598 21 63,000 $0.1644 0 0 $0.0046 F Supporting calculations for flexible budget amounts: Gasoline: 63,000 miles × $1.75 per gallon = $4,410 25 miles per gallon Oil, minor repairs, and parts: 63,000 miles × $0.006 per mile = $378 Outside repairs: $135 per auto × 21 autos = $236.25 12 months I nsurance: $6,000 ÷ 20 autos = $300 per auto 21 autos × $300 per auto = $6,300 $6,300 ÷ 12 months = $525 per month © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 701 Case 11-32 (continued) Salaries and benefits (no change): $30,000 annual cost = $2,500 per month 12 months Depreciation—Annual depreciation per auto: $26,400 ÷ 20 autos = $1,320 per auto Depreciation—Annual depreciation for 21 autos: $1,320 per auto × 21 autos = $27,720 Depreciation—Monthly depreciation for 21 autos: $27,720 ÷ 12 months = $2,310 per month 2. The performance report as originally prepared is based on a static budget approach that does not allow for variations in the number of miles driven from month to month, or for variations in the number of automobiles used. This causes the “monthly budget” figures for both variable and fixed costs to be unrealistic as benchmarks against which to compare actual costs for the month. For example, actual variable costs such as gasoline can’t be compared to the “budgeted” cost, since the budgeted figure is based on only 50,000 miles; actual fixed costs such as insurance can’t be compared to the “budgeted” costs, since the budgeted figure is based on only 20 automobiles. The performance report in Part (1) above is more realistic since the benchmark figures are based on actual miles driven and on the actual number of automobiles used during the month. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 702 Managerial Accounting, 11th Edition Case 11-33 (60 minutes) 1. The number of units produced can be computed by using the total standard cost applied for the period for any input (materials, labor, or overhead), or it can be computed by using the total standard cost applied for all inputs together. Using only the standard cost applied for materials, we have: Total standard cost applied for the period $405,000 = Standard cost per unit $18 per unit = 22,500 units The same answer can be obtained by using any other cost input. 2. 138,000 pounds; see below for a detailed analysis. 3. $2.95 per pound; see below for a detailed analysis. 4. 19,400 direct labor-hours; see below for a detailed analysis. 5. $15.75 per direct labor-hour; see below for a detailed analysis. 6. Standard variable overhead cost applied .. Add: Overhead eff iciency variance........... Deduct: Overhead spending variance....... Actual variable overhead cost incurred ..... $54,000 4,200 U (see below) 1,300 F $56,900 7. Standard f ixed overhead cost applied ...... $126,000 Add: Unfavorable volume variance........... 14,000 U Budgeted f ixed overhead cost ................. $140,000 8. Budgeted fixed overhead cost $140,000 = Fixed portion of the predetermined overhead rate $7 per DLH = 20,000 DLHs © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 703 Case 11-33 (continued) Direct materials analysis: Actual Quantity of I nputs, at Actual Price (AQ × AP) 138,000 pounds × $2.95 per pound* * * = $407,100 ↑ Actual Quantity of I nputs, at Standard Price (AQ × SP) 138,000 pounds* * × $3 per pound = $414,000 ↑ Standard Quantity Allowed for Output, at Standard Price (SQ × SP) 135,000 pounds* × $3 per pound = $405,000 Price Variance, Quantity Variance, $6,900 F $9,000 U Total Variance, $2,100 U ↑ * 22,500 units × 6 pounds per unit = 135,000 pounds * * $414,000 ÷ $3 per pound = 138,000 pounds * * * $407,100 ÷ 138,000 pounds = $2.95 per pound Direct labor analysis: Actual Hours of I nput, at the Actual Rate (AH × AR) 19,400 DLHs × $15.75 per DLH* * * = $305,550 ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 19,400 DLHs* * × $15 per DLH = $291,000 ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 18,000 DLHs* × $15 per DLH = $270,000 Rate Variance, Eff iciency Variance, $14,550 U $21,000 U Total Variance, $35,550 U ↑ * 22,500 units × 0.8 DLHs per unit = 18,000 DLHs * * $291,000 ÷ $15 per DLH = 19,400 DLHs * * * $305,550 ÷ 19,400 DLHs = $15.75 per DLH © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 704 Managerial Accounting, 11th Edition Case 11-33 (continued) Variable overhead analysis: Actual Hours of I nput, at the Actual Rate (AH × AR) $56,900* * ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 19,400 DLHs × $3 per DLH = $58,200 ↑ Spending Variance, $1,300 F Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 18,000 DLHs × $3 per DLH = $54,000 ↑ Eff iciency Variance, $4,200 U* * Computed using 19,400 actual DLHs at the $3 per DLH standard rate. * * $58,200 – $1,300 = $56,900. Fixed overhead analysis: Actual Fixed Overhead Cost $139,500* * ↑ Budgeted Fixed Overhead Cost $140,000* Budget Variance, $500 F ↑ Fixed Overhead Cost Applied to Work in Process 18,000 hours × $7 per hour = $126,000 Volume Variance, $14,000 U ↑ * $126,000 + $14,000 = $140,000. * * $140,000 – $500 = $139,500. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 705 Case 11-34 (45 minutes for each company; 90 minutes in total) (Note to the I nstructor: You may wish to assign only one company.) 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. Company A Company B Denominator activity in machine-hours .. 35,000 Standard machine-hours allowed for units produced .................................. 32,000 * Actual machine-hours worked ............... 30,000 * Flexible budget variable overhead per machine-hour .................................... $1.75 Budgeted f ixed overhead (total) ............ $210,000 Actual variable overhead cost ................ $54,000 * Actual f ixed overhead cost .................... $209,400 * Variable overhead cost applied to production ............................................. $56,000 Fixed overhead cost applied to production ........................................ $192,000 * Variable overhead spending variance ..... $1,500 U Variable overhead eff iciency variance .... $3,500 F* Fixed overhead budget variance ............ $600 F Fixed overhead volume variance............ $18,000 U* Variable portion of the predetermined overhead rate.................................... $1.75 Fixed portion of the predetermined overhead rate.................................... $6.00 Underapplied (or overapplied) overhead .......................................... $15,400 40,000 * 42,000 45,000 $2.80 * $300,000 $117,000 * $302,100 * $117,600 * $315,000 $9,000 $8,400 $2,100 $15,000 F U* U* F $2.80 $7.50 ($13,500) * Given. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 706 Managerial Accounting, 11th Edition Case 11-34 (continued) Analysis for Company A: Variable overhead: Actual Hours of I nput, at the Actual Rate (AH × AR) $54,000* ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 30,000 MHs* × $1.75 per MH = $52,500 ↑ Spending Variance, $1,500 U Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 32,000 MHs* × $1.75 per MH* * = $56,000 ↑ Eff iciency Variance, $3,500 F* Fixed overhead: Actual Fixed Overhead Cost $209,400* ↑ Budgeted Fixed Overhead Cost $210,000 Budget Variance, $600 F ↑ Fixed Overhead Cost Applied to Work in Process 32,000 MHs* × $6 per MH = $192,000* Volume Variance, $18,000 U* ↑ * Given. ** $3,500 = $1.75 per MH 32,000 MHs - 30,000 MHs © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 707 Case 11-34 (continued) Denominator activity in hours: Budgeted fixed overhead cost Fixed element of the = predetermined overhead rate Denominator activity = $210,000 Denominator activity = $6 per MH Therefore, the denominator activity is: $210,000 ÷ $6 per MH = 35,000 MHs. Underapplied overhead: Variable overhead spending variance ......... Variable overhead eff iciency variance......... Fixed overhead budget variance ................ Fixed overhead volume variance ................ Underapplied overhead ............................. $ 1,500 3,500 600 18,000 $15,400 U F F U U Analysis for Company B: Variable overhead: Actual Hours of I nput, at the Actual Rate (AH × AR) $117,000* ↑ Actual Hours of I nput, at the Standard Rate (AH × SR) 45,000 MHs × $2.80 per MH* = $126,000 Spending Variance, $9,000 F ↑ Standard Hours Allowed for Output, at the Standard Rate (SH × SR) 42,000 MHs × $2.80 per MH* = $117,600* Eff iciency Variance, $8,400 U* ↑ * Given. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 708 Managerial Accounting, 11th Edition Case 11-34 (continued) Fixed overhead: Actual Fixed Overhead Cost $302,100* ↑ Budgeted Fixed Overhead Cost $300,000 Budget Variance, $2,100 U* ↑ Fixed Overhead Cost Applied to Work in Process 42,000 MHs × $7.50 per MH* * = $315,000 Volume Variance, $15,000 F ↑ * Given * * $302,100 – $2,100 = $300,000; $300,000 ÷ 40,000 denominator MHs = $7.50 f ixed predetermined overhead rate. Overapplied overhead: Variable overhead spending variance .......... $ 9,000 F Variable overhead eff iciency variance.......... 8,400 U Fixed overhead budget variance ................. 2,100 U Fixed overhead volume variance ................. 15,000 F Overapplied overhead ................................ $13,500 F © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 709 Group Exercise 11-35 1. The tighter standards for fixed manufacturing costs are a consequence of spreading fixed costs over more units, resulting in a smaller standard cost per unit. Unless the plant operates at practical capacity, the volume variance will be unfavorable. a. The possible negative behavioral effects include: • Employees may view the standards as unreasonable. • Employees may react negatively to the change, feeling that it has been imposed by the accounting department with little input from those who would be most affected. • Motivation may suffer if employees feel increased pressure to meet the tighter standards. • General resistance to change. b. To reduce the negative behavioral effects, management could: • Explain what is expected and why this change will further the company’s objectives. • Adjust the performance evaluation system to reflect this change. For example, production managers would not be held responsible for volume variances so long as demand is satisfied and orders are shipped on time. 2. Tight standards can have positive behavioral effects because: • Employees may be energized by the challenge. • Tight standards may encourage teamwork. • Tight standards may foster problem-solving and creative thinking. 3. Representatives of all the parts of the organization that will be affected by the change should participate in setting standards. This would certainly include anyone whose performance evaluation is affected by a change in standards. Employee participation in standard setting should result in better goal congruence. The individuals who will be affected by the standards have first-hand operating knowledge, which should be invaluable in the standard setting process. I n addition, their participation in standard setting will increase the likelihood that they will be committed to meeting the standards once they have been set. (CMA unofficial solution, adapted) © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 710 Managerial Accounting, 11th Edition Group Exercise 11-36 The solution will depend on the particular college or university that the students investigate. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 11 711 Chapter 12 Segment Reporting and Decentralization Solutions to Questions 12-1 In a decentralized organization, decision-making authority isn’t confined to a few top executives, but rather is spread throughout the organization with lower-level managers and other employees empowered to make decisions. 12-2 The benefits of decentralization include: (1) freeing top managers to focus on strategy, higher-level decision making, and coordinating activity; (2) improving operational decision making, since lower-level managers often have better information about local conditions; (3) enabling quicker response to customer needs; (4) training lower-level managers to take on greater responsibility; and (5) providing greater motivation and job satisfaction for lower-level managers. 12-3 A cost center manager has control over cost, but not revenue or investment funds. A profit center manager has control over both cost and revenue. An investment center manager has control over cost and revenue and investment funds. 12-4 A segment is any part or activity of an organization about which a manager seeks cost, revenue, or profit data. Examples of segments include departments, operations, sales territories, divisions, product lines, and so forth. 12-5 Under the contribution approach, costs are assigned to a segment if and only if the costs are traceable to the segment. Common costs are not allocated to segments under the contribution approach. 12-6 A traceable cost of a segment is a cost that arises specifically because of the existence of that segment. If the segment were eliminated, the cost would disappear. A common cost, by contrast, is a cost that supports more than one segment, but is not traceable in whole or in part to any one of the segments. If the departments of a company are treated as segments, then examples of the traceable costs of a department would include the salary of the department’s supervisor, depreciation of machines used exclusively by the department, and the costs of supplies used by the department. Examples of common costs would include the salary of the general counsel of the entire company, the lease cost of the headquarters building, corporate image advertising, and periodic depreciation of machines shared by several departments. 12-7 The contribution margin is the difference between sales revenue and variable expenses. The segment margin is the amount remaining after deducting traceable fixed expenses from the contribution margin. The contribution margin is useful as a planning tool for many decisions, including those in which fixed costs don’t change. The segment margin is useful in assessing the overall profitability of a segment. 12-8 If common costs were allocated to segments, then the costs of segments would be overstated and their margins would be understated. As a consequence, some segments may appear to be unprofitable and managers may be tempted to eliminate them. If a segment were eliminated because of the existence of arbitrarily allocated common costs, the overall profit of the © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 713 company would decline by the amount of the segment margin because the common cost would remain. The common cost that had been allocated to the segment would then be reallocated to the remaining segments—making them appear less profitable. 12-9 There are often limits to how far down an organization a cost can be traced. Therefore, costs that are traceable to a segment may become common as that segment is divided into smaller segment units. For example, the costs of national TV and print advertising might be traceable to a product line, but be a common cost of the geographic sales territories in which that product line is sold. 12-10 Margin refers to the ratio of net operating income to total sales. Turnover refers to the ratio of total sales to average operating assets. The product of the two numbers is the ROI. 12-11 Residual income is the net operating income an investment center earns above the company’s minimum required rate of return on operating assets. 12-12 If ROI is used to evaluate performance, a manager of an investment center may reject a profitable investment opportunity whose rate of return exceeds the company’s required rate of return but whose rate of return is less than the investment center’s current ROI. The residual income approach overcomes this problem since any project whose rate of return exceeds the company’s minimum required rate of return will result in an increase in residual income. 12-13 A transfer price is the price charged for a transfer of goods or services between segments of the same organization, such as two departments or divisions. Transfer prices are needed for performance evaluation purposes. The selling unit gets credit for the transfer price and the buying unit must deduct the transfer price as an expense. 12-14 If the selling division has idle capacity, any transfer price above the variable cost of producing an item for transfer will generate some additional profit. 12-15 If the selling division has no idle capacity, then the transfer price would have to cover at least the division’s variable cost plus the contribution margin on lost sales. 12-16 Cost-based transfer prices are widely used because they are easily understood and convenient to use. Their disadvantages are that they can lead to poor decisions regarding whether transfers should be made, they provide little incentive for cost control, and the selling division makes no profit. 12-17 Using the market price as the transfer price can lead to incorrect decisions. When the selling division has idle capacity, the cost to the company of the transfer is just the variable cost of the item transferred. However, if the market price is used as the transfer price, the buying division regards the market price as the cost. If the market price exceeds the variable cost (which will ordinarily happen), managers in the buying division will make less than optimal pricing and other decisions concerning the product. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 714 Managerial Accounting, 11th Edition Exercise 12-1 (15 minutes) Total Amount % Sales* ......................... $300,000 100 Less variable expenses.. 183,000 61 Contribution margin ...... 117,000 39 Less traceable fixed expenses................... 66,000 22 Product line segment margin ...................... 51,000 17 Less common fixed expenses not trace33,000 11 able to products......... Net operating income.... $ 18,000 6 Weedban % Amount Greengrow Amount % $90,000 100 36,000 40 54,000 60 $210,000 100 147,000 70 63,000 30 45,000 50 21,000 10 $ 9,000 10 $ 42,000 20 * Weedban: 15,000 units × $6 per unit = $90,000. Greengrow: 28,000 units × $7.50 per unit = $210,000. Variable expenses are computed in the same way. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 715 Exercise 12-2 (10 minutes) 1. Margin = = 2. Net operating income Sales $600,000 = 8% $7,500,000 Turnover = = Sales Average operating assets $7,500,000 = 1.5 $5,000,000 3. ROI = Margin × Turnover = 8% × 1.5 = 12% © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 716 Managerial Accounting, 11th Edition Exercise 12-3 (10 minutes) Average operating assets ........................ £2,800,000 Net operating income.............................. Minimum required return: 18% × average operating assets........... Residual income ..................................... £600,000 £504,000 £ 96,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 717 Exercise 12-4 (30 minutes) 1. a. The lowest acceptable transfer price from the perspective of the selling division is given by the following formula: Total contribution margin on lost sales Transfer price ≥ Variable cost + per unit Number of units transferred Since there is enough idle capacity to fill the entire order from the HiFi Division, no outside sales are lost. And since the variable cost per unit is $42, the lowest acceptable transfer price as far as the selling division is concerned is also $42. Transfer price ≥ $42 + $0 = $42 5,000 b. The Hi-Fi division can buy a similar speaker from an outside supplier for $57. Therefore, the Hi-Fi Division would be unwilling to pay more than $57 per speaker. Transfer price ≤ Cost of buying from outside supplier = $57 c. Combining the requirements of both the selling division and the buying division, the acceptable range of transfer prices in this situation is: $42 ≤ Transfer price ≤ $57 Assuming that the managers understand their own businesses and that they are cooperative, they should be able to agree on a transfer price within this range and the transfer should take place. d. From the standpoint of the entire company, the transfer should take place. The cost of the speakers transferred is only $42 and the company saves the $57 cost of the speakers purchased from the outside supplier. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 718 Managerial Accounting, 11th Edition Exercise 12-4 (continued) 2. a. Each of the 5,000 units transferred to the Hi-Fi Division must displace a sale to an outsider at a price of $60. Therefore, the selling division would demand a transfer price of at least $60. This can also be computed using the formula for the lowest acceptable transfer price as follows: Transfer price ≥ $42 + ($60 - $42) × 5,000 5,000 = $42 + ($60 - $42) = $60 b. As before, the Hi-Fi Division would be unwilling to pay more than $57 per speaker. c. The requirements of the selling and buying divisions in this instance are incompatible. The selling division must have a price of at least $60 whereas the buying division will not pay more than $57. An agreement to transfer the speakers is extremely unlikely. d. From the standpoint of the entire company, the transfer should not take place. By transferring a speaker internally, the company gives up revenue of $60 and saves $57, for a loss of $3. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 719 Exercise 12-5 (20 minutes) 1. Total Company Amount % Sales ............................... Less variable expenses...... Contribution margin .......... Less traceable fixed expenses .......................... Divisional segment margin................................ Less common fixed expenses not traceable to divisions* ...................... Net operating income (loss) ............................ $1,000,000 100.0 390,000 39.0 610,000 61.0 535,000 53.5 75,000 7.5 90,000 9.0 $ (15,000) East Amount % $250,000 100 130,000 52 120,000 48 160,000 64 Division Central Amount % West Amount % $400,000 100 120,000 30 280,000 70 $350,000 100 140,000 40 210,000 60 200,000 $(40,000) (16) $ 80,000 50 175,000 50 20 $ 35,000 10 (1.5) *$625,000 – $535,000 = $90,000. 2. Incremental sales ($350,000 × 20%) ......... Contribution margin ratio ........................... Incremental contribution margin ................ Less incremental advertising expense ......... Incremental net operating income .............. $70,000 × 60% 42,000 15,000 $27,000 Yes, the advertising program should be initiated. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 720 Managerial Accounting, 11th Edition Exercise 12-6 (20 minutes) 1. Margin = Net operating income Sales = $150,000 = 5.00% $3,000,000 Turnover = = Sales Average operating assets $3,000,000 = 4.00 $750,000 ROI = Margin × Turnover = 5% × 4 = 20% 2. Margin = Net operating income Sales = $150,000(1.00 + 2.00) $3,000,000(1.00 + 0.50) = $450,000 = 10.00% $4,500,000 Turnover = Sales Average operating assets = $3,000,000 (1.00 + 0.50) $750,000 = $4,500,000 = 6.00 $750,000 ROI = Margin × Turnover = 10% × 6 = 60% © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 721 Exercise 12-6 (continued) 3. Margin = Net operating income Sales = $150,000 + $200,000 $3,000,000 + $1,000,000 = $350,000 = 8.75% $4,000,000 Turnover = Sales Average operating assets = $3,000,000 + $1,000,000 $750,000 + $250,000 = $4,000,000 = 4.00 $1,000,000 ROI = Margin × Turnover = 8.75% × 4 = 35% © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 722 Managerial Accounting, 11th Edition Exercise 12-7 (20 minutes) 1. $75,000 × 40% CM ratio = $30,000 increased contribution margin in Minneapolis. Since the fixed costs in the office and in the company as a whole will not change, the entire $30,000 would result in increased net operating income for the company. It is not correct to multiply the $75,000 increase in sales by Minneapolis’ 24% segment margin ratio. This approach assumes that the segment’s traceable fixed expenses increase in proportion to sales, but if they did, they would not be fixed. 2. a. The segmented income statement follows: Total Company Amount % Sales .......................... $500,000 100.0 Less variable expenses ..................... 240,000 48.0 Contribution margin ..... 260,000 52.0 Less traceable fixed expenses.................. 126,000 25.2 Office segment margin........................... 134,000 26.8 Less common fixed expenses not trace63,000 12.6 able to segments ...... Net operating income... $ 71,000 14.2 Segments Chicago Minneapolis Amount % Amount % $200,000 100 $300,000 100 60,000 140,000 30 70 180,000 120,000 60 40 78,000 39 48,000 16 31 $ 72,000 24 $ 62,000 b. The segment margin ratio rises and falls as sales rise and fall due to the presence of fixed costs. The fixed costs are spread over a larger base as sales increase. In contrast to the segment ratio, the contribution margin ratio is stable so long as there is no change in either the variable expenses or the selling price per unit of service. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 723 Exercise 12-8 (15 minutes) 1. The company should focus its campaign on the Dental market. The computations are: Medical Dental Increased sales ............................................. $40,000 $35,000 Market CM ratio............................................. × 36% × 48% Incremental contribution margin..................... 14,400 16,800 Less cost of the campaign.............................. 5,000 5,000 Increased segment margin and net operating income for the company as a whole ............. $ 9,400 $11,800 2. The $48,000 in traceable fixed expenses in Exercise 12-7 is now partly traceable and partly common. When we segment Minneapolis by market, only $33,000 remains a traceable fixed expense. This amount represents costs such as advertising and salaries of individuals that arise because of the existence of the Medical and Dental markets. The remaining $15,000 ($48,000 – $33,000) becomes a common cost when Minneapolis is segmented by market. This amount would include costs such as the salary of the manager of the Minneapolis office that could not be avoided by eliminating either of the two market segments. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 724 Managerial Accounting, 11th Edition Exercise 12-9 (30 minutes) 1. Margin = = Turnover = = Net operating income Sales $70,000 = 5% $1,400,000 Sales Average operating assets $1,400,000 = 4.00 $350,000 ROI = Margin × Turnover = 5% × 4 = 20% 2. Margin = Net operating income Sales = $70,000 + $18,200 $1,400,000 + $70,000 = $88,200 = 6% $1,470,000 Turnover = Sales Average operating assets = $1,400,000 + $70,000 $350,000 = $1,470,000 = 4.2 $350,000 ROI = Margin × Turnover = 6% × 4.20 = 25.2% © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 725 Exercise 12-9 (continued) 3. Margin = Net operating income Sales = $70,000 + $14,000 $1,400,000 = $84,000 = 6% $1,400,000 Turnover = = Sales Average operating assets $1,400,000 =4 $350,000 ROI = Margin × Turnover = 6% × 4 = 24% 4. Margin = = Turnover = Net operating income Sales $70,000 = 5% $1,400,000 Sales Average operating assets = $1,400,000 $350,000 - $70,000 = $1,400,000 =5 $280,000 ROI = Margin × Turnover = 5% × 5 = 25% © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 726 Managerial Accounting, 11th Edition Exercise 12-10 (20 minutes) 1. (a) Sales $2,500,000 $2,600,000 $2,700,000 $2,800,000 $2,900,000 $3,000,000 (b) (c) Net Average Operating Operating Income* Assets $475,000 $500,000 $525,000 $550,000 $575,000 $600,000 $1,000,000 $1,000,000 $1,000,000 $1,000,000 $1,000,000 $1,000,000 ROI (b) ÷ (c) 47.5% 50.0% 52.5% 55.0% 57.5% 60.0% *Sales × Contribution Margin Ratio – Fixed Expenses 2. The ROI increases by 2.5% for each $100,000 increase in sales. This happens because each $100,000 increase in sales brings in an additional profit of $25,000. When this additional profit is divided by the average operating assets of $1,000,000, the result is an increase in the company’s ROI of 2.5%. Increase in sales .................................................... $100,000 Contribution margin ratio........................................ 25% Increase in contribution margin and net operating income (a) × (b) ................................................. $25,000 Average operating assets........................................ $1,000,000 Increase in return on investment (c) ÷ (d) ............... 2.5% (a) (b) (c) (d) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 727 Exercise 12-11 (15 minutes) Alpha Division Bravo Sales ................................... $4,000,000 $11,500,000 * Net operating income............ $160,000 $920,000 * Average operating assets ...... $800,000 * $4,600,000 Margin ................................. 4%* 8% Turnover .............................. 5* 2.5 Return on investment (ROI) .. 20% 20%* Charlie $3,000,000 $210,000 * $1,500,000 7%* 2 14%* Note that Divisions Alpha and Bravo use different strategies to obtain the same 20% return. Division Alpha has a low margin and a high turnover, whereas Division Bravo has just the opposite. *Given. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 728 Managerial Accounting, 11th Edition Exercise 12-12 (30 minutes) 1. ROI computations: ROI = Margin × Turnover = Net operating income Sales × Sales Average operating assets Division A: ROI = $600,000 $12,000,000 × $12,000,000 $3,000,000 = 5% × 4 = 20% Division B: ROI = $560,000 $14,000,000 × $14,000,000 $7,000,000 = 4% × 2 = 8% Division C: ROI = $800,000 $25,000,000 × $25,000,000 $5,000,000 = 3.2% × 5 = 16% 2. Division A Division B Division C Average operating assets ........... $3,000,000 $7,000,000 $5,000,000 Required rate of return .............. × 14% × 10% × 16% Required operating income......... $ 420,000 $ 700,000 $ 800,000 Actual operating income............. $ 600,000 $ 560,000 $ 800,000 Required operating income (above) .................................. 420,000 700,000 800,000 Residual income ........................ $ 180,000 $(140,000) $ 0 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 729 Exercise 12-12 (continued) 3. a. and b. Division A Division B Division C Return on investment (ROI) ........... Therefore, if the division is presented with an investment opportunity yielding 15%, it probably would........................... Minimum required return for computing residual income ................ Therefore, if the division is presented with an investment opportunity yielding 15%, it probably would........................... 20% 8% 16% Reject Accept Reject 14% 10% 16% Accept Accept Reject If performance is being measured by ROI, both Division A and Division C probably would reject the 15% investment opportunity. These divisions’ ROIs currently exceed 15%; accepting a new investment with a 15% rate of return would reduce their overall ROIs. Division B probably would accept the 15% investment opportunity, since accepting it would increase the division’s overall rate of return. If performance is measured by residual income, both Division A and Division B probably would accept the 15% investment opportunity. The 15% rate of return promised by the new investment is greater than their required rates of return of 14% and 10%, respectively, and would therefore add to the total amount of their residual income. Division C would reject the opportunity, since the 15% return on the new investment is less than its 16% required rate of return. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 730 Managerial Accounting, 11th Edition Exercise 12-13 (15 minutes) 1. ROI computations: ROI = Margin × Turnover = Net operating income Sales × Sales Average operating assets Queensland Division: ROI = $360,000 $4,000,000 × $4,000,000 $2,000,000 = 9% × 2 = 18% New South Wales Division: ROI = $420,000 $7,000,000 × $7,000,000 $2,000,000 = 6% × 3.5 = 21% 2. The manager of the New South Wales Division seems to be doing the better job. Although her margin is three percentage points lower than the margin of the Queensland Division, her turnover is higher (a turnover of 3.5, as compared to a turnover of two for the Queensland Division). The greater turnover more than offsets the lower margin, resulting in a 21% ROI, as compared to an 18% ROI for the other division. Notice that if you look at margin alone, then the Queensland Division appears to be the stronger division. This fact underscores the importance of looking at turnover as well as at margin in evaluating performance in an investment center. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 731 Exercise 12-14 (20 minutes) 1. ROI computations: ROI = Margin × Turnover = Net operating income Sales × Sales Average operating assets Osaka Division: ROI = ¥210,000 ¥3,000,000 × ¥3,000,000 ¥1,000,000 = 7% × 3 = 21% Yokohama Division: ROI = ¥720,000 ¥9,000,000 × ¥9,000,000 ¥4,000,000 = 8% × 2.25 = 18% Osaka 2. Yokohama Average operating assets (a)....................... ¥1,000,000 ¥4,000,000 Net operating income ................................. ¥ 210,000 ¥ 720,000 Minimum required return on average operating assets: 15% × (a) ........................... 150,000 600,000 Residual income ......................................... ¥ 60,000 ¥ 120,000 3. No, the Yokohama Division is simply larger than the Osaka Division and for this reason one would expect that it would have a greater amount of residual income. Residual income can’t be used to compare the performance of divisions of different sizes. Larger divisions will almost always look better, not necessarily because of better management but simply because they are larger. In fact, in the case above, the Yokohama Division does not appear to be as well managed as the Osaka Division. Note from Part (1) that Yokohama has only an 18% ROI as compared to 21% for Osaka. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 732 Managerial Accounting, 11th Edition Exercise 12-15 (15 minutes) 1. Division A 1 Division B 2 Sales............................. $2,500,000 $1,200,000 Less expenses: Added by the division... 1,800,000 400,000 Transfer price paid ....... 500,000 Total expenses ............... 1,800,000 900,000 Net operating income ..... $ 700,000 $ 300,000 Total Company 3 $3,200,000 2,200,000 2,200,000 $1,000,000 1 20,000 units × $125 per unit = $2,500,000. 4,000 units × $300 per unit = $1,200,000. 3 Division A outside sales (16,000 units × $125 per unit) ..................... $2,000,000 Division B outside sales (4,000 units × $300 per unit) ....................... 1,200,000 Total outside sales......................................... $3,200,000 2 Note that the $500,000 in intracompany sales has been eliminated. 2. Division A should transfer the 1,000 additional circuit boards to Division B. Note that Division B’s processing adds $175 to each unit’s selling price (B’s $300 selling price, less A’s $125 selling price = $175 increase), but it adds only $100 in cost. Therefore, each board transferred to Division B ultimately yields $75 more in contribution margin ($175 – $100 = $75) to the company than can be obtained from selling to outside customers. Thus, the company as a whole will be better off if Division A transfers the 1,000 additional boards to Division B. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 733 Exercise 12-16 (15 minutes) A Company B C Sales ........................................ $9,000,000 * $7,000,000 * $4,500,000 * Net operating income................. $540,000 $280,000 * $360,000 Average operating assets ........... $3,000,000 * $2,000,000 $1,800,000 * Return on investment (ROI) ....... 18%* 14%* 20% Minimum required rate of return: Percentage ............................. 16%* 16% 15%* Dollar amount......................... $480,000 $320,000 * $270,000 Residual income ........................ $60,000 $(40,000) $90,000 * *Given. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 734 Managerial Accounting, 11th Edition Exercise 12-17 (20 minutes) 1. The lowest acceptable transfer price from the perspective of the selling division is given by the following formula: Total contribution margin on lost sales Transfer price ≥ Variable cost + . per unit Number of units transferred There is no idle capacity, so each of the 40,000 units transferred from Division X to Division Y reduces sales to outsiders by one unit. The contribution margin per unit on outside sales is $20 (= $90 – $70). Transfer price ≥ ($70 - $3) + $20 × 40,000 40,000 = $67 + $20 = $87 The buying division, Division Y, can buy a similar unit from an outside supplier for $86. Therefore, Division Y would be unwilling to pay more than $86 per unit. Transfer price ≤ Cost of buying from outside supplier = $86 The requirements of the two divisions are incompatible and no transfer will take place. 2. In this case, Division X has enough idle capacity to satisfy Division Y’s demand. Therefore, there are no lost sales and the lowest acceptable price as far as the selling division is concerned is the variable cost of $60 per unit. Transfer price ≥ $60+ $0 =$60 40,000 The buying division, Division Y, can buy a similar unit from an outside supplier for $74. Therefore, Division Y would be unwilling to pay more than $74 per unit. Transfer price ≤ Cost of buying from outside supplier = $74 In this case, the requirements of the two divisions are compatible and a transfer hopefully will take place at a transfer price within the range: $60 ≤ Transfer price ≤ $74 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 735 Problem 12-18 (30 minutes) 1. Total Company Sales ................................................... Less variable expenses ......................... Contribution margin.............................. Less traceable fixed expenses ............... Territorial segment margin .................... Less common fixed expenses not traceable to sales territories ($378,000 – $228,000 = $150,000) .... Net operating income ........................... Sales Territory Northern Southern $750,000 100.0 % $300,000 44.8 156,000 336,000 414,000 55.2 144,000 30.4 120,000 228,000 186,000 24.8 $ 24,000 150,000 $ 36,000 100 % $450,000 100 % 52 180,000 40 48 270,000 60 40 108,000 24 8 % $162,000 36 % 20.0 4.8 % Product Line Northern Territory Sales ..................................................$300,000 Less variable expenses ........................ 156,000 Contribution margin............................. 144,000 Less traceable fixed expenses .............. 70,000 Product line segment margin................ 74,000 Less common fixed expenses not traceable to product lines ($120,000 – $70,000 = $50,000) ....... 50,000 Territorial segment margin ................... $ 24,000 100.0 % 52.0 48.0 23.3 24.7 Paks $50,000 11,000 39,000 30,000 $ 9,000 Tibs 100 % $250,000 22 145,000 78 105,000 60 40,000 18 % $ 65,000 100 % 58 42 16 26 % 16.7 8.0 % © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 736 Managerial Accounting, 11th Edition Problem 12-18 (continued) 2. Two insights should be brought to the attention of management. First, compared to the Southern territory, the Northern territory has a low contribution margin ratio. Second, the Northern territory has high traceable fixed expenses. Overall, compared to the Southern territory, the Northern territory is very weak. 3. Again, two insights should be brought to the attention of management. First, the Northern territory has a poor sales mix. Note that the territory sells very little of the Paks product, which has a high contribution margin ratio. This poor sales mix accounts for the low overall contribution margin ratio in the Northern territory mentioned in part (2) above. Second, the traceable fixed expenses of the Paks product seem very high in relation to sales. These high fixed expenses may simply mean that the Paks product is highly leveraged; if so, then an increase in sales of this product line would greatly enhance profits in the Northern territory and in the company as a whole. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 737 Problem 12-19 (30 minutes) 1. Breaking the ROI computation into two separate elements helps the manager to see important relationships that might remain hidden if net operating income were simply related to operating assets. First, the importance of turnover of assets as a key element to overall profitability is emphasized. Prior to use of the ROI formula, managers tended to allow operating assets to swell to excessive levels. Second, the importance of sales volume in profit computations is stressed and explicitly recognized. Third, breaking the ROI computation into margin and turnover elements stresses the possibility of trading one off for the other in attempts to improve the overall profit picture. That is, a company may shave its margins slightly hoping for a great enough increase in turnover to increase the overall rate of return. Fourth, ratios make it easier to make comparisons between segments of the organization. Companies in the Same Industry A B C 2. Sales ......................................$600,000 * $500,000 * $2,000,000 Net operating income .............. $84,000 * $70,000 * $70,000 Average operating assets .........$300,000 * $1,000,000 $1,000,000 * Margin.................................... 14% 14% 3.5% * Turnover................................. 2.0 0.5 2.0 * Return on investment (ROI) ..... 28% 7% * 7% *Given. Because of differences in size between Company A and the other two companies (notice that B and C are equal in income and assets), it is difficult to say much about comparative performance looking at net operating income and operating assets alone. That is, it is impossible to determine whether Company A’s higher ROI is a result of its lower assets or its higher income. This points up the need to specifically include sales as an element in ROI computations. By including sales, light is shed on the comparative performance and possible problems in the three companies. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 738 Managerial Accounting, 11th Edition Problem 12-19 (continued) NAA Report No. 35 states (p. 35): “Introducing sales to measure level of operations helps to disclose specific areas for more intensive investigation. Company B does as well as Company A in terms of profit margin, for both companies earn 14% on sales. But Company B has a much lower turnover of capital than does Company A. Whereas a dollar of investment in Company A supports two dollars in sales each period, a dollar investment in Company B supports only fifty cents in sales each period. This suggests that the analyst should look carefully at Company B’s investment. Is the company keeping an inventory larger than necessary for its sales volume? Are receivables being collected promptly? Or did Company A acquire its fixed assets at a price level which was much lower than that at which Company B purchased its plant?” Thus, by including sales specifically in ROI computations the manager is able to discover possible problems, as well as reasons underlying a strong or a weak performance. Looking at Company A compared to Company C, notice that C’s turnover is the same as A’s, but C’s margin on sales is much lower. Why would C have such a low margin? Is it due to inefficiency, is it due to geographical location (requiring higher salaries or transportation charges), is it due to excessive materials costs, or is it due to other factors? ROI computations raise questions such as these, which form the basis for managerial action. To summarize, in order to bring B’s ROI into line with A’s, it seems obvious that B’s management will have to concentrate its efforts on increasing turnover, either by increasing sales or by reducing assets. It seems unlikely that B can appreciably increase its ROI by improving its margin on sales. On the other hand, C’s management should concentrate its efforts on the margin element by trying to pare down its operating expenses. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 739 Problem 12-20 (30 minutes) Present 1. (1) (2) (3) (4) (5) (6) Sales......................... Net operating income . Operating assets ........ Margin (2) ÷ (1) ........ Turnover (1) ÷ (3) ..... ROI (4) × (5) ............ New Line $10,000,000 $800,000 $4,000,000 8% 2.5 20.0% Total $2,000,000 $12,000,000 $160,000 * $960,000 $1,000,000 $5,000,000 8% 8% 2.0 2.4 16.0% 19.2% * Sales ........................................................... $2,000,000 Less variable expenses (60% × $2,000,000)... 1,200,000 Contribution margin ...................................... 800,000 Less fixed expenses ...................................... 640,000 Net operating income.................................... $ 160,000 2. Dell Havasi will be inclined to reject the new product line, since accepting it would reduce his division’s overall rate of return. 3. The new product line promises an ROI of 16%, whereas the company’s overall ROI last year was only 15%. Thus, adding the new line would increase the company’s overall ROI. Present 4. a. Operating assets ..................... Minimum return required ......... Minimum net operating income................................... Actual net operating income .... Minimum net operating income (above)....................... Residual income...................... New Line Total $4,000,000 $1,000,000 $5,000,000 12% × 12% × 12% × $ 480,000 $ 800,000 $ 120,000 $ 600,000 $ 160,000 $ 960,000 480,000 $ 320,000 120,000 600,000 $ 40,000 $ 360,000 b. Under the residual income approach, Dell Havasi would be inclined to accept the new product line, since adding the line would increase the total amount of his division’s residual income, as shown above. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 740 Managerial Accounting, 11th Edition Problem 12-21 (45 minutes) 1. The lowest acceptable transfer price from the perspective of the selling division is given by the following formula: Transfer price ≥ Variable cost + per unit Total contribution margin on lost sales Number of units transferred The Pulp Division has no idle capacity, so transfers from the Pulp Division to the Carton Division would cut directly into normal sales of pulp to outsiders. Since the costs are the same whether the pulp is transferred internally or sold to outsiders, the only relevant cost is the lost revenue of $70 per ton from the pulp that could be sold to outsiders. This is confirmed below: Transfer price ≥ $42 + ($70 - $42) × 5,000 = $42 + ($70 - $42) = $70 5,000 Therefore, the Pulp Division will refuse to transfer at a price less than $70 a ton. The Carton Division can buy pulp from an outside supplier for $70 a ton, less a 10% quantity discount of $7, or $63 a ton. Therefore, the Division would be unwilling to pay more than $63 per ton. Transfer price ≤ Cost of buying from outside supplier = $63 The requirements of the two divisions are incompatible. The Carton Division won’t pay more than $63 and the Pulp Division will not accept less than $70. Thus, there can be no mutually agreeable transfer price and no transfer will take place. 2. The price being paid to the outside supplier, net of the quantity discount, is only $63. If the Pulp Division meets this price, then profits in the Pulp Division and in the company as a whole will drop by $35,000 per year: Lost revenue per ton ............................. $70 Outside supplier’s price .......................... $63 Loss in contribution margin per ton......... $7 Number of tons per year ........................ × 5,000 Total loss in profits ................................ $35,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 741 Problem 12-21 (continued) Profits in the Carton Division will remain unchanged, since it will be paying the same price internally as it is now paying externally. 3. The Pulp Division has idle capacity, so transfers from the Pulp Division to the Carton Division do not cut into normal sales of pulp to outsiders. In this case, the minimum price as far as the Carton Division is concerned is the variable cost per ton of $42. This is confirmed in the following calculation: Transfer price ≥ $42 + $0 = $42 5,000 The Carton Division can buy pulp from an outside supplier for $63 a ton and would be unwilling to pay more than that for pulp in an internal transfer. If the managers understand their own businesses and are cooperative, they should agree to a transfer and should settle on a transfer price within the range: $42 ≤ Transfer price ≤ $63 4. Yes, $59 is a bona fide outside price. Even though $59 is less than the Pulp Division’s $60 “full cost” per unit, it is within the range given in Part 3 and therefore will provide some contribution to the Pulp Division. If the Pulp Division does not meet the $59 price, it will lose $85,000 in potential profits: Price per ton .......................................... Less variable costs .................................. Contribution margin per ton..................... $59 42 $17 5,000 tons × $17 per ton = $85,000 potential increased profits This $85,000 in potential profits applies to the Pulp Division and to the company as a whole. 5. No, the Carton Division should probably be free to go outside and get the best price it can. Even though this would result in suboptimization for the company as a whole, the buying division should probably not be forced to buy inside if better prices are available outside. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 742 Managerial Accounting, 11th Edition Problem 12-21 (continued) 6. The Pulp Division will have an increase in profits: Selling price ............................................. Less variable costs .................................... Contribution margin per ton....................... $70 42 $28 5,000 tons × $28 per ton = $140,000 increased profits The Carton Division will have a decrease in profits: Inside purchase price ................................ Outside purchase price.............................. Increased cost per ton .............................. $70 59 $11 5,000 tons × $11 per ton = $55,000 decreased profits The company as a whole will have an increase in profits: Increased contribution margin in the Pulp Division........... Decreased contribution margin in the Carton Division ...... Increased contribution margin per ton ............................ $28 11 $17 5,000 tons × $17 per ton = $85,000 increased profits So long as the selling division has idle capacity, profits in the company as a whole will increase if internal transfers are made. However, there is a question of fairness as to how these profits should be split between the selling and buying divisions. The inflexibility of management in this situation damages the profits of the Carton Division and greatly enhances the profits of the Pulp Division. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 743 Problem 12-22 (60 minutes) 1. Total Company Cookbook Travel Guide Handy Speller Sales ...................................... $300,000 100 % $90,000 100 % $150,000 100 % $60,000 100 % Less variable expenses: Printing cost ......................... 102,000 34 27,000 30 63,000 42 12,000 20 9,000 10 15,000 10 6,000 10 Sales commissions ................ 30,000 10 36,000 40 78,000 52 18,000 30 Total variable expenses ............ 132,000 44 54,000 60 72,000 48 42,000 70 Contribution margin ................. 168,000 56 Less traceable fixed expenses: Advertising ........................... 36,000 12 13,500 15 19,500 13 3,000 5 Salaries ................................ 33,000 11 18,000 20 9,000 6 6,000 10 Equipment depreciation* 9,000 3 2,700 3 4,500 3 1,800 3 4 1,800 2 6,000 4 4,200 7 Warehouse rent**................. 12,000 36,000 40 39,000 26 15,000 25 Total traceable fixed expenses .. 90,000 30 $18,000 20 % $ 33,000 22 % $27,000 45 % Product line segment margin .... 78,000 26 Less common fixed expenses: General sales ........................ 18,000 6 General administration........... 42,000 14 1 Depreciation—office facilities . 3,000 Total common fixed expenses... 63,000 21 5% Net operating income............... $ 15,000 *$9,000 × 30%, 50%, and 20%, respectively. **$48,000 square feet × $3 per square foot = $144,000; $144,000 ÷ 12 months = $12,000 per month. $12,000 ÷ 48,000 square feet = $0.25 per square foot per month. $0.25 × 7,200 square feet, 24,000 square feet, and 16,800 square feet, respectively. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 744 Managerial Accounting, 11th Edition Problem 12-22 (continued) 2. a. No, the cookbook line should not be eliminated. The cookbook is covering all of its own costs and is generating an $18,000 segment margin toward covering the company’s common costs and toward profits. (Note: Problems relating to the elimination of a product line are covered in more depth in Chapter 13.) b. No, it is probably unwise to focus all available resources on promoting the travel guide. The company is already spending nearly as much on the promotion of this line as it is on the other two lines together. Furthermore, the travel guide has the lowest contribution margin ratio of the three products. Nevertheless, we cannot say for sure which product should be emphasized in this situation without more information. If the equipment is being fully utilized, increasing the production of any one product would require cutting back on one of the other products. In Chapter 13 we will discuss how to choose the most profitable product when there is a constraint that forces such a trade-off between products. 3. At least three additional points should be brought to the attention of management: i. Compared to the other two lines, salaries are very high for the cookbook line. This should be investigated to find the reason for the wide difference in cost. ii. The company pays a commission of 10% on the selling price of any book. Consideration should be given to revising the commission structure to base it on contribution margin, rather than on sales. iii. Management should consider JIT deliveries to reduce warehouse costs. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 745 Problem 12-23 (20 minutes) 1. Operating assets do not include investments in other companies or in undeveloped land. Ending Balances Beginning Balances Cash ..................................................... $ 120,000 Accounts receivable ................................ 530,000 Inventory............................................... 380,000 Plant and equipment (net) ...................... 620,000 Total operating assets............................. $1,650,000 Average operating assets = Margin = = Turnover= = $ 140,000 450,000 320,000 680,000 $1,590,000 $1,650,000 + $1,590,000 = $1,620,000 2 Net operating income Sales $405,000 = 10% $4,050,000 Sales Average operating assets $4,050,000 = 2.5 $1,620,000 ROI = Margin × Turnover = 10% × 2.5 = 25% 2. Net operating income ............................................ Minimum required return (15% × $1,620,000) ........ Residual income.................................................... $405,000 243,000 $162,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 746 Managerial Accounting, 11th Edition Problem 12-24 (60 minutes) 1. From the standpoint of the selling division, Alpha Division: Transfer price ≥ Variable cost + per unit Transfer price ≥ ($18 - $2)+ Total contribution margin on lost sales Number of units transferred ($30 - $18) × 5,000 = $16 + $12 = $28 5,000 But, from the standpoint of the buying division, Beta Division: Transfer price ≤ Cost of buying from outside supplier = $27 Beta Division won’t pay more than $27 and Alpha Division will not accept less than $28, so no deal is possible. There will be no transfer. 2. a. From the standpoint of the selling division, Alpha Division: Transfer price ≥ Variable cost + per unit Transfer price ≥ ($65 - $5) + Total contribution margin on lost sales Number of units transferred ($90 - $65) × 30,000 = $60 + $25 = $85 30,000 From the standpoint of the buying division, Beta Division: Transfer price ≤ Cost of buying from outside supplier = $89 In this instance, an agreement is possible within the range: $85 ≤ Transfer price ≤ $89 Even though both managers would be better off with any transfer price within this range, they may disagree about the exact amount of the transfer price. It would not be surprising to hear the buying division arguing strenuously for $85 while the selling division argues just as strongly for $89. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 747 Problem 12-24 (continued) b. The loss in potential profits to the company as a whole will be: Beta Division’s outside purchase price ......................... Alpha Division’s variable cost on the internal transfer.... Potential added contribution margin lost to the company as a whole...................................................... Number of units ........................................................ Potential added contribution margin and company profits forgone........................................................ $89 85 $4 × 30,000 $120,000 Another way to derive the same answer is to look at the loss in potential profits for each division and then total the losses for the impact on the company as a whole. The loss in potential profits in Alpha Division will be: Suggested selling price per unit .................................. Alpha Division’s variable cost on the internal transfer.... Potential added contribution margin per unit................ Number of units ........................................................ Potential added contribution margin and divisional profits forgone........................................................ $88 85 $3 × 30,000 $ 90,000 The loss in potential profits in Beta Division will be: Outside purchase price per unit .................................. Suggested price per unit inside ................................... Potential cost avoided per unit.................................... Number of units ........................................................ Potential added contribution margin and divisional profits forgone........................................................ $89 88 $1 × 30,000 $ 30,000 The total of these two amounts equals the $120,000 loss in potential profits for the company as a whole. 3. a. From the standpoint of the selling division, Alpha Division: Transfer price ≥ Variable cost + per unit Total contribution margin on lost sales Number of units transferred Transfer price ≥ $40 + $0 = $40 20,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 748 Managerial Accounting, 11th Edition Problem 12-24 (continued) From the standpoint of the buying division, Beta Division: Transfer price ≤ Cost of buying from outside supplier Transfer price ≤ $75 - (0.08 × $75) = $69 In this case, an agreement is possible within the range: $40 ≤ Transfer price ≤ $69 If the managers understand what they are doing and are reasonably cooperative, they should be able to come to an agreement with a transfer price within this range. b. Alpha Division’s ROI should increase. Since the division has idle capacity, there should be little or no increase needed in the division’s operating assets as a result of selling 20,000 units a year to Beta Division. Therefore, Alpha Division’s turnover should increase. The division’s margin earned on sales should also increase, since its contribution margin will increase by $400,000 as a result of the new sales, with no offsetting increase in fixed costs: Selling price ..................................... Less variable costs............................ Contribution margin .......................... Number of units ............................... Added contribution margin ................ $60 40 $20 × 20,000 $400,000 Thus, with both the margin and the turnover increasing, the division’s ROI would also increase. 4. From the standpoint of the selling division, Alpha Division: Transfer price ≥ Variable cost + per unit Transfer price ≥ $21 + Total contribution margin on lost sales Number of units transferred ($50 - $26) × 45,000 120,000 = $21 + $9 = $30 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 749 Problem 12-25 (60 minutes) 1. The disadvantages or weaknesses to the company’s format are as follows: a. The company should include a column showing the combined results of the three regions taken together. b. Additional columns showing percentages would be helpful in assessing performance and pinpointing areas of difficulty. c. The regional expenses should be segregated into variable and fixed categories to permit the computation of both a contribution margin and a regional segment margin. d. The corporate expenses are probably common to the regions and should not be arbitrarily allocated. 2. Corporate advertising expenses have been allocated on the basis of sales dollars; the general administrative expenses have been allocated evenly among the three regions. Such allocations should not be made under the contribution approach, since they can be misleading to management and tend to call attention away from the segment margin. The segment margin should be used to measure the performance of a segment, not the “net operating income” or “net loss” after allocating common expenses. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 750 Managerial Accounting, 11th Edition Problem 12-25 (continued) 3. Total Amount % West Amount % Central Amount % East Amount % Sales .....................................$2,000,000 100.0 $450,000 100.0 $800,000 100.0 $750,000 Less variable expenses: Cost of goods sold ............... 819,400 41.0 162,900 36.2 280,000 35.0 376,500 Shipping expense................. 77,600 3.9 17,100 3.8 32,000 4.0 28,500 Total variable expenses ........... 897,000 44.9 180,000 40.0 312,000 39.0 405,000 Contribution margin ................ 1,103,000 55.1 270,000 60.0 488,000 61.0 345,000 Less traceable fixed expenses: Advertising .......................... 518,000 25.9 108,000 24.0 200,000 25.0 210,000 Salaries ............................... 313,000 15.6 90,000 20.0 88,000 11.0 135,000 Utilities................................ 40,500 2.0 13,500 3.0 12,000 1.5 15,000 Depreciation ........................ 85,000 4.3 27,000 6.0 28,000 3.5 30,000 Total traceable fixed expenses ................................ 956,500 47.8 238,500 53.0 328,000 41.0 390,000 Regional segment margin........ 146,500 7.3 $31,500 7.0 $160,000 20.0 $(45,000) Less common fixed expenses not traceable to the regions: Advertising (general) 80,000 4.0 General admin. expenses...... 150,000 7.5 Total common fixed expenses.. 230,000 11.5 Net loss ................................. $ (83,500) (4.2) 100.0 50.2 3.8 54.0 46.0 28.0 18.0 2.0 4.0 52.0 (6.0) Note: Percentage figures may not total down due to rounding. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 751 Problem 12-25 (continued) 4. The following points should be brought to the attention of management: a. Sales in the West are much lower than in the other two regions. This is not due to lack of salespeople since salaries in the West are about the same as in the Central Region, which has the highest sales of the three regions. b. The West is spending about half as much for advertising as the Central Region. Perhaps this is the reason for the West’s lower sales. c. The East apparently is selling a large amount of low-margin items. Note that it has a contribution margin ratio of only 46%, compared to 60% or more for the other two regions. d. The East appears to be overstaffed. Its salaries are about 50% greater than in either of the other two regions. e. The East is not covering its own traceable costs. Major attention should be given to improving the sales mix and reducing expenses in this region. f. Apparently, the salespeople in all three regions are on a salary basis. Perhaps a change to a commission basis would encourage the sales staff to be more aggressive and improve sales throughout the company. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 752 Managerial Accounting, 11th Edition Problem 12-26 (60 minutes) 1. (a) Total Cost (b) Total Activity (a) ÷ (b) Rate Sales support .............. $3,600,000 24,000 calls Order processing ......... 1,720,000 8,600 orders Warehousing ............... 940,000 117,500 square feet Packing and shipping ... 520,000 104,000 pounds shipped $150 per call $200 per order $8 per square foot $5 per pound shipped Assignment of expenses to markets: Commercial Market Events or Amount Transactions Sales support, at $150 per call........... Order processing, at $200 per order........ Warehousing, at $8 per square foot ....... Packing and shipping, at $5 per pound .................... Home Market Events or Transactions Amount School Market Events or Transactions Amount 8,000 $1,200,000 5,000 $ 750,000 11,000 $1,650,000 1,750 350,000 5,200 1,040,000 1,650 330,000 35,000 280,000 65,000 520,000 17,500 140,000 24,000 120,000 16,000 80,000 64,000 320,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 753 Problem 12-26 (continued) 2. The segmented income statement follows (All dollar amounts are in thousands of dollars): Total Amount % Commercial Amount % Sales ................................. $20,000 100.0 $8,000 100.0 Less variable expenses: Cost of goods sold ........... 9,500 47.5 3,900 48.8 Sales support................... 3,600 18.0 1,200 15.0 Order processing.............. 1,720 8.6 350 4.4 Packing and shipping........ 520 2.6 120 1.5 Total variable expenses ....... 15,340 76.7 5,570 69.6 Contribution margin ............ 4,660 23.3 2,430 30.4 Less traceable fixed expenses: Warehousing ................... 940 4.7 280 3.5 Advertising ...................... 1,460 7.3 700 8.8 General mgmt—salaries .... 410 2.1 150 1.9 Total traceable fixed expenses ............................ 2,810 14.1 1,130 14.1 Market segment margin ...... 1,850 9.3 $1,300 16.3 [The statement is continued on the next page] Market Home Amount % School Amount % $5,000 100.0 $7,000 100.0 2,400 750 1,040 80 4,270 730 48.0 15.0 20.8 1.6 85.4 14.6 3,200 1,650 330 320 5,500 1,500 45.7 23.6 4.7 4.6 78.6 21.4 520 180 120 10.4 3.6 2.4 140 580 140 2.0 8.3 2.0 860 $ 640 12.3 9.1 820 16.4 $(90) (1.8) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 754 Managerial Accounting, 11th Edition Problem 12-26 (continued) Total Amount % Market segment margin ...... 1,850 Less common fixed expenses not traceable to markets: Advertising.................... 230 General management .... 900 Total common fixed expenses ............................ 1,130 Net operating income.......... $ 720 9.3 Commercial Amount % $1,300 16.3 Market Home Amount % $(90) (1.8) School Amount % $ 640 9.1 1.2 4.5 5.7 3.6 Note: Percentage figures may not total down due to rounding. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 755 Problem 12-26 (continued) 3. The following comments relate to the three markets: Commercial market: • The commercial market is the company’s strongest segment rather than its weakest. It is generating enough segment margin by itself to cover all of the company’s common costs. • The manager of the commercial market is doing an outstanding job of controlling expenses. Expenses as a percentage of sales are lower than the company average for every category except cost of sales and advertising, and these latter two costs do not seem out of line. Home Market: • The home market spends very little on advertising. A more generous advertising budget may yield a substantial increase in sales in this segment. • Order processing expenses are extremely high in the home market. Note from the data in the problem that more orders are written in this market (5,200 orders) than in the other two markets combined. This large number of orders, combined with the low overall sales in the home market, means that the home market is taking many small orders. • Warehousing expenses are also high in the home market. • The home market is not covering its own traceable costs. If sales can’t be increased through a more generous advertising budget and through a concerted effort to make larger sales per order and other actions, then consideration should be given to eliminating this market segment. School Market: • The school market has extremely high sales support expenses. This is because nearly as many sales calls are made to this market (11,000 calls) as are made to the other two markets combined. Can contacts be made by phone or by other means? • Over 60% of the packing and shipping expenses are traceable to the school market. The company may want to investigate cheaper shipping methods. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 756 Managerial Accounting, 11th Edition Problem 12-27 (30 minutes) 1. ROI = Margin × Turnover = Net operating income Sales × Sales Average operating assets = $360,000 $4,000,000 × $4,000,000 $2,000,000 = 9% × 2 = 18% 2. ROI = $360,000 $4,000,000 × $4,000,000 $1,600,000 = 9% × 2.5 = 22.5% (Unchanged) (Increase) (Increase) 3. ROI = = $392,000 $4,000,000 × $4,000,000 $2,000,000 9.8% × 2 = (Increase) (Unchanged) 19.6% (Increase) 4. Interest is a financing expense and thus it is not used to compute net operating income. ROI = = $380,000 $4,000,000 × $4,000,000 $2,500,000 9.5% × 1.6 = (Increase) (Decrease) 15.2% (Decrease) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 757 Problem 12-27 (continued) 5. The company has a contribution margin ratio of 30% ($24 CM per unit, divided by the $80 selling price per unit). Therefore, a 20% increase in sales would result in a new net operating income of: Sales (1.20 × $4,000,000) ........................ Less variable expenses.............................. Contribution margin.................................. Less fixed expenses.................................. Net operating income ............................... ROI = = 6. ROI = = 7. ROI = $4,800,000 3,360,000 1,440,000 840,000 $ 600,000 100 % 70 30 % $600,000 $4,800,000 × $4,800,000 $2,000,000 12.5% × 2.4 = 30% (Increase) (Increase) (Increase) $320,000 $4,000,000 × $4,000,000 $1,960,000 8% × 2.04 = 16.3% (Decrease) (Increase) (Decrease) $360,000 $4,000,000 × $4,000,000 $1,800,000 = 9% × 2.22 = 20% (Unchanged) (Increase) (Increase) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 758 Managerial Accounting, 11th Edition Problem 12-28 (30 minutes) 1. The average operating assets for the year must be computed before determining the ROI and residual income. The computation is: Ending balance........................................... $12,960,000 Beginning balance ($12,960,000 ÷ 1.08)...... 12,000,000 Total.......................................................... $24,960,000 Average balance ($24,960,000 ÷ 2) ............. $12,480,000 a. ROI = Margin × Turnover = Net operating income Sales × Sales Average operating assets = $1,872,000 $31,200,000 × = 6% × 2.5 = 15% $31,200,000 $12,480,000 b. Net operating income ............................. $1,872,000 Minimum required net operating income: Average operating assets ..................... $12,480,000 Minimum required return...................... × 11% 1,372,800 Residual income ..................................... $ 499,200 2. The division’s management would have been more likely to accept the investment opportunity if residual income, rather than ROI, had been used to evaluate performance and determine bonuses. The investment would have lowered the division’s ROI because its expected return of 13% is lower than the division’s historical returns of 14% to 17% as well as its most recent ROI of 15%. In contrast, the division’s residual income would be increased by the investment opportunity. From the standpoint of the entire company, an investment whose return exceeds the minimum required return should be accepted. However, when bonuses are based on ROI, the division will likely reject any investment that lowers the division’s ROI even if it exceeds the minimum required rate of return. 3. Reigis must be free to control all items related to profit (revenues and expenses) and investment if it is to be evaluated fairly as an investment center. This is true under both the ROI and residual income approaches. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 759 Problem 12-29 (45 minutes) 1. The Quark Division will probably reject the $340 price because it is below the division’s variable costs of $350 per set. This variable cost includes the $140 transfer price from the Cabinet Division, which in turn includes $30 per unit in fixed costs. Nevertheless, from the perspective of the Quark Division, the entire $140 transfer price from the Cabinet Division is a variable cost. Thus, it will reject the offered $340 price. 2. If both the Cabinet Division and the Quark Division have idle capacity, then from the perspective of the entire company the $340 offer should be accepted. By rejecting the $340 price, the company will lose $60 in potential contribution margin per set: Price offered per set ................................ Less variable costs per set: Cabinet Division .................................... Quark Division ...................................... Potential contribution margin per set......... $340 $ 70 210 280 $ 60 3. If the Cabinet Division is operating at capacity, any cabinets transferred to the Quark Division to fill the overseas order will have to be diverted from outside customers. Whether a cabinet is sold to outside customers or is transferred to the Quark Division, its production cost is the same. However, if a set is diverted from outside sales, the Cabinet Division (and the entire company) loses the $140 in revenue. As a consequence, as shown below, there would be a net loss of $10 on each TV set sold for $340. Price offered per set .............................................. $340 Less: Lost revenue from sales of cabinets to outsiders ... $140 Variable cost of Quark Division............................. 210 350 Net loss per TV ..................................................... ($ 10) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 760 Managerial Accounting, 11th Edition Problem 12-29 (continued) 4. When the selling division has no idle capacity, as in part (3), market price works very well as a transfer price. The cost to the company of a transfer when there is no idle capacity is the lost revenue from sales to outsiders. If the market price is used as the transfer price, the buying division will view the market price of the transferred item as its cost— which is appropriate since that is the cost to the company. As a consequence, the manager of the buying division should be motivated to make decisions that are in the best interests of the company. When the selling division has idle capacity, the cost to the company of the transfer is just the variable cost of producing the item. If the market price is used as the transfer price, the manager of the buying division will view that as his/her cost rather than the real cost to the company, which is just variable cost. Hence, the manager will have the wrong cost information for making decisions as we observed in parts (1) and (2) above. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 761 Problem 12-30 (60 minutes) 1. Segments defined as product lines: Glass Division Amount % Sales..................................... R600,000 Less variable expenses ........... 300,000 Contribution margin ............... 300,000 Less traceable fixed expenses: Advertising.......................... 120,000 Depreciation........................ 48,000 Administration ..................... 42,000 Total ..................................... 210,000 Product line segment margin... 90,000 Less common fixed expenses not traceable to product lines: Administration ..................... 60,000 Divisional segment margin ...... R 30,000 100 50 50 Flat Glass Amount % Product Line Auto Glass Amount % R200,000 100 R300,000 100 130,000 65 120,000 40 70,000 35 180,000 60 20 8 7 35 15 R 30,000 10,000 14,000 54,000 16,000 15 5 7 27 8 R 42,000 24,000 21,000 87,000 93,000 14 8 7 29 31 Specialty Glass Amount % R100,000 100 50,000 50 50,000 50 48,000 14,000 7,000 69,000 R (19,000) 48 14 7 69 (19) 10 5 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 762 Managerial Accounting, 11th Edition Problem 12-30 (continued) 2. Segments defined as markets for Specialty Glass: Specialty Glass Amount % Sales ........................................... R100,000 Less variable expenses ................. 50,000 Contribution margin...................... 50,000 Less traceable fixed expenses: Advertising ................................ 48,000 Market segment margin ................ 2,000 Less common fixed expenses not traceable to sales markets: Depreciation.............................. 14,000 Administration ........................... 7,000 Total............................................ 21,000 Product line segment margin......... R (19,000) Sales Market Domestic Foreign Amount % Amount % 100 50 50 48 2 R60,000 100 30,000 50 30,000 50 R 40,000 100 20,000 50 20,000 50 18,000 R12,000 30,000 75 R(10,000) (25) 30 20 14 7 21 (19) Flat Glass Auto Glass 3. Incremental contribution margin: 35% × R40,000 increased sales................ 60% × R30,000 increased sales................ Less cost of the promotional campaign ........ Increased net operating income .................. R14,000 8,000 R 6,000 R18,000 8,000 R10,000 Based on these data, the campaign should be directed toward Auto Glass. Note that the analysis uses the contribution margin ratio rather than the segment margin ratio. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 763 Problem 12-31 (45 minutes) 1. The number of valves that must be sold would be: Let X $5X $2X X = = = = units sold $3X + $462,000 + $98,000* $560,000 280,000 valves, or $1,400,000 in sales *$700,000 × 14% = $98,000. a. b. Margin = Net operating income $98,000 = = 7% Sales $1,400,000 Turnover = Sales $1,400,000 = = 2.0 Operating assets $700,000 2. and 3. Sales Volume Units sold................................. 260,000 280,000 300,000 (1) Sales @ $5.20*, $5.00 and $4.80* .................................. $1,352,000 $1,400,000 $1,440,000 840,000 900,000 Less variable expense @ $3....... 780,000 Contribution margin .................. 572,000 560,000 540,000 462,000 462,000 Less fixed expenses .................. 462,000 (2) Net operating income................ $ 110,000 $ 98,000 $ 78,000 (3) Total assets .............................. $ 650,000 $ 700,000 $ 750,000 (4) Margin (2) ÷ (1) ....................... (5) Turnover (1) ÷ (3) .................... ROI (4) × (5) ........................... 8.14% 2.08 16.93% 7.00% 2.00 14.00% 5.42% 1.92 10.41% *$5.00 × 1.04 = $5.20; $5.00 × 0.96 = $4.80. Note: The $280,000 column is not required. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 764 Managerial Accounting, 11th Edition Problem 12-31 (continued) 4. Present Sales New Sales Total Sales Units sold...................................... 280,000 20,000 300,000 (1) Sales @ $5.00 and $4.25 ........ $1,400,000 $85,000 $1,485,000 900,000 Less variable expenses @ $3... 840,000 60,000 Contribution margin ............... 560,000 25,000 585,000 0 462,000 Less fixed expenses ............... 462,000 (2) Net operating income ............. $ 98,000 $25,000 $ 123,000 (3) Total assets ........................... $ 700,000 $50,000 $ 750,000 (4) Margin (2) ÷ (1) .................... (5) Turnover (1) ÷ (3) ................. ROI (4) × (5) ........................ 7.00% 2.00 14.00% 29.41% 1.70 50.00% 8.28% 1.98 16.39% Yes, the manager of the Valve Division should accept the $4.25 price. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 765 Problem 12-32 (30 minutes) 1. The variable cost of the new tube will be: Direct materials..................................... $ 60 Direct labor .......................................... 49 Variable overhead (1/3 × $54) ............... 18 Total variable cost ................................. $127 The lost contribution margin on outside sales will be: Selling price (regular tubes) ................... Less variable expenses: Direct materials .................................. Direct labor ........................................ Variable overhead (25% × $40) .......... Variable selling and administrative* ..... Contribution margin per tube ................. *Total selling and administrative............... Less fixed portion ................................. Variable portion .................................... $170 $38 27 10 5 80 $ 90 $390,000 350,000 $ 40,000 $40,000 ÷ 8,000 tubes = $5 per tube. The lowest acceptable transfer price from the perspective of the selling division is given by the following formula: Transfer price ≥ Variable + cost Transfer price ≥ $127+ Total contribution margin on lost sales Number of units transferred $90 × 3,000 = $127 + $108 = $235 2,500 2. Any price below $235 will result in a decline in the profits of both the Tube Division and the entire company. If the Tube Division meets a price of $200, then profits will decrease by $87,500 as show below: $235 Minimum transfer price.................................................. 200 Outside supplier’s price.................................................. Potential decrease in contribution margin ........................ $ 35 Number of units ............................................................ × 2,500 Total potential decrease in contribution margin and net operating income........................................................ $87,500 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 766 Managerial Accounting, 11th Edition Case 12-33 (90 minutes) 1. Total Company Amount % Sales ....................................... $1,500,000 Less variable expenses: Production............................. 336,000 Selling................................... 142,000 Total variable expenses ............. 478,000 Contribution margin .................. 1,022,000 Less traceable fixed expenses: Production............................. 376,000 Selling................................... 282,000 Total traceable fixed expenses ... 658,000 Product segment margin ........... 364,000 Less common fixed expenses: Production............................. 210,000 Administrative........................ 180,000 Total common fixed expenses.... 390,000 Net loss .................................... $ (26,000) 100.0 Product A Amount % Product B Amount % Product C Amount % $600,000 100 $400,000 100 $500,000 100 22.4 9.5 31.9 68.1 108,000 60,000 168,000 432,000 18 10 28 72 128,000 32,000 160,000 240,000 32 8 40 60 100,000 50,000 150,000 350,000 20 10 30 70 25.1 18.8 43.9 24.3 180,000 102,000 282,000 $150,000 30 17 47 25 36,000 80,000 116,000 $124,000 9 20 29 31 160,000 100,000 260,000 $ 90,000 32 20 52 18 14.0 12.0 26.0 (1.7) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 767 Case 12-33 (continued) 2. Product C should not be eliminated. As shown on the income statement in part 1, product C is covering all of its own traceable costs and it is generating a segment margin of $90,000 per month. If the product is eliminated, all of this segment margin will be lost to the company, resulting in even larger overall monthly losses. 3. No, the company should concentrate its remaining inventory of X7 chips on making product A, not product B. The company should focus on the product that will provide the greatest amount of contribution margin. Under the conditions posed, product A will provide the greatest amount of contribution margin since (1) it has a CM ratio of 72% as compared to only 60% for product B; (2) the two products have the same selling price, and therefore, due to its higher CM ratio, product A will generate a greater amount of contribution margin per chip than product B; and (3) the two products require the same number of chips per unit. 4. a. An income statement showing product C segmented by markets appears on the next page. b. The following insights should be brought to the attention of management: 1. Sales in the vending market are very low as compared to the home market. 2. Variable selling expenses are 28% of sales in the vending market as compared to only 8% in the home market. Is this just the nature of the markets, or are the high variable selling expenses in the vending market a result of poor cost control? 3. The traceable fixed selling expenses in the vending market are 50% higher than in the home market, even though the vending market has only a fraction of the sales of the home market. Why would these costs be so high in the vending market? 4. The vending market has a negative segment margin. If sales can’t be increased enough in future months to permit the market to cover its own costs, then consideration should be given to eliminating the market. (Instructor’s note: The question of elimination of product lines and other segments is covered in more detail in Chapter 13.) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 768 Managerial Accounting, 11th Edition Case 12-33 (continued) Product C Amount % Sales ............................................ $500,000 100 Less variable expenses: Production.................................. 100,000 20 Selling........................................ 50,000 10 Total variable expenses .................. 150,000 30 Contribution margin ....................... 350,000 70 Less traceable fixed expenses: Selling........................................ 75,000 15 Market segment margin ................. 275,000 55 Less common fixed expenses not traceable to market segments: Production.................................. 160,000 32 5 Selling* ...................................... 25,000 Total common fixed expenses......... 185,000 37 Product segment margin ................ $ 90,000 18 *Total fixed selling expenses ........................................ Less fixed selling expenses traceable to the markets .... Fixed selling expenses common to the markets............ Vending Market Amount % Home Market Amount % $ 50,000 100 $450,000 100.0 90,000 36,000 126,000 324,000 20.0 8.0 28.0 72.0 30,000 $294,000 6.7 65.3 10,000 14,000 24,000 26,000 20 28 48 52 45,000 90 $(19,000) (38) $100,000 75,000 $ 25,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 769 Case 12-34 (45 minutes) 1. The Electrical Division is presently operating at capacity; therefore, any sales of X52 electrical fitting to the Brake Division will require that the Electrical Division give up an equal number of sales to outside customers. Using the transfer pricing formula, we get a minimum transfer price of: Transfer price ≥ Variable cost + per unit Total contribution margin on lost sales Number of units transferred Transfer price ≥ $4.25 + ($7.50 - $4.25) Transfer price ≥ $4.25 + $3.25 Transfer price ≥ $7.50 Thus, the Electrical Division should not supply the fitting to the Brake Division for $5 each. The Electrical Division must give up revenues of $7.50 on each fitting that it sells internally. Since management performance in the Electrical Division is measured by ROI, selling the fittings to the Brake Division for $5 would adversely affect these performance measurements. 2. The key is to realize that the $8 in fixed overhead and administrative costs contained in the Brake Division’s $49.50 “cost” per brake unit is not relevant. There is no indication that winning this contract would actually affect any of the fixed costs. If these costs would be incurred regardless of whether or not the Brake Division gets the airplane brake contract, they should be ignored when determining the effects of the contract on the company’s profits. Another key is that the variable cost of the Electrical Division is not relevant either. Whether the fittings are used in the brake units or sold to outsiders, the production costs of the fittings would be the same. The only difference between the two alternatives is the revenue on outside sales that is given up when the fittings are transferred within the company. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 770 Managerial Accounting, 11th Edition Case 12-34 (continued) Selling price of the brake units .................................. $50.00 Less: The cost of the fittings used in the brakes (i.e. the lost revenue from sale of fittings to outsiders)....... $ 7.50 Variable costs of the Brake Division excluding the fitting ($22.50 + $14.00)..................................... 36.50 44.00 Net positive effect on the company’s profit................. $ 6.00 Therefore, the company as a whole would be better off by $6.00 for each brake unit that is sold to the airplane manufacturer. 3. As shown in part (1) above, the Electrical Division would insist on a transfer price of at least $7.50 for the fitting. Would the Brake Division make any money at this price? Again, the fixed costs are not relevant in this decision since they would not be affected. Once this is realized, it is evident that the Brake Division would be ahead by $6.00 per brake unit if it accepts the $7.50 transfer price. Selling price of the brake units ................................. $50.00 Less: Purchased parts (from outside vendors) ................. $22.50 Electrical fitting X52 (assumed transfer price) ......... 7.50 Other variable costs .............................................. 14.00 44.00 Brake Division contribution margin ........................... $ 6.00 In fact, since there is a positive contribution margin of $6, any transfer price within the range of $7.50 to $13.50 (= $7.50 + $6.00) will improve the profits of both divisions. So yes, the managers should be able to agree on a transfer price. 4. It is in the best interests of the company and of the divisions to come to an agreement concerning the transfer price. As demonstrated in part (3) above, any transfer price within the range $7.50 to $13.50 would improve the profits of both divisions. What happens if the two managers do not come to an agreement? © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 771 Case 12-34 (continued) In this case, top management knows that there should be a transfer and could step in and force a transfer at some price within the acceptable range. However, such an action, if done on a frequent basis, would undermine the autonomy of the managers and turn decentralization into a sham. Our advice to top management would be to ask the two managers to meet to discuss the transfer pricing decision. Top management should not dictate a course of action or what is to happen in the meeting, but should carefully observe what happens in the meeting. If there is no agreement, it is important to know why. There are at least three possible reasons. First, the managers may have better information than the top managers and refuse to transfer for very good reasons. Second, the managers may be uncooperative and unwilling to deal with each other even if it results in lower profits for the company and for themselves. Third, the managers may not be able to correctly analyze the situation and may not understand what is actually in their own best interests. For example, the manager of the Brake Division may believe that the fixed overhead and administrative cost of $8 per brake unit really does have to be covered in order to avoid a loss. If the refusal to come to an agreement is the result of uncooperative attitudes or an inability to correctly analyze the situation, top management can take some positive steps that are completely consistent with decentralization. If the problem is uncooperative attitudes, there are many training companies that would be happy to put on a short course in team building for the company. If the problem is that the managers are unable to correctly analyze the alternatives, they can be sent to executive training courses that emphasize economics and managerial accounting. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 772 Managerial Accounting, 11th Edition Case 12-35 (75 minutes) 1. See the segmented statement on the second following page. Supporting computations for the statement are given below: Revenues: Membership dues (20,000 × $100) ............................ $2,000,000 Assigned to Magazine Subscriptions Division (20,000 × $20) ...................................................... 400,000 Assigned to Membership Division ............................... $1,600,000 Non-member magazine subscriptions (2,500 × $30).... $ 75,000 Reports and texts (28,000 × $25) .............................. $ 700,000 Continuing education courses: One-day (2,400 × $75)........................................... $ 180,000 Two-day (1,760 × $125) ......................................... 220,000 Total revenue ........................................................... $ 400,000 Salary and personnel costs: Membership Division ..................... Magazine Subscriptions Division ..... Books and Reports Division ............ Continuing Education Division ........ Total assigned to divisions ............. Corporate staff.............................. Total ............................................ Salaries Personnel Costs (25% of Salaries) $210,000 150,000 300,000 180,000 840,000 80,000 $920,000 $ 52,500 37,500 75,000 45,000 210,000 20,000 $230,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 773 Case 12-35 (continued) Some may argue that, except for the $50,000 in rental cost directly attributed to the Books and Reports Division, occupancy costs are common costs that should not be allocated. The correct treatment of the occupancy costs depends on whether they could be avoided in part by eliminating a division. In the solution below, we have assumed they could be avoided. Occupancy costs ($230,000 allocated + $50,000 direct to the Books and Reports Division = $280,000): Allocated to: Membership Division ($230,000 × 0.2) ............................................ $ 46,000 Magazine Subscriptions Division ($230,000 × 0.2) ............................................ 46,000 Books and Reports Division ($230,000 × 0.3 + $50,000) ............................ 119,000 Continuing Education Division ($230,000 × 0.2) ............................................ 46,000 Corporate staff ($230,000 × 0.1) ............................................ 23,000 Total occupancy costs ........................................ $280,000 Printing and paper costs ....................................... $320,000 Assigned to: Magazine Subscriptions Division (22,500 × $7) .............................................. $157,500 Books and Reports Division (28,000 × $4) .............................................. 112,000 269,500 Remainder—Continuing Education Division........ $ 50,500 Postage and shipping costs ................................... $176,000 Assigned to: Magazine Subscriptions Division (22,500 × $4) .............................................. $ 90,000 Books and Reports Division (28,000 × $2) .............................................. 56,000 146,000 Remainder—corporate staff.............................. $ 30,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 774 Managerial Accounting, 11th Edition Case 12-35 (continued) Division Magazine Books & Continuing Association Membership Subscriptions Reports Education Total Revenues: Membership dues ........................... $2,000,000 Non-member magazine subscriptions ........................................... 75,000 Advertising ..................................... 100,000 Reports and texts ........................... 700,000 Continuing education courses .......... 400,000 Total revenues ................................ 3,275,000 Expenses traceable to segments: Salaries.......................................... 840,000 Personnel costs............................... 210,000 Occupancy costs ............................. 257,000 Reimbursement of member costs to local chapters ................................. 600,000 Other membership services ............. 500,000 Printing and paper .......................... 320,000 Postage and shipping ...................... 146,000 Instructors’ fees.............................. 80,000 Total traceable expenses ................. 2,953,000 Division segment margin.................... 322,000 [The statement is continued on the next page.] $1,600,000 $400,000 75,000 100,000 $700,000 1,600,000 575,000 700,000 $400,000 400,000 210,000 52,500 46,000 150,000 37,500 46,000 300,000 75,000 119,000 180,000 45,000 46,000 157,500 90,000 112,000 56,000 50,500 600,000 500,000 1,408,500 $ 191,500 481,000 $ 94,000 662,000 $ 38,000 80,000 401,500 $ (1,500) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 775 Case 12-35 (continued) [Continuation of the segmented income statement.] Division Association Magazine Books & Continuing Total Membership Subscriptions Reports Education Division segment margin.................... Less common expenses not traceable to divisions: Salaries—corporate staff.................. Personnel costs............................... Occupancy costs ............................. Postage and shipping ...................... General and administrative .............. Total common expenses..................... Excess of revenues over expenses ...... 322,000 $ 191,500 $ 94,000 $ 38,000 $ (1,500) 80,000 20,000 23,000 30,000 38,000 191,000 $ 131,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 776 Managerial Accounting, 11th Edition Case 12-35 (continued) 2. While we do not favor the allocation of common costs to segments, the most common reason given for this practice is that segment managers need to be aware of the fact that common costs do exist and that they must be covered. Arguments against allocation of all costs: • Allocation bases will need to be chosen arbitrarily since no cause-andeffect relationship exists between common costs and the segments to which they are allocated. • Management may be misled into eliminating a profitable segment that appears to be unprofitable because of allocated common costs. • Segment managers usually have little control over common costs. They should not be held accountable for costs over which they have no control. • Allocations of common costs undermine the credibility of performance reports. Segment managers may resent such allocations and ignore the entire performance report as arbitrary and unfair. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 777 Group Exercise 12-36 The answers to this question will depend on the nature of the financial reports students obtain from their college. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 778 Managerial Accounting, 11th Edition Group Exercise 12-37 Note: This is a very difficult problem that requires an excellent understanding of the course to this point and analytical skills. The two groups—representing managers in a transfer pricing negotiation—should be able to come to an agreement concerning the transfer price. From the standpoint of the Consumer Products Division, a deal with the Industrial Products Division to acquire the electric motors at the transfer price “TP” makes sense only if the deal will increase the division’s residual income over and above what it would be without producing and selling the new sorbet maker. In other words, the residual income from the sorbet maker itself, after taking into account the deduction for the cost of the electric motor, must be positive: Residual income from the sorbet maker > $0 Contribution margin - Fixed cost - Minimum required return > $0 ($89 - $54 - TP) × 50,000 - $180,000 - 0.20 × $3,000,000 > $0 ($35 - TP) × 50,000 - $180,000 - $600,000 > $0 ($35 - TP) × 50,000 - $780,000 > $0 ($35 - TP) × 50,000 > $780,000 ($35 - TP) > $15.60 TP < $19.40 Therefore, any transfer price that is less than $19.40 will result in an increase in the Consumer Product Division’s residual income if the sorbet maker product is launched. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 12 779 Group Exercise 12-37 (continued) On the other hand, from the standpoint of the Industrial Products Division, selling the electric motor to the Consumer Products Division will make sense only if the Industrial Products Division’s residual income is increased. This will occur if and only if: Residual income from selling the electric motor > $0 Contribution margin - Fixed cost - Minimum required return > $0 (TP - $13) × 50,000 - $30,000 - 0.20 × $400,000 > $0 (TP - $13) × 50,000 - $30,000 - $80,000 > $0 (TP - $13) × 50,000 > $110,000 (TP - $13) > $2.20 TP > $15.20 Therefore, any transfer price in excess of $15.20 will result in an increase in the Industrial Product Division’s residual income if the sorbet maker product is launched. Combining the two requirements, any transfer price within the range $15.20 < TP < $19.40 will result in an increase in both Divisions’ residual incomes. Therefore, the two groups should be able to come to a mutually satisfactory agreement. However, they may fail to come to an agreement. This could occur for a number of reasons, just as in the real world. They may not be able to figure out what is in their own best interests. They may get caught up in the negotiations and lose sight of their goal—which should be to maximize residual income. Or negotiations may break down over fairness and equity issues. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 780 Managerial Accounting, 11th Edition Chapter 13 Relevant Costs for Decision Making Solutions to Questions 13-1 A relevant cost is a cost that differs in total between the alternatives in a decision. 13-2 An incremental cost (or benefit) is the change in cost (or benefit) that will result from some proposed action. An opportunity cost is the benefit that is lost or sacrificed in rejecting some course of action. A sunk cost is a cost that has already been incurred and that cannot be changed by any future decision. 13-3 No. Variable costs are relevant costs only if they differ in total between the alternatives under consideration. 13-4 No. Not all fixed costs are sunk—only those for which the cost has already been irrevocably incurred. A variable cost can be a sunk cost, if it has already been incurred. 13-5 No. A variable cost is a cost that varies in total amount in direct proportion to changes in the level of activity. A differential cost measures the difference in cost between two alternatives. If the level of activity is the same for the two alternatives, a variable cost will be unaffected and it will be irrelevant. 13-6 No. Only those future costs that differ between the alternatives under consideration are relevant. 13-7 Only those costs that can be avoided as a result of dropping the product line are relevant in the decision. Costs that will not differ regardless of whether the line is retained or discontinued are irrelevant. 13-8 Not necessarily. An apparent loss may be the result of allocated common costs or of sunk costs that cannot be avoided if the product line is dropped. A product line should be discon- tinued only if the contribution margin that will be lost as a result of dropping the line is less than the fixed costs that can be avoided. Even in that situation there may be arguments in favor of retaining the product line if its presence promotes the sale of other products. 13-9 Allocations of common fixed costs can make a product line (or other segment) appear to be unprofitable, whereas in fact it may be profitable. 13-10 If a company decides to make a part internally rather than to buy it from an outside supplier, then a portion of the company’s facilities have to be used to make the part. The company’s opportunity cost is measured by the benefits that could be derived from the best alternative use of the facilities. 13-11 Any resource that is required to make products and get them into the hands of customers could be a constraint. Some examples are machine time, direct labor time, floor space, raw materials, investment capital, supervisory time, and storage space. While not covered in the text, constraints can also be intangible and often take the form of a formal or informal policy that prevents the organization from furthering its goals. 13-12 Assuming that fixed costs are not affected, profits are maximized when the total contribution margin is maximized. A company can maximize its contribution margin by focusing on the products with the greatest amount of contribution margin per unit of the constrained resource. 13-13 Joint products are two or more products that are produced from a common input. Joint costs are the costs that are incurred up to the © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 781 split-off point. The split-off point is the point in the manufacturing process where joint products can be recognized as individual products. 13-14 Joint costs should not be allocated among joint products. If joint costs are allocated among the joint products, then managers may think they are avoidable costs of the end products. However, the joint costs will continue to be incurred as long as the process is run regardless of what is done with one of the end products. Thus, when making decisions about the end products, the joint costs are not avoidable and are irrelevant. of further processing, the product should be processed further. 13-16 Most costs of a flight are either sunk costs, or costs that do not depend on the number of passengers on the flight. Depreciation of the aircraft, salaries of personnel on the ground and in the air, and fuel costs, for example, are the same whether the flight is full or almost empty. Therefore, adding more passengers at reduced fares at certain times of the week when seats would otherwise be empty does little to increase the total costs of making the flight, but can do much to increase the total contribution and total profit. 13-15 As long as the incremental revenue from further processing exceeds the incremental costs © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 782 Managerial Accounting, 11th Edition Exercise 13-1 (15 minutes) Item a. b. c. d. e. f. g. h. i. j. k. l. Sales revenue ................. Direct materials ............... Direct labor ..................... Variable manufacturing overhead...................... Depreciation— Model B100 machine............... Book value— Model B100 machine............... Disposal value— Model B100 machine............... Market value—Model B300 machine (cost) ..... Fixed manufacturing overhead...................... Variable selling expense ... Fixed selling expense ....... General administrative overhead...................... Case 1 Not Relevant Relevant X X X Case 2 Not Relevant Relevant X X X X X X X X X X X X X X X X X X X X X © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 783 Exercise 13-2 (30 minutes) 1. No, production and sale of the racing bikes should not be discontinued. If the racing bikes were discontinued, then the net operating income for the company as a whole would decrease by $11,000 each quarter: Lost contribution margin .................................. $(27,000) Fixed costs that can be avoided: Advertising, traceable ................................... $ 6,000 Salary of the product line manager ................ 10,000 16,000 Decrease in net operating income for the company as a whole ..................................... $(11,000) The depreciation of the special equipment is a sunk cost and is not relevant to the decision. The common costs are allocated and will continue regardless of whether or not the racing bikes are discontinued; thus, they are not relevant to the decision. Alternative Solution: Current Total Sales............................................. $300,000 Less variable expenses ................... 120,000 Contribution margin ....................... 180,000 Less fixed expenses: Advertising, traceable .................. 30,000 Depreciation on special equipment*.............................. 23,000 Salaries of product managers ....... 35,000 Common allocated costs .............. 60,000 Total fixed expenses....................... 148,000 Net operating income ..................... $ 32,000 Difference: Total If Net OperatRacing ing Income Bikes Are Increase or Dropped (Decrease) $240,000 87,000 153,000 24,000 23,000 25,000 60,000 132,000 $ 21,000 $(60,000) 33,000 (27,000) 6,000 0 10,000 0 16,000 $ (11,000) *Includes pro-rated loss on the special equipment if it is disposed of. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 784 Managerial Accounting, 11th Edition Exercise 13-2 (continued) 2. The segmented report can be improved by eliminating the allocation of the common fixed expenses. Following the format introduced in Chapter 12 for a segmented income statement, a better report would be: Total Dirt Bikes Mountain Bikes Racing Bikes Sales ..................................... $300,000 $90,000 $150,000 $60,000 Less variable manufacturing and selling expenses............. 120,000 27,000 60,000 33,000 Contribution margin ................ 180,000 63,000 90,000 27,000 Less traceable fixed expenses: Advertising .......................... 30,000 10,000 14,000 6,000 Depreciation of special equipment......................... 23,000 6,000 9,000 8,000 Salaries of the product line managers.......................... 35,000 12,000 13,000 10,000 Total traceable fixed expenses ............................. 88,000 28,000 36,000 24,000 Product line segment margin ... 92,000 $35,000 $ 54,000 $ 3,000 Less common fixed expenses... 60,000 Net operating income .............. $ 32,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 785 Exercise 13-3 (30 minutes) 1. Per Unit Differential Costs Make Buy Cost of purchasing ...................... Direct materials .......................... Direct labor ................................ Variable manufacturing overhead . Fixed manufacturing overhead, traceable1 ................................ Fixed manufacturing overhead, common .................................. Total costs .................................. Difference in favor of continuing to make the carburetors............ 1 15,000 units Make Buy $35 $525,000 $14 10 3 $210,000 150,000 45,000 2 30,000 $29 $35 $6 $435,000 $525,000 $90,000 Only the supervisory salaries can be avoided if the carburetors are purchased. The remaining book value of the special equipment is a sunk cost; hence, the $4 per unit depreciation expense is not relevant to this decision. Based on these data, the company should reject the offer and should continue to produce the carburetors internally. Make 2. Buy Cost of purchasing (part 1) ............................ $525,000 Cost of making (part 1) ................................. $435,000 Opportunity cost—segment margin foregone on a potential new product line ................... 150,000 Total cost ..................................................... $585,000 $525,000 Difference in favor of purchasing from the outside supplier........................................... $60,000 Thus, the company should accept the offer and purchase the carburetors from the outside supplier. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 786 Managerial Accounting, 11th Edition Exercise 13-4 (15 minutes) Only the incremental costs and benefits are relevant. In particular, only the variable manufacturing overhead and the cost of the special tool are relevant overhead costs in this situation. The other manufacturing overhead costs are fixed and are not affected by the decision. Total for 20 Per Unit Bracelets Incremental revenue.............................. $169.95 $3,399.00 Incremental costs: Variable costs: Direct materials................................ $ 84.00 1,680.00 Direct labor...................................... 45.00 900.00 Variable manufacturing overhead ...... 4.00 80.00 Special filigree.................................. 2.00 40.00 Total variable cost............................... $135.00 2,700.00 Fixed costs: Purchase of special tool .................... 250.00 Total incremental cost ........................... 2,950.00 Incremental net operating income .......... $ 449.00 Even though the price for the special order is below the company's regular price for such an item, the special order would add to the company's net operating income and should be accepted. This conclusion would not necessarily follow if the special order affected the regular selling price of bracelets or if it required the use of a constrained resource. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 787 Exercise 13-5 (30 minutes) A 1. (1) (2) (3) (4) (5) B Contribution margin per unit.............................. $54 $108 Direct material cost per unit .............................. $24 $72 Direct material cost per pound........................... $8 $8 Pounds of material required per unit (2) ÷ (3) .... 3 9 Contribution margin per pound (1) ÷ (4) ............ $18 $12 C $60 $32 $8 4 $15 2. The company should concentrate its available material on product A: A B C Contribution margin per pound (above) .... $ 18 $ 12 $ 15 Pounds of material available..................... × 5,000 × 5,000 × 5,000 Total contribution margin ......................... $90,000 $60,000 $75,000 Although product A has the lowest contribution margin per unit and the second lowest contribution margin ratio, it is preferred over the other two products since it has the greatest amount of contribution margin per pound of material, and material is the company’s constrained resource. 3. The price Barlow Company would be willing to pay per pound for additional raw materials depends on how the materials would be used. If there are unfilled orders for all of the products, Barlow would presumably use the additional raw materials to make more of product A. Each pound of raw materials used in product A generates $18 of contribution margin over and above the usual cost of raw materials. Therefore, Barlow should be willing to pay up to $26 per pound ($8 usual price plus $18 contribution margin per pound) for the additional raw material, but would of course prefer to pay far less. The upper limit of $26 per pound to manufacture more product A signals to managers how valuable additional raw materials are to the company. If all of the orders for product A have been filled, Barlow Company would then use additional raw materials to manufacture product C. The company should be willing to pay up to $23 per pound ($8 usual price plus $15 contribution margin per pound) for the additional raw materials to manufacture more product C, and up to $20 per pound ($8 usual price plus $12 contribution margin per pound) to manufacture more product B if all of the orders for product C have been filled as well. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 788 Managerial Accounting, 11th Edition Exercise 13-6 (10 minutes) A B C Selling price after further processing..... $20 $13 $32 Selling price at the split-off point .......... 16 8 25 Incremental revenue per pound or gallon .............................................. $4 $5 $7 Total quarterly output in pounds or gallons............................................. ×15,000 ×20,000 ×4,000 Total incremental revenue.................... $60,000 $100,000 $28,000 Total incremental processing costs........ 63,000 80,000 36,000 Total incremental profit or loss ............. $(3,000) $ 20,000 $(8,000) Therefore, only product B should be processed further. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 789 Exercise 13-7 (20 minutes) 1. Fixed cost per mile ($5,000* ÷ 50,000 miles)...... $0.10 Variable cost per mile ........................................ 0.07 Average cost per mile........................................ $0.17 * Insurance.......................... $1,600 Licenses ............................ 250 Taxes ................................ 150 Garage rent ....................... 1,200 Depreciation ...................... 1,800 Total ................................. $5,000 This answer assumes the resale value of the truck does not decline because of the wear and tear that comes with use. 2. The insurance, the licenses, and the variable costs (gasoline, oil, tires, and repairs) would all be relevant to the decision, since these costs are avoidable by not using the truck. (However, the owner of the garage might insist that the truck be insured and licensed if it is left in the garage. In that case, the insurance and licensing costs would not be relevant since they would be incurred regardless of the decision.) The taxes would not be relevant, since they must be paid regardless of use; the garage rent would not be relevant, since it must be paid to park the truck; and the depreciation would not be relevant, since it is a sunk cost. However, any decrease in the resale value of the truck due to its use would be relevant. 3. Only the variable costs of $0.07 would be relevant, since they are the only costs that can be avoided by having the delivery done commercially. 4. In this case, only the fixed costs associated with the second truck would be relevant. The variable costs would not be relevant, since they would not differ between having one or two trucks. (Students are inclined to think that variable costs are always relevant in decision-making, and to think that fixed costs are always irrelevant. This requirement helps to dispel that notion.) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 790 Managerial Accounting, 11th Edition Exercise 13-8 (30 minutes) No, the bilge pump product line should not be discontinued. The computations are: Contribution margin lost if the line is dropped ...... €(460,000) Fixed costs that can be avoided: Advertising...................................................... €270,000 Salary of the product line manager ................... 32,000 Insurance on inventories .................................. 8,000 310,000 Net disadvantage of dropping the line.................. €(150,000) The same solution can be obtained by preparing comparative income statements: Keep Product Line Drop Product Line Sales ................................................ €850,000 € 0 Less variable expenses: Variable manufacturing expenses ..... 330,000 0 Sales commissions .......................... 42,000 0 Shipping......................................... 18,000 0 Total variable expenses ...................... 390,000 0 Contribution margin........................... 460,000 0 Less fixed expenses: Advertising ..................................... 270,000 0 Depreciation of equipment............... 80,000 80,000 General factory overhead ................ 105,000 105,000 Salary of product line manager ........ 32,000 0 Insurance on inventories ................. 8,000 0 Purchasing department expenses ..... 45,000 45,000 Total fixed expenses .......................... 540,000 230,000 Net operating loss ............................. € (80,000) €(230,000) Difference: Net Operating Income Increase or (Decrease) €(850,000) 330,000 42,000 18,000 390,000 (460,000) 270,000 0 0 32,000 8,000 0 310,000 €(150,000) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 791 Exercise 13-9 (20 minutes) The costs that are relevant in a make-or-buy decision are those costs that can be avoided as a result of purchasing from the outside. The analysis for this exercise is: Per Unit Differential Costs Make Buy 30,000 Units Make Buy Cost of purchasing..................... $21.00 Cost of making: Direct materials ...................... $ 3.60 Direct labor ............................ 10.00 Variable overhead ................... 2.40 Fixed overhead ....................... 3.00 * Total cost.................................. $19.00 $21.00 $630,000 $108,000 300,000 72,000 90,000 $570,000 $630,000 * The remaining $6 of fixed overhead cost would not be relevant, since it will continue regardless of whether the company makes or buys the parts. The $80,000 rental value of the space being used to produce part S-6 represents an opportunity cost of continuing to produce the part internally. Thus, the completed analysis would be: Make Total cost, as above.......................................... Rental value of the space (opportunity cost) ....... Total cost, including opportunity cost ................. $570,000 80,000 $650,000 Net advantage in favor of buying .......................... Buy $630,000 $630,000 $20,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 792 Managerial Accounting, 11th Edition Exercise 13-10 (15 minutes) 1. Annual profits will be increased by $39,000: Per Unit Incremental sales ................................. Incremental costs: Direct materials.................................. Direct labor........................................ Variable manufacturing overhead......... Variable selling and administrative ....... Total incremental costs.......................... Incremental profits ............................... 15,000 Units $14.00 $210,000 5.10 76,500 3.80 57,000 1.00 15,000 1.50 22,500 11.40 171,000 $ 2.60 $ 39,000 The fixed costs are not relevant to the decision, since they will be incurred regardless of whether the special order is accepted or rejected. 2. The relevant cost is $1.50 (the variable selling and administrative expenses). All other variable costs are sunk, since the units have already been produced. The fixed costs would not be relevant, since they will not change in total as a consequence of the price charged for the leftover units. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 793 Exercise 13-11 (15 minutes) The company should accept orders first for C, second for A, and third for B. The computations are: A (1) (2) (3) (4) (5) B Direct materials required per unit ........ $24 $15 Cost per pound.................................. $3 $3 Pounds required per unit (1) ÷ (2) ...... 8 5 Contribution margin per unit ............... $32 $14 Contribution margin per pound of materials used (4) ÷ (3) .................. $4.00 $2.80 C $9 $3 3 $21 $7.00 Since C uses the least amount of material per unit of the three products, and since it is the most profitable of the three in terms of its use of materials, some students will immediately assume that this is an infallible relationship. That is, they will assume that the way to spot the most profitable product is to find the one using the least amount of the constrained resource. The way to dispel this notion is to point out that product A uses more material (the constrained resource) than does product B, but yet it is preferred over product B. The key factor is not how much of a constrained resource a product uses, but rather how much contribution margin the product generates per unit of the constrained resource. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 794 Managerial Accounting, 11th Edition Exercise 13-12 (10 minutes) Sales value if processed further (7,000 units × $12 per unit) ................................. $84,000 Sales value at the split-off point (7,000 units × $9 per unit) ................................... 63,000 Incremental revenue .............................................. 21,000 Less cost of processing further ................................ 9,500 Net advantage of processing further ........................ $11,500 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 795 Exercise 13-13 (30 minutes) 1. The relevant costs of a hunting trip would be: Travel expense (100 miles @ $0.21 per mile) ... Shotgun shells ............................................... One bottle of whiskey .................................... Total ............................................................. $21 20 15 $56 This answer assumes that Bill would not be drinking the bottle of whiskey anyway. It also assumes that the resale values of the camper, pickup truck, and boat are not affected by taking one more hunting trip. The money lost in the poker game is not relevant because Bill would have played poker even if he did not go hunting. He plays poker every weekend. The other costs are sunk at the point at which the decision is made to go on another hunting trip. 2. If Bill gets lucky and bags another two ducks, all of his costs are likely to be about the same as they were on his last trip. Therefore, it really doesn’t cost him anything to shoot the last two ducks—except possibly the costs for extra shotgun shells. The costs are really incurred in order to be able to hunt ducks and would be the same whether one, two, three, or a dozen ducks were actually shot. All of the costs, with the possible exception of the costs of the shotgun shells, are basically fixed with respect to how many ducks are actually bagged during any one hunting trip. 3. In a decision of whether to give up hunting entirely, more of the costs listed by John are relevant. If Bill did not hunt, he would not need to pay for: gas, oil, and tires; shotgun shells; the hunting license; and the whiskey. In addition, he would be able to sell his camper, equipment, boat, and possibly pickup truck, the proceeds of which would be considered relevant in this decision. The original costs of these items are not relevant, but their resale values are relevant. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 796 Managerial Accounting, 11th Edition Exercise 13-13 (continued) These three requirements illustrate the slippery nature of costs. A cost that is relevant in one situation can be irrelevant in the next. None of the costs—except possibly the cost of the shotgun shells—are relevant when we compute the cost of bagging a particular duck; some of them are relevant when we compute the cost of a hunting trip; and more of them are relevant when we consider the possibility of giving up hunting. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 797 Exercise 13-14 (10 minutes) Contribution margin lost if the Linen Department is dropped: Lost from the Linen Department ............................................ $600,000 Lost from the Hardware Department (10% × $2,100,000) ....... 210,000 Total lost contribution margin ................................................... 810,000 Less fixed costs that can be avoided ($800,000 – $340,000)....... 460,000 Decrease in profits for the company as a whole ......................... $350,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 798 Managerial Accounting, 11th Edition Exercise 13-15 (15 minutes) The target production level is 40,000 starters per period, as shown by the relations between per-unit and total fixed costs. “Cost” Differential Per Costs Unit Make Buy Direct materials ...... $3.10 $3.10 Direct labor ............ 2.70 2.70 Variable manufacturing overhead.... 0.60 0.60 Supervision............. 1.50 1.50 Depreciation 1.00 — Rent ...................... 0.30 — Outside purchase price.................... $8.40 Total cost ............... $9.20 $7.90 $8.40 Explanation Can be avoided by buying Can be avoided by buying Can be avoided by buying Can be avoided by buying Sunk Cost Allocated Cost The company should make the starters, rather than continuing to buy from the outside supplier. Making the starters will result in a $0.50 per starter cost savings, or a total savings of $20,000 per period: $0.50 per starter × 40,000 starters = $20,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 799 Problem 13-16 (30 minutes) 1. Contribution margin lost if the flight is discontinued ...................................................... $(12,950) Flight costs that can be avoided if the flight is discontinued: Flight promotion................................................. $ 750 Fuel for aircraft .................................................. 5,800 Liability insurance (1/3 × $4,200) ........................ 1,400 Salaries, flight assistants ..................................... 1,500 Overnight costs for flight crew and assistants ....... 300 9,750 Net decrease in profits if the flight is discontinued ... $ (3,200) The following costs are not relevant to the decision: Cost Reason Salaries, flight crew Fixed annual salaries, which will not change. Depreciation of aircraft Sunk cost. Liability insurance (two-thirds) Two-thirds of the liability insurance is unaffected by this decision. Baggage loading and flight preparation This is an allocated cost that will continue even if the flight is discontinued. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 800 Managerial Accounting, 11th Edition Problem 13-16 (continued) Alternative Solution: Difference: Net Operating Income Keep the Drop the Increase or Flight Flight (Decrease) Ticket revenue ...................................... $14,000 $ 0 Less variable expenses .......................... 1,050 0 Contribution margin .............................. 12,950 0 Less flight expenses: Salaries, flight crew ............................ 1,800 1,800 Flight promotion ................................. 750 0 Depreciation of aircraft........................ 1,550 1,550 Fuel for aircraft................................... 5,800 0 Liability insurance ............................... 4,200 2,800 Salaries, flight assistants ..................... 1,500 0 Baggage loading and flight preparation 1,700 1,700 Overnight costs for flight crew and assistants at destination ................... 300 0 Total flight expenses.............................. 17,600 7,850 Net operating loss ................................. $ (4,650) $ (7,850) $(14,000) 1,050 (12,950) 0 750 0 5,800 1,400 1,500 0 300 9,750 $ (3,200) 2. The goal of increasing the seat occupancy could be obtained by eliminating flights with a lower-than-average seat occupancy. By eliminating these flights and keeping the flights with a higher average seat occupancy, the overall average seat occupancy for the company as a whole would be improved. This could reduce profits, however, in at least two ways. First, the flights that are eliminated could have contribution margins that exceed their avoidable costs (such as in the case of flight 482 in part 1). If so, then eliminating these flights would reduce the company’s total contribution margin more than it would reduce total costs, and profits would decline. Second, these flights might be acting as “feeder” flights, bringing passengers to cities where connections to more profitable flights are made. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 801 Problem 13-17 (15 minutes) 1. Per 16-Ounce T-Bone Revenue from further processing: Sales price of one filet mignon (6 ounces × $4.00 per pound ÷ 16 ounces per pound)........ Sales price of one New York cut (8 ounces × $2.80 per pound ÷ 16 ounces per pound)........ Total revenue from further processing .................. Less sales revenue from one T-bone steak ............ Incremental revenue from further processing ........ Less cost of further processing............................. Profit per pound from further processing .............. $1.50 1.40 2.90 2.25 0.65 0.25 $0.40 2. The T-bone steaks should be processed further into the filet mignon and the New York cut. This will yield $0.40 per pound in added profit for the company. The $0.45 “profit” per pound shown in the text is not relevant to the decision, since it contains allocated joint costs. The company will incur the joint costs regardless of whether the T-bone steaks are sold outright or processed further; thus, this cost should be ignored in the decision. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 802 Managerial Accounting, 11th Edition Problem 13-18 (60 minutes) 1. The simplest approach to the solution is: Gross margin lost if the store is closed ............ Costs that can be avoided: Sales salaries ............................................. $70,000 Direct advertising ....................................... 51,000 Store rent .................................................. 85,000 Delivery salaries ......................................... 4,000 Store management salaries ($21,000 – $12,000) ................................ 9,000 Salary of new manager ............................... 11,000 General office compensation ....................... 6,000 Insurance on inventories ($7,500 × 2/3)....... 5,000 Utilities ...................................................... 31,000 Employment taxes ...................................... 15,000 * Decrease in company profits if the North Store is closed............................................ $(316,800) 287,000 $ (29,800) *Salaries avoided by closing the store: Sales salaries............................................ $70,000 Delivery salaries........................................ 4,000 Store management salaries........................ 9,000 Salary of new manager ............................. 11,000 General office compensation...................... 6,000 Total avoided .............................................. 100,000 Employment tax rate ................................... × 15% Employment taxes avoided........................... $15,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 803 Problem 13-18 (continued) Alternative Solution: North Store Kept Open North Store Closed Difference: Net Operating Income Increase or (Decrease) Sales ........................................... $720,000 $ 0 $(720,000) Less cost of goods sold ................. 403,200 0 403,200 Gross margin ............................... 316,800 0 (316,800) Operating expenses: Selling expenses: Sales salaries .......................... 70,000 0 70,000 Direct advertising .................... 51,000 0 51,000 General advertising.................. 10,800 10,800 0 Store rent ............................... 85,000 0 85,000 Depreciation of store fixtures ... 4,600 4,600 0 Delivery salaries ...................... 7,000 3,000 4,000 Depreciation of delivery equipment............................ 3,000 3,000 0 Total selling expenses ................ 231,400 21,400 210,000 Administrative expenses: Store management salaries ...... 21,000 12,000 9,000 Salary of new manager ............ 11,000 0 11,000 General office compensation .... 12,000 6,000 6,000 Insurance on fixtures and inventory ............................. 7,500 2,500 5,000 Utilities ................................... 31,000 0 31,000 Employment taxes................... 18,150 3,150 15,000 * General office—other............... 18,000 18,000 0 Total administrative expenses ..... 118,650 41,650 77,000 Total operating expenses .............. 350,050 63,050 287,000 Net operating income (loss) .......... $(33,250) $(63,050) $ (29,800) *See the computation on the prior page. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 804 Managerial Accounting, 11th Edition Problem 13-18 (continued) 2. Based on the data in (1), the North Store should not be closed. If the store is closed, then the company’s overall net operating income will decrease by $29,800 per quarter. If the store space cannot be subleased or the lease broken without penalty, a decision to close the store would cause an even greater decline in the company’s overall net income. If the $85,000 rent cannot be avoided and the North Store is closed, the company’s overall net operating income would be reduced by $114,800 per quarter ($29,800 + $85,000). 3. Under these circumstances, the North Store should be closed. The computations are as follows: Gross margin lost if the North Store is closed (part 1) ...... $(316,800) Gross margin gained from the East Store: $720,000 × 1/4 = $180,000; $180,000 × 45%* = $81,000 ............. 81,000 Net operating loss in gross margin.................................. (235,800) Less costs that can be avoided if the North Store is closed (part 1) ........................................................... 287,000 Net advantage of closing the North Store ........................ $ 51,200 *The East Store’s gross margin percentage is: $486,000 ÷ $1,080,000 = 45% © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 805 Problem 13-19 (60 minutes) 1. The fl2.80 per drum general overhead cost is not relevant to the decision, since this cost will be the same regardless of whether the company decides to make or buy the drums. Also, the present depreciation figure of fl1.60 per drum is not a relevant cost, since it represents a sunk cost (in addition to the fact that the old equipment is worn out and must be replaced). The cost of supervision is relevant to the decision, since this cost can be avoided by buying the drums. Differential Costs Per Drum Make Buy Outside supplier’s price.... Direct materials............... fl10.35 Direct labor (fl6.00 × 70%)............. 4.20 Variable overhead (fl1.50 × 70%)............. 1.05 Supervision..................... 0.75 Equipment rental*........... 2.25 * Total cost ....................... fl18.60 Difference in favor of buying .. Total Differential Costs— 60,000 Drums Make Buy fl18.00 fl1,080,000 fl621,000 252,000 fl18.00 63,000 45,000 135,000 fl1,116,000 fl0.60 fl1,080,000 fl36,000 * fl135,000 per year ÷ 60,000 drums = fl2.25 per drum. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 806 Managerial Accounting, 11th Edition Problem 13-19 (continued) 2. a. Notice that unit costs for both supervision and equipment rental decrease with the greater volume since these fixed costs are spread over more units. Differential Cost Per Drum Make Buy Total Differential Cost— 75,000 Drums Make Buy Outside supplier’s price...... fl18.00 Direct materials................. fl10.35 Direct labor ...................... 4.20 Variable overhead ............. 1.05 Supervision (fl45,000 ÷ 75,000 0.60 drums) .......................... Equipment rental (fl135,000 ÷ 75,000 drums) .......................... 1.80 Total cost ......................... fl18.00 fl18.00 fl1,350,000 Difference......................... fl0 fl776,250 315,000 78,750 45,000 135,000 fl1,350,000 fl1,350,000 fl0 The company would be indifferent between the two alternatives if 75,000 drums were needed each year. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 807 Problem 13-19 (continued) b. Again, notice that the unit costs for both supervision and equipment rental decrease with the greater volume of units. Differential Costs Per Drum Make Buy Total Differential Cost— 90,000 Drums Make Buy Outside supplier’s price...... fl18.00 Direct materials................. fl10.35 Direct labor ...................... 4.20 Variable overhead ............. 1.05 Supervision (fl45,000 ÷ 90,000 drums) .......................... 0.50 Equipment rental (fl135,000 ÷ 90,000 1.50 drums) .......................... Total cost ......................... fl17.60 fl18.00 fl1,620,000 Difference in favor of making ............................ fl0.40 fl931,500 378,000 94,500 45,000 135,000 fl1,584,000 fl1,620,000 fl36,000 The company should purchase the new equipment and make the drums if 90,000 units per year are needed. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 808 Managerial Accounting, 11th Edition Problem 13-19 (continued) 3. Other factors that the company should consider include: a. Will volume in future years be increasing, or will it remain constant at 60,000 units per year? (If volume increases, then renting the new equipment becomes more desirable, as shown in the computations above.) b. Can quality control be maintained if the drums are purchased from the outside supplier? c. Will costs for materials and labor increase in future years, thereby increasing the cost of making the drums? d. Will the outside supplier be dependable in meeting shipping schedules? e. Can the company begin making the drums again if the supplier proves to be undependable, or are there alternative suppliers? f. What is the labor outlook in the supplier’s industry (e.g., are frequent labor strikes likely)? g. If the outside supplier’s offer is accepted and the need for drums increases in future years, will the supplier have the added capacity to provide more than 60,000 drums per year? © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 809 Problem 13-20 (45 minutes) 1. Selling price per unit ............................................. Less variable expenses per unit.............................. Contribution margin per unit .................................. $32 18 * $14 *$10.00 + $4.50 + $2.30 + $1.20 = $18.00 Increased sales in units (60,000 units × 25%)......... 15,000 Contribution margin per unit .................................. × $14 Incremental contribution margin............................. $210,000 Less added fixed selling expenses .......................... 80,000 Incremental net operating income .......................... $130,000 Yes, the increase in fixed selling expenses would be justified. 2. Variable manufacturing cost per unit ...................... $16.80 * Import duties per unit ........................................... 1.70 Permits and licenses ($9,000 ÷ 20,000 units).......... 0.45 Shipping cost per unit ........................................... 3.20 Break-even price per unit....................................... $22.15 *$10 + $4.50 + $2.30 = $16.80. 3. The relevant cost is $1.20 per unit, which is the variable selling expense per Dak. Since the irregular units have already been produced, all production costs (including the variable production costs) are sunk. The fixed selling expenses are not relevant since they will be incurred whether or not the irregular units are sold. Depending on how the irregular units are sold, the variable expense of $1.20 per unit may not even be relevant. For example, the units may be disposed of through a liquidator without incurring the normal variable selling expense. 4. If the plant operates at 30% of normal levels, then only 3,000 units will be produced and sold during the two-month period: 60,000 units per year × 2/12 = 10,000 units. 10,000 units × 30% = 3,000 units produced and sold. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 810 Managerial Accounting, 11th Edition Problem 13-20 (continued) Given this information, the simplest approach to the solution is: Contribution margin lost if the plant is closed $(42,000) (3,000 units × $14 per unit*) ............................ Fixed costs that can be avoided if the plant is closed: Fixed manufacturing overhead cost ($300,000 × 2/12 = $50,000; $50,000 × 40%) ............... $20,000 Fixed selling cost ($210,000 × 2/12 = $35,000; $35,000 × 20%) .............................. 7,000 27,000 Net disadvantage of closing the plant ................... $(15,000) *$32.00 – ($10.00 + $4.50 + $2.30 + $1.20) = $14.00 Some students will take a longer approach such as that shown below: Sales (3,000 units × $32 per unit) ................. Less variable expenses (3,000 units × $18 per unit) ................................................... Contribution margin ..................................... Less fixed expenses: Fixed manufacturing overhead cost: $300,000 × 2/12..................................... $300,000 × 2/12 × 60% ......................... Fixed selling expense: $210,000 × 2/12..................................... $210,000 × 2/12 × 80% ......................... Total fixed expenses..................................... Net operating income (loss) .......................... Continue to Operate Close the Plant $ 96,000 $ 54,000 42,000 0 0 0 50,000 30,000 35,000 28,000 85,000 58,000 $(43,000) $(58,000) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 811 Problem 13-20 (continued) 5. The relevant costs are those that can be avoided by purchasing from the outside manufacturer. These costs are: Variable manufacturing costs........................................ $16.80 Fixed manufacturing overhead cost ($300,000 × 75% = $225,000; $225,000 ÷ 60,000 units) ...................... 3.75 Variable selling expense ($1.20 × 1/3).......................... 0.40 Total costs avoided...................................................... $20.95 To be acceptable, the outside manufacturer’s quotation must be less than $20.95 per unit. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 812 Managerial Accounting, 11th Edition Problem 13-21 (45 minutes) 1. Product RG-6 yields a contribution margin of $8 per unit ($22 – $14 = $8). If the plant closes, this contribution margin will be lost on the 16,000 units (8,000 units per month × 2 months) that could have been sold during the two-month period. However, the company will be able to avoid certain fixed costs as a result of closing down. The analysis is: Contribution margin lost by closing the plant for $(128,000) two months ($8 per unit × 16,000 units)............ Costs avoided by closing the plant for two months: Fixed manufacturing overhead cost $45,000 per month × 2 months = $90,000) ....................... $90,000 Fixed selling costs ($30,000 per month × 10% × 2 months) ..................................................... 6,000 96,000 Net disadvantage of closing, before start-up costs . (32,000) Add start-up costs ............................................... 8,000 Disadvantage of closing the plant ......................... $ (40,000) No, the company should not close the plant; it should continue to operate at the reduced level of 8,000 units produced and sold each month. Closing will result in a $40,000 greater loss over the two-month period than if the company continues to operate. An additional factor is the potential loss of goodwill among the customers who need the 8,000 units of RG-6 each month. By closing down, the needs of these customers will not be met (no inventories are on hand), and their business may be permanently lost to another supplier. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 813 Problem 13-21 (continued) Alternative Solution: Plant Kept Open Sales (8,000 units × $22 per unit × 2) .............................. $ 352,000 Less variable expenses (8,000 units × $14 per unit × 2) ...... 224,000 Contribution margin................. 128,000 Less fixed costs: Fixed manufacturing overhead costs ($150,000 × 2).. 300,000 Fixed selling costs ($30,000 × 2) .................... 60,000 Total fixed costs ...................... 360,000 Net operating loss before start-up costs ....................... (232,000) Start-up costs ......................... 0 Net operating loss ................... $(232,000) Difference: Net Operating Income Increase or (Decrease) Plant Closed $ 0 $(352,000) 0 0 224,000 (128,000) 210,000 90,000 54,000 * 264,000 6,000 96,000 (264,000) (8,000) $(272,000) (32,000) (8,000) $ (40,000) * $30,000 × 90% = $27,000 × 2 = $54,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 814 Managerial Accounting, 11th Edition Problem 13-21 (continued) 2. Birch Company will be indifferent at a level of 11,000 total units sold over the two-month period. The computations are: Cost avoided by closing the plant for two months (see above) .......................................................... $96,000 Less start-up costs ................................................... 8,000 Net avoidable costs .................................................. $88,000 Net avoidable costs $88,000 = 11,000 units = Per unit contribution margin $8 per unit Verification: Operate at 11,000 Units for Two Months Sales (11,000 units × $22 per unit) ........... Less variable expenses (11,000 units × $14 per unit)......................................... Contribution margin ................................. Less fixed expenses: Manufacturing overhead ($150,000 and $105,000, × 2) ................................... Selling ($30,000 and $27,000, × 2)......... Total fixed expenses................................. Start-up costs .......................................... Total costs............................................... Net operating loss .................................... Close for Two Months $ 242,000 $ 0 154,000 88,000 0 0 300,000 210,000 60,000 54,000 360,000 264,000 0 8,000 360,000 272,000 $(272,000) $(272,000) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 815 Problem 13-22 (60 minutes) 1. The $90,000 in fixed overhead costs charged to the new product is a common cost that will be the same whether the tubes are produced internally or purchased from the outside. Hence, they are not relevant. The variable manufacturing overhead per box of Chap-Off would be $0.50, as shown below: Total manufacturing overhead cost per box of Chap-Off ... $1.40 Less fixed portion ($90,000 ÷ 100,000 boxes)................. 0.90 Variable overhead cost per box....................................... $0.50 The total variable costs of producing one box of Chap-Off would be: Direct materials............................................................. $3.60 Direct labor................................................................... 2.00 Variable manufacturing overhead ................................... 0.50 Total variable cost per box ............................................. $6.10 If the tubes for the Chap-Off are purchased from the outside supplier, then the variable cost per box of Chap-Off would be: Direct materials ($3.60 × 75%)...................................... $2.70 Direct labor ($2.00 × 90%)............................................ 1.80 Variable manufacturing overhead ($0.50 × 90%)............. 0.45 Cost of tube from outside .............................................. 1.35 Total variable cost per box ............................................. $6.30 Therefore, the company should reject the outside supplier’s offer. A savings of $0.20 per box of Chap-Off will be realized by producing the tubes internally. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 816 Managerial Accounting, 11th Edition Problem 13-22 (continued) Another approach to the solution would be: Cost avoided by purchasing the tubes: Direct materials ($3.60 × 25%) ............................ $0.90 Direct labor ($2.00 × 10%) .................................. 0.20 Variable manufacturing overhead ($0.50 × 10%) ... 0.05 Total costs avoided................................................. $1.15 * Cost of purchasing the tubes from the outside.......... $1.35 Cost savings per box by making internally ................ $0.20 * This $1.15 is the cost of making one box of tubes internally, since it represents the overall cost savings that will be realized per box of Chap-Off by purchasing the tubes from the outside. 2. The maximum purchase price would be $1.15 per box. The company would not be willing to pay more than this amount, since the $1.15 represents the cost of producing one box of tubes internally, as shown in Part 1. To make purchasing the tubes attractive, however, the purchase price should be less than $1.15 per box. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 817 Problem 13-22 (continued) 3. At a volume of 120,000 boxes, the company should buy the tubes. The computations are: Cost of making 120,000 boxes: 120,000 boxes × $1.15 per box ..................... $138,000 Rental cost of equipment............................... 40,000 Total cost........................................................ $178,000 Cost of buying 120,000 boxes: 120,000 boxes × $1.35 per box ..................... $162,000 Or, on a total cost basis, the computations are: Cost of making 120,000 boxes: 120,000 boxes × $6.10 per box ..................... $732,000 Rental cost of equipment............................... 40,000 Total cost........................................................ $772,000 Cost of buying 120,000 boxes: 120,000 boxes × $6.30 per box ..................... $756,000 Thus, buying the boxes will save the company $16,000 per year. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 818 Managerial Accounting, 11th Edition Problem 13-22 (continued) 4. Under these circumstances, the company should make the 100,000 boxes of tubes and purchase the remaining 20,000 boxes from the outside supplier. The costs would: Cost of making: 100,000 boxes × $1.15 per box....... $115,000 Cost of buying: 20,000 boxes × $1.35 per box ......... 27,000 Total cost............................................................... $142,000 Or, on a total cost basis, the computation would be: Cost of making: 100,000 boxes × $6.10 per box....... $610,000 Cost of buying: 20,000 boxes × $6.30 per box ......... 126,000 Total cost............................................................... $736,000 Since the amount of cost under this alternative is $20,000 less than the best alternative in Part 3, the company should make as many tubes as possible with the current equipment and buy the remaining tubes from the outside supplier. 5. Management should take into account at least the following additional factors: a) The ability of the supplier to meet required delivery schedules. b) The quality of the tubes purchased from the supplier. c) Alternative uses of the capacity that would be used to make the tubes. d) The ability of the supplier to supply tubes if volume increases in future years. e) The problem of alternative sources of supply if the supplier proves undependable. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 819 Problem 13-23 (30 minutes) 1. Since the fixed costs will not change as a result of the order, they are not relevant to the decision. The cost of the new machine is relevant, and this cost will have to be recovered by the current order since there is no assurance of future business from the retail chain. Total— Unit 5,000 units Revenue from the order ($50 × 84%) .................. $42 Less costs associated with the order: Direct materials ................................................ 15 Direct labor ...................................................... 8 Variable manufacturing overhead ....................... 3 Variable selling expense ($4 × 25%).................. 1 Special machine ($10,000 ÷ 5,000 units) ........... 2 Total costs .......................................................... 29 Net increase in profits ......................................... $13 2. Revenue from the order: Reimbursement for costs of production (variable production costs of $26, plus fixed manufacturing overhead cost of $9 = $35 per unit; $35 per unit × 5,000 units)........................................................... Fixed fee ($1.80 per unit × 5,000 units)..................... Total revenue ............................................................. Less incremental costs—variable production costs ($26 per unit × 5,000 units)...................................... Net increase in profits ................................................. 3. Sales revenue: From the U.S. Army (above)...................................... From regular channels ($50 per unit × 5,000 units) .... Net decrease in revenue .............................................. Less variable selling expenses avoided if the Army’s order is accepted ($4 per unit × 5,000 units).............. Net decrease in profits if the Army’s order is accepted ... $210,000 75,000 40,000 15,000 5,000 10,000 145,000 $ 65,000 $175,000 9,000 184,000 130,000 $ 54,000 $184,000 250,000 (66,000) 20,000 $(46,000) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 820 Managerial Accounting, 11th Edition Problem 13-24 (45 minutes) 1. Debbie Trish Direct labor cost per unit ... Direct labor hours per unit* (a) ........................ Selling price...................... Less variable costs: Direct materials .............. Direct labor.................... Variable overhead........... Total variable costs ........... Contribution margin (b) ..... Contribution margin per DLH (b) ÷ (a) ................ Sarah Mike Sewing Kit $ 3.20 $2.00 $ 5.60 $ 4.00 $ 1.60 0.40 0.25 0.70 0.50 $13.50 $5.50 $21.00 $10.00 0.20 $ 8.00 4.30 1.10 6.44 3.20 2.00 5.60 0.80 0.50 1.40 8.30 3.60 13.44 $ 5.20 $1.90 $ 7.56 $ 3.20 1.60 0.40 5.20 $ 2.80 2.00 4.00 1.00 7.00 3.00 $13.00 $7.60 $10.80 $ 6.00 $14.00 * Direct labor cost per unit ÷ 8 direct labor hour. 2. Product Debbie ........................... Trish .............................. Sarah ............................. Mike .............................. Sewing Kit ...................... Total hours required ........ DLH Per Unit 0.40 0.25 0.70 0.50 0.20 hours hours hours hours hours Estimated Sales (units) 50,000 42,000 35,000 40,000 325,000 Total Hours 20,000 10,500 24,500 20,000 65,000 140,000 3. Since the Mike doll has the lowest contribution margin per labor hour, its production should be reduced by 20,000 dolls (10,000 excess hours divided by 0.5 hours production time per doll = 20,000 dolls). Thus, production and sales of the Mike doll will be reduced to one-half of that planned, or 20,000 dolls for the year. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 821 Problem 13-24 (continued) 4. Since the additional capacity would be used to produce the Mike doll, the company should be willing to pay up to $14 per hour ($8 usual rate plus $6 contribution margin per hour) for added labor time. Thus, the company could employ workers for overtime at the usual time-and-ahalf rate of $12 per hour ($8 × 1.5 = $12), and still improve overall profit. 5. Additional output could be obtained in a number of ways including working overtime, adding another shift, expanding the workforce, contracting out some work to outside suppliers, and eliminating wasted labor time in the production process. The first four methods are costly, but the last method can add capacity at very low cost. Note: Some would argue that direct labor is a fixed cost in this situation and should be excluded when computing the contribution margin per unit. However, when deciding which products to emphasize, no harm is done by misclassifying a fixed cost as a variable cost—providing that the fixed cost is the constraint. If direct labor were removed from the variable cost category, the net effect would be to bump up the contribution margin per direct labor-hour by $8 for each of the products. The products will be ranked exactly the same—in terms of the contribution margin per unit of the constrained resource—whether direct labor is considered variable or fixed. However, this only works when the fixed cost is the cost of the constraint itself. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 822 Managerial Accounting, 11th Edition Problem 13-25 (45 minutes) 1. A product should be processed further so long as the incremental revenue from the further processing exceeds the incremental costs. The incremental revenue from further processing of the Grit 337 is: Selling price of the silver polish, per jar................... $4.00 Selling price of 1/4 pound of Grit 337 ($2.00 ÷ 4).... 0.50 Incremental revenue per jar................................... $3.50 The incremental variable costs are: Other ingredients .................................................. $0.65 Direct labor........................................................... 1.48 Variable manufacturing overhead (25% × $1.48)..... 0.37 Variable selling costs (7.5% × $4) .......................... 0.30 Incremental variable cost per jar ............................ $2.80 Therefore, the incremental contribution margin is $0.70 per jar ($3.50 – $2.80). The $1.60 cost per pound ($0.40 per 1/4 pound) required to produce the Grit 337 would not be relevant in this computation, since it is incurred regardless of whether the Grit 337 is further processed into silver polish or sold outright. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 823 Problem 13-25 (continued) 2. Only the cost of advertising and the cost of the production supervisor are avoidable if production of the silver polish is discontinued. Therefore, the number of jars of silver polish that must be sold each month to justify continued processing of the Grit 337 into silver polish is: Production supervisor ........................................... $3,000 Advertising—direct ............................................... 4,000 Avoidable fixed costs ............................................ $7,000 Avoidable fixed costs $7,000 = 10,000 jars per month = Incremental CM per jar $0.70 per jar Therefore, if 10,000 jars of silver polish can be sold each month, the company would be indifferent between selling it or selling all of the Grit 337 as a cleaning powder. If the sales of the silver polish are greater than 10,000 jars per month, then continued processing of the Grit 337 into silver polish would be advisable since the company’s total profits will be increased. If the company can’t sell at least 10,000 jars of silver polish each month, then production of the silver polish should be discontinued. To verify this, we show on the next page the total contribution to profits of sales of 9,000, 10,000 and 11,000 jars of silver polish, contrasted to sales of equivalent amounts of Grit 337 sold outright (i.e., 10,000 jars of silver polish would require the use of 2,500 pounds of Grit 337 that otherwise could be sold outright as cleaning powder, etc.): © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 824 Managerial Accounting, 11th Edition Problem 13-25 (continued) 9,000 Jars of Polish; or 2,250 pounds of Grit 337 10,000 Jars of Polish; or 2,500 pounds of Grit 337 11,000 Jars of Polish; or 2,750 pounds of Grit 337 Sales of Silver Polish: $40,000 $44,000 Sales @ $4.00 per jar.......................... $36,000 Less variable expenses: Production cost of Grit 337 @ $1.60 per pound........................................ 3,600 * 4,000 * 4,400 * Further processing and selling costs of the polish @ $2.80 per jar................. 25,200 28,000 30,800 Total variable expenses .......................... 28,800 32,000 35,200 Contribution margin............................... 7,200 8,000 8,800 Less avoidable fixed costs: Production supervisor.......................... 3,000 3,000 3,000 4,000 4,000 Advertising ......................................... 4,000 Total avoidable fixed costs ..................... 7,000 7,000 7,000 Total contribution to common fixed costs and to profits ............................. $ 200 $ 1,000 $ 1,800 Sales of Grit 337: Sales @ $2.00 per pound $ 4,500 $ 5,000 $ 5,500 Less variable expenses: Production cost of Grit 337 @ $1.60 per pound........................................ 4,000 * 4,400 * 3,600 * Contribution to common fixed costs and to profits............................................ $ 900 $ 1,000 $ 1,100 * This cost will be incurred regardless of whether the Grit 337 is further processed into silver polish or sold outright as cleaning powder; therefore, it is not relevant to the decision, as stated earlier. It is included in the computation above for the specific purpose of showing that it will be incurred under either alternative. The same thing could have been done with the depreciation on the mixing equipment. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 825 Problem 13-26 (45 minutes) 1. Only the avoidable costs are relevant in a decision to drop the Model C3 lawnchair product. The avoidable costs are: Direct materials .................................................... R122,000 Direct labor .......................................................... 72,000 Fringe benefits (20% of direct labor)...................... 14,400 Variable manufacturing overhead ........................... 3,600 Product manager’s salary....................................... 10,000 Sales commissions (5% of sales)............................ 15,000 Fringe benefits (20% of salaries and commissions) . 5,000 Shipping............................................................... 10,000 Total avoidable cost .............................................. R252,000 The following costs are not relevant in this decision: Cost Reason not relevant Building rent and maintenance All products use the same facilities; no space would be freed if a product were dropped. Depreciation All products use the same equipment so no equipment can be sold. Furthermore, the equipment does not wear out through use. General administrative expenses Dropping the Model C3 lawnchair would have no effect on total general administrative expenses. Having determined the costs that can be avoided if the Model C3 lawnchair is dropped, we can now make the following computation: Sales revenue lost if the Model C3 lawnchair is dropped .. R300,000 Less costs that can be avoided (see above).................... 252,000 Decrease in overall company net operating income if the Model C3 lawnchair is dropped.............................. R 48,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 826 Managerial Accounting, 11th Edition Problem 13-26 (continued) Thus, the Model C3 lawnchair should not be dropped unless the company can find more profitable uses for the resources consumed by the Model C3 lawnchair. 2. To determine the minimum acceptable level of sales, we must first classify the avoidable costs into variable and fixed costs as follows: Variable Fixed Direct materials ............................................... R122,000 Direct labor ..................................................... 72,000 Fringe benefits (20% of direct labor) ................. 14,400 Variable manufacturing overhead ...................... 3,600 Product managers’ salaries ............................... R10,000 Sales commissions (5% of sales)....................... 15,000 Fringe benefits (20% of salaries and commissions) ................. 3,000 2,000 Shipping.......................................................... 10,000 Total costs ....................................................... R240,000 R12,000 The Model C3 lawnchair should be retained as long as its contribution margin covers its avoidable fixed costs. Break-even analysis can be used to find the sales volume where the contribution margin just equals the avoidable fixed costs. The contribution margin ratio is computed as follows: CM ratio = = Contribution margin Sales R300,000-R240,000 = 20% R300,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 827 Problem 13-26 (continued) The break-even sales volume can be found using the break-even formula: Break-even point = = Fixed costs CM ratio R12,000 = R60,000 0.20 Therefore, as long as the sales revenue from the Model C3 lawnchair exceeds R60,000, it is covering its own avoidable fixed costs and is contributing toward covering the common fixed costs and toward the profits of the entire company. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 828 Managerial Accounting, 11th Edition Case 13-27 (60 minutes) 1. The original cost of the facilities at Clayton is a sunk cost and should be ignored in any decision. The decision being considered here is whether to continue operations at Clayton. The only relevant costs are the future facility costs that would be affected by this decision. If the facility were shut down, the Clayton facility has no resale value. In addition, if the Clayton facility were sold, the company would have to rent additional space at the remaining processing centers. On the other hand, if the facility were to remain in operation, the building should last indefinitely, so the company does not have to be concerned about eventually replacing it. Essentially, there is no real cost at this point of using the Clayton facility despite what the financial performance report indicates. Indeed, it might be a better idea to consider shutting down the other facilities since the rent on those facilities might be avoided. The costs that are relevant in the decision to shut down the Clayton facility are: Increase in rent at Billings and Great Falls................... $600,000 Decrease in local administrative expenses ................... (90,000) Net increase in costs ................................................. $510,000 In addition, there would be costs of moving the equipment from Clayton and there might be some loss of sales due to disruption of services. In sum, closing down the Clayton facility would almost certainly lead to a decline in BSC’s profits. Even though closing down the Clayton facility would result in a decline in overall company profits, it would result in an improved performance report for the Rocky Mountain Region (ignoring the costs of moving equipment and potential loss of revenues from disruption of service to customers). © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 829 Case 13-27 (continued) Financial Performance After Shutting Down the Clayton Facility Rocky Mountain Region Total Sales ............................................................. $50,000,000 Operating expenses: Direct labor ................................................. 32,000,000 Variable overhead ........................................ 850,000 Equipment depreciation ................................ 3,900,000 Facility expense*.......................................... 2,300,000 Local administrative expense** ..................... 360,000 Regional administrative expense.................... 1,500,000 Corporate administrative expense.................. 4,750,000 Total operating expense .................................. 45,660,000 Net operating income...................................... $ 4,340,000 * $2,800,000 – $1,100,000 + $600,000 = $2,300,000 ** $450,000 – $90,000 = $360,000 2. If the Clayton facility is shut down, BSC’s profits will decline, employees will lose their jobs, and customers will at least temporarily suffer some decline in service. Therefore, Romeros is willing to sacrifice the interests of the company, its employees, and its customers just to make her performance report look better. While Romeros is not a management accountant, the Standards of Ethical Conduct for Management Accountants still provide useful guidelines. a) By recommending closing the Clayton facility, Romeros would violate the Competence Standard that stipulates recommendations should be based on appropriate analysis of relevant and reliable information. b) The Integrity Standard requires that management accountants “avoid actual or apparent conflicts of interest and advise all appropriate parties of any potential conflict.” Romeros has a conflict of interest in this case, since her recommendation will serve to make her own performance look better while actually leading to a decline in the company’s profits. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 830 Managerial Accounting, 11th Edition Case 13-27 (continued) c) The Integrity Standard is also violated in that her recommendation to close down the Clayton facility would “subvert the attainment of the organization’s legitimate and ethical objectives.” d) Romeros would also be violating the Objectivity Standard that requires a management accountant to “disclose fully all relevant information that could reasonably be expected to influence an intended user’s understanding of the reports, comments, and recommendations presented.” Presumably, if the corporate board were fully informed of the consequences of this action, they would disapprove. In sum, it is difficult to describe the recommendation to close the Clayton facility as ethical behavior. In Romeros’ defense, however, it is not fair to hold her responsible for the mistake made by her predecessor. It should be noted that the performance report required by corporate headquarters is likely to lead to other problems such as the one illustrated here. The arbitrary allocations of corporate and regional administrative expenses to processing centers may make other processing centers appear to be unprofitable even though they are not. In this case, the problems created by these arbitrary allocations were compounded by using an irrelevant facilities expense figure on the performance report. 3. Prices should be set ignoring the depreciation on the Clayton facility. As argued in part (1) above, the real cost of using the Clayton facility is zero. Any attempt to recover the sunk cost of the original cost of the building by charging higher prices than the market will bear will lead to less business and lower profits. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 831 Case 13-28 (60 minutes) 1. Continuing to obtain covers from its own Denver Cover Plant would allow QualSupport to maintain its current level of control over the quality of the covers and the timing of their delivery. Keeping the Denver Cover Plant open also allows QualSupport more flexibility than purchasing the coverings from outside suppliers. QualSupport could more easily alter the coverings’ design and change the quantities produced, especially if long-term contracts are required with outside suppliers. QualSupport should also consider the economic impact that closing Denver Cover will have on the community and how this might affect QualSupport’s other operations in the region. 2. a. The following costs can be avoided by closing the plant, and therefore are relevant to the decision: Materials..................................... $14,000,000 Labor: Direct....................................... $13,100,000 Supervision............................... 900,000 Indirect plant............................ 4,000,000 18,000,000 Differential pension cost ($5,000,000 – $3,000,000) ........ 2,000,000 Total annual relevant costs ........... $34,000,000 b. The following costs can’t be avoided by closing the plant, and therefore are not relevant to the decision: Depreciation—equipment ....................................... $ 3,200,000 Depreciation—building ........................................... 7,000,000 Continuing pension cost ($5,000,000 – $2,000,000) . 3,000,000 Plant manager and staff ......................................... 800,000 Corporate allocation............................................... 4,000,000 Total annual continuing costs.................................. $18,000,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 832 Managerial Accounting, 11th Edition Case 13-28 (continued) Depreciation is not relevant because it represents expiration of a sunk cost. Three-fifths of the annual pension expense ($3,000,000) is not relevant because it would continue whether or not the plant is closed. The amount for plant manager and staff is not relevant because Vosilo and his staff would continue with QualSupport and administer the three remaining plants. The corporate allocation is not relevant because this represents costs incurred outside Denver Cover and assigned to the plant. c. The following nonrecurring costs would arise in the year that the plant is closed, but would not be incurred in any other year: Termination charges on canceled material orders ($14,000,000 × 20%) .......................................... Employment assistance ........................................... Total recurring costs ............................................... $2,800,000 1,500,000 $4,300,000 These two costs are relevant to the decision because they will be incurred only if the plant is closed. 3. No, the plant should not be closed. The computations are: First Year Other Years Cost of purchasing the covers outside...... $(35,000,000) $(35,000,000) Costs avoided by closing the plant (Part 2a)............................................. 34,000,000 34,000,000 Cost of closing the plant (first year only) . (4,300,000) Salvage value of equipment and building . 3,200,000 Net advantage (disadvantage) of closing the plant............................................. $ (2,100,000) $ (1,000,000) © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 833 Case 13-28 (continued) 4. Factors that should be considered by QualSupport before making a decision include: a. Alternative uses of the building and equipment. b. Any tax implications. c. The outside supplier’s prices in future years. d. The cost to manufacture coverings at the Denver Cover Plant in future years. e. The value of the time Vosilo and his staff would have spent managing the Denver Cover Plant. This time may be spent on other important matters. f. The morale of QualSupport employees at remaining plants. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 834 Managerial Accounting, 11th Edition Case 13-29 (75 minutes) This is a difficult case that will challenge the best students. Part of the challenge is simply to understand the alternatives. As an aid, a diagram of the two alternatives, which we will call Alternatives A and B, is show below, together with the relevant data. Alternative A 2,000 parts Grathin Division variable cost: $200 per part 2,000 motors Facet Division Able Division transfer price: $400 per part variable cost: $450 per motor transfer price: $1,600 per part Alternative B 2,000 parts Grathin Division variable cost: $175 per part 2,000 motors Waverly Corp. selling price: $350 per part Facet Division selling price: $1,500 per motor AND 2,500 parts Grathin Division variable cost: $100 per part 2,500 motors Able Division transfer price: variable cost: $200 per part $500 per motor HighTech Corp. selling price: $1,200 per motor © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 835 Case 13-29 (continued) In both parts of the case the general fixed overhead costs are irrelevant since they are allocated costs that will remain the same regardless of which alternative is accepted. Also note that the same amount of total machine time would be consumed in both the Grathin Division’s plant and the Able Division’s plant regardless of which order is accepted. Thus, the amount of machine time that would be required is not a factor in the decision. Grathin’s plant: Facet Division order: 2,000 motors × 2.5 hours per motor = 5,000 hours. HighTech Corporation order: 2,500 motors × 2.0 hours per motor = 5,000 hours. Able’s plant: Facet Division order: 2,000 motors × 5.0 hours per motor = 10,000 hours. HighTech Corporation order: 2,500 motors × 4.0 hours per motor = 10,000 hours. 1. The Able Division would accept the order from the Facet Division. Computations to support this conclusion follow: Expected contribution margin from the Facet Division order: Sales revenue to Able Division (2,000 motors × $1,600 per motor) ...... Less variable costs: Transfer price to Grathin Division (2,000 parts × $400 per part) ............ Other variable costs (2,000 motors × $450 per motor) ...... Contribution margin................................ $3,200,000 $800,000 900,000 1,700,000 $1,500,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 836 Managerial Accounting, 11th Edition Case 13-29 (continued) Expected contribution margin from HighTech Corporation order: Sales revenue to Able Division (2,500 motors × $1,200 per motor) ...... Less variable costs: Transfer price to Grathin Division (2,500 parts × $200 per part) ............ Other variable costs (2,500 motors × $500 per motor) ...... Contribution margin................................ $3,000,000 $ 500,000 1,250,000 1,750,000 $1,250,000 Thus, the Able Division will net $250,000 ($1,500,000 – $1,250,000) more in contribution margin by taking the order from the Facet Division. 2. From the perspective of the company as a whole, the situation is at once simpler and more complex. It is simpler because transfer prices are irrelevant. Whatever one division pays, the other receives. From the standpoint of the entire company, money is taken out of one pocket and put into the other. The situation is more complex in that the company must take into account that if Able Division accepts the order from HighTech Corporation, Facet Division will need to acquire its motors from Waverly Corporation rather than from Able Division. This is Alternative B in the diagram on the first page of the solution. But let’s start with Alternative A, the simpler alternative. From the standpoint of the entire company, the cost of the motors transferred to Facet Division is $650 per motor, the variable costs of Grathin Division plus the variable costs of Able Division. The total cost of the motors would be $1,300,000 (2,000 motors @ $650 per motor). This is restated in slightly different form below: Alternative A Facet Division acquires motors from Able Division, which acquires parts from Grathin Division Grathin Division’s variable expenses (2,000 parts × $200 per part).............................. Able Division’s variable expenses (2,000 motors × $450 per motor) ........................ Total cost of Alternative A ...................................... $ 400,000 900,000 $1,300,000 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 837 Case 13-29 (continued) Alternative B This alternative is more complex than Alternative A. There are really two parts to this alternative. In the first part, Facet Division purchases the required motors from Waverly Corporation, which purchases parts from Grathin Division. In the second part, Able Division sells motors to HighTech Corporation using parts supplied by Grathin Division. (Refer back to the diagram.) We will compute the financial consequences of these two parts separately and then combine them. Part 1: Facet Division’s purchase of motors Facet Division’s payment to Waverly Corporation (2,000 motors × $1,500 per motor) ..................... Waverly Corporation’s payments to Grathin Division (2,000 parts × $350 per part).............................. Grathin Division’s variable expenses (2,000 parts × $175 per part).............................. Total cost (a) ........................................................ $3,000,000 (700,000) 350,000 $2,650,000 Part 2: HighTech Corporation’s purchase of motors HighTech Corporation’s payments to Able Division (2,500 motors × $1,200 per motor) ..................... Able Division’s variable expenses (2,500 motors × $500 per motor) ........................ Grathin Division’s variable expenses (2,500 motors × $100 per motor) ........................ Total contribution margin (b).................................. Net cost to the company of Alternative B (a) – (b) ... $3,000,000 (1,250,000) (250,000) $1,500,000 $1,150,000 Since the $1,150,000 cost of Alternative B is less than the $1,300,000 cost of Alternative A, it is the preferred alternative. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 838 Managerial Accounting, 11th Edition Case 13-30 (30 minutes) 1. As much yarn as possible should be processed into sweaters. Products should be processed further so long as the added revenues from further processing are greater than the added costs. In the case at hand, the added revenues and costs are: Per Sweater Added revenue ($30.00 – $20.00) ......... Added costs: Buttons, thread, lining........................ $2.00 Direct labor ....................................... 5.80 Added contribution margin.................... $10.00 7.80 $ 2.20 Thus, the company will gain $2.20 in contribution margin for each spindle of yarn that is further processed into a sweater. The fixed manufacturing overhead costs are not relevant to the decision, since they will be the same regardless of whether the yarn is sold or processed further. Also, in making this computation we must omit the $16.00 cost of manufacturing the yarn, since this cost will be incurred whether the yarn is sold as is or is used in sweaters. 2. The lowest price the company should accept is $27.80 per sweater. The simplest approach to this answer is: Present selling price per sweater .......... Less added contribution margin being realized on each sweater sold ............ Minimum selling price per sweater........ $30.00 2.20 $27.80 A more involved approach to the $27.80 figure is to reason as follows: If the wool yarn is sold outright, then the company will realize a contribution margin of $9.40 per spindle: Per Spindle Selling price........................... Less variable expenses: Raw wool ............................ Direct labor ......................... Contribution margin................ $20.00 $7.00 3.60 10.60 $ 9.40 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 839 Case 13-30 (continued) This $9.40 represents an opportunity cost to the company; thus, the price of the sweaters must be high enough to include this minimum contribution margin figure. In addition, the company must be able to cover all of its variable costs from the time the raw wool is purchased until the sweater is completed. Therefore, the minimum price would be: Variable costs of producing a spindle of yarn: Raw wool ................................................... $7.00 Direct labor ................................................ 3.60 Added variable costs of producing a sweater: Buttons, etc. .............................................. 2.00 Direct labor ................................................ 5.80 Total variable costs........................................ Opportunity cost—contribution margin if the yarn is sold outright .................................... Minimum selling price per sweater.................. $10.60 7.80 18.40 9.40 $27.80 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 840 Managerial Accounting, 11th Edition Case 13-31 (90 minutes) 1. The lowest price Wesco could bid for the one-time special order of 20,000 pounds (20 lots) without losing money would be $24,200—the relevant cost of the order, as shown below. Direct materials: AG-5: 300 pounds per lot × 20 lots = 6,000 pounds. Substitute BH-3 on a one-for-one basis to its total of 3,500 pounds. If BH-3 is not used in this order, it will be salvaged for $600. Therefore, the relevant cost is.............................. $ 600 The remaining 2,500 pounds would be AG-5 at a cost of $1.20 per pound ............................................................... 3,000 KL-2: 200 pounds per lot × 20 lots = 4,000 pounds at $1.05 per pound......................................................................... 4,200 CW-7: 150 pounds per lot × 20 lots = 3,000 pounds at $1.35 per pound ............................................................... 4,050 DF-6: 175 pounds per lot × 20 lots = 3,500 pounds. Use 3,000 pounds in inventory at $0.60 per pound ($0.70 market price – $0.10 handling charge), and purchase the remaining 500 pounds at $0.70 per pound ............................. 2,150 Total direct materials cost ..................................................... 14,000 Direct labor: 25 DLHs per lot × 20 lots = 500 DLHs. Because only 400 hours can be scheduled during regular time this month, overtime would have to be used for the remaining 100 hours. 400 DLHs × $14.00 per DLH................................................. 100 DLHs × $21.00 per DLH................................................. Total direct labor cost........................................................... 5,600 2,100 7,700 Overhead: This special order will not increase fixed overhead costs. Therefore, only the variable overhead is relevant. 500 DLHs × $3.00 per DLH................................................... 1,500 Total relevant cost of the special order..................................... $23,200 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 841 Case 13-31 (continued) 2. In this part, we calculate the price for recurring orders of 20,000 pounds (20 lots) using the company’s rule of marking up its full manufacturing cost. This is not the best pricing policy to follow, but is a common practice in business. Direct materials: Because the initial order will exhaust existing inventories of BH-3 and DF-6 and new supplies would have to be purchased, all raw materials should be charged at their expected future cost, which is the current market price. AG-5: 6,000 pounds × $1.20 per pound .............................. $ 7,200 KL-2: 4,000 pounds × $1.05 per pound ............................... 4,200 CW-7: 3,000 pounds × $1.35 per pound.............................. 4,050 DF-6: 3,500 pounds × $0.70 per pound............................... 2,450 Total direct materials cost ................................................... 17,900 Direct labor: 90% (i.e., 450 DLHs) of the production of a batch can be done on regular time; but the remaining production (i.e., 50 DLHs) must be done on overtime. Regular time 450 DLHs × $14.00 per DLH ........................... Overtime premium 50 DLHs × $21.00 per DLH..................... Total direct labor cost......................................................... 6,300 1,050 7,350 Overhead: The full manufacturing cost includes both fixed and variable manufacturing overhead. Manufacturing overhead applied: 500 DLHs × $13.50 per DLH ............................................ 6,750 Full manufacturing cost ....................................................... 32,000 Markup (40% × $32,000) .................................................... 12,800 Selling price (full manufacturing cost plus markup) ................ $44,800 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 842 Managerial Accounting, 11th Edition Case 13-32 (120 minutes) 1. The product margins computed by the accounting department for the drums and bike frames should not be used in the decision of which product to make. The product margins are lower than they should be due to the presence of allocated fixed common costs that are irrelevant in this decision. Moreover, even after the irrelevant costs have been removed, what matters is the profitability of the two products in relation to the amount of the constrained resource—welding time—that they use. A product with a very low margin may be desirable if it uses very little of the constrained resource. In short, the financial data provided by the accounting department are useless and potentially misleading for making this decision. 2. Students may have answered this question assuming that direct labor is a variable cost, even though the case strongly hints that direct labor is a fixed cost. The solution is shown here assuming that direct labor is fixed. The solution assuming that direct labor is variable will be shown in part (4). Solution assuming direct labor is fixed Manufactured Selling price..................................... Less variable costs: Materials....................................... Variable manufacturing overhead.... Variable selling and administrative .. Total variable cost ............................ Contribution margin ......................... Purchased WVD Drums WVD Drums Bike Frames $149.00 $149.00 $239.00 138.00 0.00 0.75 138.75 $ 10.25 52.10 1.35 0.75 54.20 $ 94.80 99.40 1.90 1.30 102.60 $136.40 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 843 Case 13-32 (continued) 3. Since the demand for the welding machine exceeds the 2,000 hours that are available, products that use the machine should be prioritized based on their contribution margin per welding hour. The computations are carried out below under the assumption that direct labor is a fixed cost and then under the assumption that it is a variable cost. Solution assuming direct labor is fixed Manufactured WVD Bike Drums Frames Contribution margin per unit (above) (a)............ Welding hours per unit (b)................................ Contribution margin per welding hour (a) ÷ (b).. $94.80 0.4 hour $237.00 per hour $136.40 0.5 hour $272.80 per hour © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 844 Managerial Accounting, 11th Edition Case 13-32 (continued) Since the contribution margin per unit of the constrained resource (i.e., welding time) is larger for the bike frames than for the WVD drums, the frames make the most profitable use of the welding machine. Consequently, the company should manufacture as many bike frames as possible up to demand and then use any leftover capacity to produce WVD drums. Buying the drums from the outside supplier can fill any remaining unsatisfied demand for WVD drums. The necessary calculations are carried out below. Analysis assuming direct labor is a fixed cost (a) (b) Unit Contribution Quantity Margin Total hours available ................... Bike frames produced.................. WVD Drums—make..................... WVD Drums—buy ....................... Total contribution margin............. Less: Contribution margin from present operations: 5,000 drums × $94.80 CM per drum ... Increased contribution margin and net operating income ......... 1,600 3,000 3,000 $136.40 $94.80 $10.25 (c) Welding Time per Unit 0.5 0.4 (a) × (c) (a) × (b) Total Welding Time Balance of Welding Time 800 1,200 2,000 1,200 0 Total Contribution $218,240 284,400 30,750 533,390 474,000 $ 59,390 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 845 Case 13-32 (continued) 4. The computation of the contribution margins and the analysis of the best product mix are repeated here under the assumption that direct labor costs are variable. Solution assuming direct labor is a variable cost Manufactured Selling price..................................... Less variable costs: Materials....................................... Direct labor................................... Variable manufacturing overhead.... Variable selling and administrative .. Total variable cost ............................ Contribution margin ......................... Purchased WVD Drums WVD Drums Bike Frames $149.00 $149.00 $239.00 138.00 0.00 0.00 0.75 138.75 $ 10.25 52.10 3.60 1.35 0.75 57.80 $ 91.20 99.40 28.80 1.90 1.30 131.40 $107.60 Solution assuming direct labor is a variable cost Manufactured WVD Bike Drums Frames Contribution margin per unit (above) (a)............. $91.20 Welding hours per unit (b)................................. 0.4 hour Contribution margin per welding hour (a) ÷ (b)... $228.00 per hour $107.60 0.5 hour $215.20 per hour When direct labor is assumed to be a variable cost, the conclusion is reversed from the case in which direct labor is assumed to be a fixed cost—the WVD drums appear to be a better use of the constraint than the bike frames. The assumption about the behavior of direct labor really does matter. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 846 Managerial Accounting, 11th Edition Case 13-32 (continued) Solution assuming direct labor is a variable cost (a) (b) Unit Contribution Quantity Margin Total hours available ................... WVD Drums—make..................... Bike frames produced.................. WVD Drums—buy ....................... Total contribution margin............. Less: Contribution margin from present operations: 5,000 drums × $91.20 CM per drum ... Increased contribution margin and net operating income ......... 5,000 0 1,000 $91.20 $107.60 $10.25 (c) Welding Time per Unit 0.4 0.5 (a) × (c) (a) × (b) Total Welding Time Balance of Welding Time 2,000 0 2,000 0 0 Total Contribution $456,000 0 10,250 466,250 456,000 $ 10,250 © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 847 Case 13-32 (continued) 5. The case strongly suggests that direct labor is fixed: “The bike frames could be produced with existing equipment and personnel.” Nevertheless, it would be a good idea to examine how much labor time is really needed under the two opposing plans. Production Direct LaborHours Per Unit Total Direct Labor-Hours Plan 1: Bike frames ................. WVD drums ................. 1,600 3,000 1.6* 0.2** 2,560 600 3,160 Plan 2: WVD drums ................. 5,000 0.2** 1,000 * $28.80 ÷ $18.00 per hour = 1.6 hour ** $3.60 ÷ $18.00 per hour = 0.2 hour Some caution is advised. Plan 1 assumes that direct labor is a fixed cost. However, this plan requires 2,160 more direct labor-hours than Plan 2 and the present situation. At 40 hours per week a typical full-time employee works about 1,900 hours a year, so the added workload is equivalent to more than one full-time employee. Does the plant really have that much idle time at present? If so, and if shifting workers over to making bike frames would not jeopardize operations elsewhere, then Plan 1 is indeed the better plan. However, if taking on the bike frame as a new product would lead to pressure to hire another worker, more analysis is in order. It is still best to view direct labor as a fixed cost, but taking on the frames as a new product could lead to a jump in fixed costs of about $34,200 (1,900 hours × $18 per hour)—assuming that the remaining 260 hours could be made up using otherwise idle time. See the additional analysis on the next page. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 848 Managerial Accounting, 11th Edition Case 13-32 (continued) Contribution margin from Plan 1: Bike frames produced (1,600 × $136.40) ....................... WVD Drums—make (3,000 × $94.80)............................ WVD Drums—buy (3,000 × $10.25) .............................. Total contribution margin .............................................. Less: Additional fixed labor costs ..................................... Net effect of Plan 1 on net operating income .................... 218,240 284,400 30,750 533,390 34,200 $499,190 Contribution margin from Plan 2: ..................................... WVD Drums—make (5,000 × $94.80)............................ WVD Drums—buy (1,000 × $10.25) .............................. Net effect of Plan 2 on net operating income .................... $474,000 10,250 $484,250 If an additional direct labor employee would have to be hired, Plan 1 is still optimal. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. Solutions Manual, Chapter 13 849 Group Exercise 13-33 1. A manufacturing overhead rate of 500% of direct labor means that the total manufacturing overhead is five times as large as the total direct labor. It also means that for every $1 of direct labor a product incurs, it is charged for $5 of manufacturing overhead. 2. If a product requires a large amount of direct labor, the overhead applied to that product will make that product expensive relative to products that require less direct labor. 3. When products are outsourced, any common fixed manufacturing overhead or joint costs that had been allocated to the outsourced products must be allocated to the remaining products. As a consequence, their apparent costs rise. 4. Labor cost is a declining percentage of total cost in many industries and approaches insignificant levels in some. Rather than obsess on reducing labor costs, it may be better to attack overhead costs, which are much more substantial, or to concentrate time and effort on improving the product or tapping new markets. The potential competitive advantage from lower labor costs is not as important as it once was and is transitory—competitors can always go overseas too. In addition, locating production overseas increases transportation costs and time delays in shipping goods and may increase coordination problems between marketing and production. Moreover, the company may not have as much control over quality when production is moved to a new location. 5. As mentioned in part (3) above, when products are outsourced, the apparent costs of the remaining products almost inevitably rise as fixed overhead costs are spread over a smaller base. As a consequence, the remaining products often become candidates for outsourcing as well. Of course, the second wave of outsourcing leads to further increases in the costs of the remaining products. This vicious cycle can lead managers to eventually move all production out of the country. © The McGraw-Hill Companies, Inc., 2006. All rights reserved. 850 Managerial Accounting, 11th Edition CHAPTER 14 Corporations: Dividends, Retained Earnings, and Income Reporting ASSIGNMENT CLASSIFICATION TABLE Exercises A Problems B Problems 1, 2, 3 1, 2, 3, 4, 5, 6, 7 1A, 2A, 3A, 4A, 5A 1B, 2B, 3B, 4B, 5B 9, 10, 11, 12, 13, 14 4, 5 6, 8, 9 2A, 3A, 4A 2B, 3B, 4B Prepare and analyze a comprehensive stockholders’ equity section. 14, 15 6, 7 5, 6, 10, 11, 13, 15, 16 1A, 2A, 3A, 4A, 5A 1B, 2B, 3B, 4B, 5B 4. Describe the form and content of corporation income statements. 15, 16 8 12, 13, 14 5. Compute earnings per share. 17 9, 10 12, 14, 15, 16, 17 3A 3B Study Objectives Questions 1. Prepare the entries for cash dividends and stock dividends. 1, 2, 3, 4, 5, 6, 7, 8 2. Identify the items reported in a retained earnings statement. 3. Brief Exercises 14-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Time Level Allotted (min.) 1A Prepare dividend entries and stockholders’ equity section. Simple 30–40 2A Journalize and post transactions; prepare retained earnings statement and stockholders’ equity section. Moderate 30–40 3A Prepare retained earnings statement and stockholders’ equity section, and compute earnings per share. Moderate 30–40 4A Prepare the stockholders’ equity section, reflecting dividends and stock split. Moderate 20–30 5A Prepare the stockholders’ equity section, reflecting various events. Moderate 20–30 1B Prepare dividend entries and stockholders’ equity section. Simple 30–40 2B Journalize and post transactions; prepare retained earnings statement and stockholders’ equity section. Moderate 30–40 3B Prepare retained earnings statement and stockholders’ equity section, and compute earnings per share. Moderate 30–40 4B Prepare the stockholders’ equity section, reflecting dividends and stock split. Moderate 20–30 5B Prepare the stockholders’ equity section, reflecting various events. Moderate 20–30 14-2 Study Objective Knowledge Comprehension Application E14-4 E14-5 P14-1A P14-2A P14-3A P14-4A P14-5A 14-3 Q14-7 Q14-4 Q14-8 BE14-1 BE14-2 BE14-3 E14-1 E14-2 E14-3 Q14-9 Q14-11 Q14-13 Q14-14 Q14-10 BE14-4 BE14-5 E14-8 Prepare and analyze a comprehensive stockholders’ equity section. Q14-14 Q14-15 BE14-6 BE14-7 E14-5 E14-10 E14-11 E14-13 4. Describe the form and content of corporation income statements. Q14-15 Q14-16 BE14-8 E14-12 E14-13 E14-14 5. Compute earnings per share. Q14-17 BE14-9 BE14-10 E14-12 E14-14 E14-15 E14-16 E14-17 P14-3A P14-3B Prepare the entries for cash dividends and stock dividends. 2. Identify the items reported in a retained earnings statement. 3. Broadening Your Perspective Q14-12 Synthesis Evaluation P14-1B E14-6 P14-2B E14-7 P14-3B P14-4B P14-5B Q14-1 Q14-2 Q14-3 Q14-5 Q14-6 1. Analysis E14-9 P14-2B E14-6 P14-2A P14-3B P14-3A P14-4B P14-4A E14-15 E14-16 P14-1A P14-2A P14-3A P14-4A P14-5A E14-6 P14-1B P14-2B P14-3B P14-4B P14-5B Communication Financial Reporting Decision Making Across Comparative Analysis Exploring the Web the Organization All About You Ethics Case BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. (a) A dividend is a distribution of cash or stock by a corporation to its stockholders on a pro rata (proportional) basis. (b) Disagree. Dividends may take four forms: cash, property, scrip (promissory note to pay cash), or stock. 2. Sue DeVine is not correct. Adequate cash is only one of the conditions. In order for a cash dividend to occur, a corporation must also have retained earnings and the dividend must be declared by the board of directors. 3. (a) The three dates are: Declaration date is the date when the board of directors formally declares the cash dividend and announces it to stockholders. The declaration commits the corporation to a binding legal obligation that cannot be rescinded. Record date is the date that marks the time when ownership of the outstanding shares is determined from the stockholder records maintained by the corporation. The purpose of this date is to identify the persons or entities that will receive the dividend. Payment date is the date on which the dividend checks are mailed to the stockholders. (b) The accounting entries and their dates are: Declaration date—Debit Retained Earnings and Credit Dividends Payable. No entry is made on the record date. Payment date—Debit Dividends Payable and Credit Cash. 4. The allocation of the cash dividend is as follows: Total dividend............................................................................................... Allocated to preferred stock Dividends in arrears—one year....................................................... Current year dividend ........................................................................ Remainder allocated to common stock................................................... $45,000 $10,000 10,000 20,000 $25,000 5. A cash dividend decreases assets, retained earnings, and total stockholders’ equity. A stock dividend decreases retained earnings, increases paid-in capital, and has no effect on total assets and total stockholders’ equity. 6. A corporation generally issues stock dividends for one of the following reasons: (1) To satisfy stockholders’ dividend expectations without spending cash. (2) To increase the marketability of its stock by increasing the number of shares outstanding and thereby decreasing the market price per share. Decreasing the market price of the stock makes the shares easier to purchase for smaller investors. (3) To emphasize that a portion of stockholders’ equity that had been reported as retained earnings has been permanently reinvested in the business and therefore is unavailable for cash dividends. 7. In a stock split, the number of shares is increased in the same proportion that par value is decreased. Thus, in the Meenen Corporation the number of shares will increase to 60,000 = (30,000 X 2) and the par value will decrease to $5 = ($10 ÷ 2). The effect of a split on market value is generally inversely proportional to the size of the split. In this case, the market price would fall to approximately $60 per share ($120 ÷ 2). 14-4 Questions Chapter 14 (Continued) 8. The different effects of a stock split versus a stock dividend are: Item Total paid-in capital Total retained earnings Total par value (common stock) Par value per share Stock Split No change No change No change Decrease Stock Dividend Increase Decrease Increase No Change 9. A prior period adjustment is a correction of an error in previously issued financial statements. The correction is reported in the current year’s retained earnings statement as an adjustment of the beginning balance of retained earnings. 10. The understatement of depreciation in a prior year overstates the beginning retained earnings balance. The retained earnings statement presentation is: Balance, January 1, as reported ................................................................................... Correction for understatement of prior year’s depreciation ..................................... Balance, January 1, as adjusted................................................................................... $210,000 (50,000) $160,000 11. The purpose of a retained earnings restriction is to indicate that a portion of retained earnings is currently unavailable for dividends. Restrictions may result from the following causes: legal, contractual, or voluntary. 12. Retained earnings restrictions are generally reported in the notes to the financial statements. 13. The debits and credits to retained earnings are: Debits 1. 2. 3. 4. Credits Net loss Prior period adjustments for overstatement of net income Cash and stock dividends Some disposals of treasury stock 1. Net income 2. Prior period adjustments for understatement of net income 14. Juan is incorrect. Only the ending balance of retained earnings is reported in the stockholders’ equity section. 15. Gene should be told that although many factors affect the market price of a stock at a given time, the reported net income is one of the most significant factors. When companies announce increases or decreases in net income, the market price of their stock usually increases or decreases immediately. Net income also provides an indication of the amount of dividends that a company can distribute. In addition, net income leads to a growth in retained earnings, which is often reflected in a stock’s market price. 14-5 Questions Chapter 14 (Continued) 16. The unique feature of a corporation income statement is a separate section that shows income taxes or income tax expense. The presentation is as follows: Income before income taxes .................................................................................................. Income tax expense................................................................................................................. Net income................................................................................................................................. 17. $500,000 150,000 $350,000 Earnings per share means earnings per share of common stock. Preferred stock dividends are subtracted from net income in computing EPS in order to obtain income available to common stockholders. 14-6 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 14-1 Nov. 1 Dec. 31 Retained Earnings (80,000 X $1/share)............ Dividends Payable ......................................... 80,000 Dividends Payable.................................................. Cash ................................................................... 80,000 80,000 80,000 BRIEF EXERCISE 14-2 Dec. 1 31 Retained Earnings (5,000 X $16)........................ Common Stock Dividends Distributable (5,000 X $10)................................................ Paid-in Capital in Excess of Par Value (5,000 X $6) ...................................... 80,000 Common Stock Dividends Distributable......... Common Stock ............................................... 50,000 50,000 30,000 50,000 BRIEF EXERCISE 14-3 (a) Stockholders’ equity Paid-in capital Common stock, $10 par In excess of par value Total paid-in capital Retained earnings Total stockholders’ equity (b) Outstanding shares (c) Book value per share 14-7 Before Dividend After Dividend $2,000,000 — 2,000,000 500,000 $2,500,000 $2,200,000 80,000 2,280,000 220,000 $2,500,000 200,000 220,000 $12.50 $11.36 BRIEF EXERCISE 14-4 KERNS INC. Retained Earnings Statement For the Year Ended December 31, 2008 Balance, January 1..................................................................................... Add: Net income....................................................................................... Less: Dividends ......................................................................................... Balance, December 31 .............................................................................. $220,000 140,000 360,000 85,000 $275,000 BRIEF EXERCISE 14-5 PERSINGER INC. Retained Earnings Statement For the Year Ended December 31, 2008 Balance, January 1 as reported ........................................ Correction for overstatement of net income in prior period (depreciation expense error)........... Balance, January 1, as adjusted....................................... Add: Net income................................................................... Less: Cash dividend............................................................ Stock dividend .......................................................... Balance, December 31 ......................................................... $800,000 (50,000) 750,000 120,000 870,000 $90,000 8,000 98,000 $772,000 BRIEF EXERCISE 14-6 Return on stockholders’ equity ratio: $386 ÷ $2,210 + $2,510 = 16.4% 2 BRIEF EXERCISE 14-7 Return on common stockholders’ equity 14-8 $152,000 = 20% ($700,000 + $820,000) ÷ 2 BRIEF EXERCISE 14-8 DIXEN CORPORATION Income Statement For the Year Ended December 31, 2008 Sales.............................................................................................................. Cost of goods sold ................................................................................... Gross profit ................................................................................................. Operating expenses ................................................................................. Income from operations.......................................................................... Other revenues and gains...................................................................... Income before income taxes ................................................................. Income tax expense ($220,000 X 30%)............................................... Net income .................................................................................................. BRIEF EXERCISE 14-9 Earnings per share = $1.90, or ($380,000 ÷ 200,000) BRIEF EXERCISE 14-10 Earnings per share = $1.80, or [($380,000 – $20,000) ÷ 200,000] 14-9 $450,000 205,000 245,000 75,000 170,000 50,000 220,000 66,000 $154,000 SOLUTIONS TO EXERCISES EXERCISE 14-1 (a) June 15 July 10 Dec. 15 Retained Earnings (120,000 X $1)......... Dividends Payable ............................ 120,000 Dividends Payable ..................................... Cash....................................................... 120,000 Retained Earnings (122,000 X $1.20) ... Dividends Payable ............................ 146,400 120,000 120,000 146,400 (b) In the retained earnings statement, dividends of $266,400 will be deducted. In the balance sheet, Dividends Payable of $146,400 will be reported as a current liability. EXERCISE 14-2 (a) Total dividend declaration Allocation to preferred stock Remainder to common stock (b) 2007 2008 2009 $6,000 6,000 $ 0 $12,000 7,000 $ 5,000 $28,000 7,000 $21,000 2007 Total dividend declaration Allocation to preferred stock Remainder to common stock $6,000 6,000 $ 0 2008 $12,000 10,0001 $ 2,000 2009 $28,000 8,000 $20,000 1 Dividends in arrears for Year 1, $2,000 + current dividend for Year 2, $8,000. (c) Dec. 31 Retained Earnings ......................................... Dividends Payable ................................ 14-10 28,000 28,000 EXERCISE 14-3 (a) Retained Earnings (21,000* X $18) ............................. Common Stock Dividends Distributable ......... (21,000 X $10) Paid-in Capital in Excess of Par Value............. (21,000 X $8) 378,000 210,000 168,000 *[($1,000,000 ÷ $10) + 40,000] X 15%. (b) Retained Earnings (36,000* X $20) ............................. Common Stock Dividends Distributable ......... (36,000 X $5) Paid-in Capital in Excess of Par Value............. (36,000 X $15) 720,000 180,000 540,000 *[($1,000,000 ÷ 5) + 40,000] X 15%. EXERCISE 14-4 Before Action After Stock Dividend After Stock Split $ 300,000 0 300,000 900,000 $ 315,000 6,000 321,000 879,000 $ 300,000 0 300,000 900,000 $1,200,000 $1,200,000 $1,200,000 Outstanding shares 30,000 31,500 60,000 Book value per share $40.00 $38.10 $20.00 Stockholders’ equity Paid-in capital Common stock In excess of par value Total paid-in capital Retained earnings Total stockholders’ equity 14-11 EXERCISE 14-5 (a) (1) Book value before the stock dividend was $7.25 ($580,000 ÷ 80,000). (2) Book value after the stock dividend is $6.59 ($580,000 ÷ 88,000). (b) Common stock Balance before dividend ......................................................... Dividend shares (8,000 X $5) ................................................. New balance ....................................................................... $400,000 40,000 $440,000 Paid-in capital in excess of par value Balance before dividend ......................................................... Excess over par of shares issued (8,000 X $10) ............. New balance ....................................................................... $ 25,000 80,000 $105,000 Retained earnings Balance before dividend ......................................................... Dividend (8,000 X $15).............................................................. New balance ....................................................................... $155,000 120,000 $ 35,000 EXERCISE 14-6 Paid-in Capital Item Capital Stock Additional Retained Earnings 1. 2. 3. 4. 5. 6. 7. 8. NE I NE I NE NE NE I NE NE NE I NE NE NE I D NE NE D D NE NE NE 14-12 EXERCISE 14-7 1. 2. 3. Dec. 31 31 31 Retained Earnings ............................... Interest Expense ......................... 50,000 Retained Earnings ............................... Dividends Payable............................... Common Stock Dividends Distributable............................. Paid-in Capital in Excess of Par Value .............................. 8,000 10,000 Common Stock ..................................... Retained Earnings ...................... 2,000,000 50,000 10,000 8,000 2,000,000 EXERCISE 14-8 FELTER CORPORATION Retained Earnings Statement For the Year Ended December 31, 2008 Balance, January 1, as reported ................................... Correction for overstatement of 2007 net income (depreciation error) ....................................... Balance, January 1, as adjusted ................................... Add: Net income................................................................ Less: Cash dividends ...................................................... Stock dividends..................................................... Balance, December 31...................................................... 14-13 $550,000 (40,000) 510,000 350,000 860,000 $120,000 60,000 180,000 $680,000 EXERCISE 14-9 SASHA COMPANY Retained Earnings Statement For the Year Ended December 31, 2008 Balance, January 1, as reported........................................ Correction for understatement of 2006 net income......... Balance, January 1, as adjusted........................................ Add: Net income ..................................................................... Less: Cash dividends............................................................ $100,0001 Stock dividends .......................................................... 150,0002 Balance, December 31 .......................................................... 1 (200,000 X $.50/sh) $310,000 20,000 330,000 285,000 615,000 (250,000) $365,000 2 (200,000 X .05 X $15/sh) EXERCISE 14-10 KELLY GROUCUTT COMPANY Balance Sheet (Partial) December 31, 2008 Paid-in capital Capital stock Preferred stock.......................................................... $125,000 Common stock .......................................................... 400,000 Total capital stock............................................. $ 525,000 Additional paid-in capital In excess of par value—preferred stock........... 75,000 In excess of par value—common stock............ 100,000 Total additional paid-in capital ..................... 175,000 Total paid-in capital ............................................................... 700,000 Retained earnings .................................................................. 334,000* Total paid-in capital and retained earnings ................... 1,034,000 Less treasury stock—common.......................................... (40,000) Total stockholder’s equity................................................... $ 994,000 *$250,000 + $140,000 – $56,000 14-14 EXERCISE 14-11 ORTIZ INC. Balance Sheet (Partial) December 31, 200X Stockholders’ equity Paid-in capital Capital stock 8% Preferred stock, $5 par value, 40,000 shares authorized, 30,000 shares issued ...................... Common stock, no par, $1 stated value, 400,000 shares authorized, 300,000 shares issued and 290,000 outstanding ............... Common stock dividends distributable....................................... Total capital stock....................... Additional paid-in capital In excess of par value— preferred stock ................................. In excess of stated value— common stock .................................. Total additional paid-in capital ......................................... Total paid-in capital .................... Retained earnings (see Note R)......................... Total paid-in capital and retained earnings.................... Less: Treasury stock (10,000 common shares) ..................................................... Total stockholders’ equity........ $ 150,000 $ 300,000 30,000 330,000 480,000 344,000 1,200,000 1,544,000 2,024,000 800,000 2,824,000 74,000 $2,750,000 Note R: Retained earnings is restricted for plant expansion, $100,000. 14-15 EXERCISE 14-12 (a) PATEL CORPORATION Income Statement For the Year Ended December 31, 2008 ______________________________________________________________ Sales ............................................................................................. Cost of goods sold................................................................... Gross profit ................................................................................ Operating expenses................................................................. Income from operations ......................................................... Other revenues and gains ..................................................... Other expenses and losses................................................... Income before income taxes ................................................ Income tax expense ($285,000 X 20%) .............................. Net income.................................................................................. (b) $800,000 465,000 335,000 110,000 225,000 $92,000 (32,000) 60,000 285,000 57,000 $228,000 Earnings per share = $3.96, or [($228,000 – $30,000) ÷ 50,000] EXERCISE 14-13 (a) MIKE SINGLETARY CORPORATION Income Statement For the Year Ended December 31, 2008 ______________________________________________________________ Net sales ...................................................................................... Cost of goods sold................................................................... Gross profit ................................................................................ Operating expenses................................................................. Income from operations ......................................................... Interest expense........................................................................ Income before income taxes ................................................ Income tax expense (30% X $79,500)................................. Net income.................................................................................. (b) $ 600,000 360,000 240,000 153,000 87,000 7,500 79,500 23,850 $ 55,650 Net income – preferred dividends $55,650 – $15,000 = = 20.3% Average common stockholders’ equity $200,000 14-16 EXERCISE 14-14 Net income: $2,000,000 – $1,200,000 = $800,000; $800,000 – (30% X $800,000) = $560,000 Preferred dividends: (50,000 X $20) X 8% = $80,000 Average common shares outstanding: 200,000 Earnings per share: $560,000 – $80,000 = $2.40 200,000 EXERCISE 14-15 2008 Earnings per share 2007 $290, 000 – $20, 000 100, 000 Return on common stockholders’ equity $290, 000 – $20, 000 $1, 200, 000 = $2.70 = 22.5% $200, 000 – $20, 000 80, 000 $200, 000 – $20, 000 $900, 000 = $2.25 = 20.0% EXERCISE 14-16 2008 Earnings per share 2007 $290, 000 – $20, 000 150, 000 Return on common stockholders’ equity $290, 000 – $20, 000 $1, 800, 000 = $1.80 = 15.0% 14-17 $248, 000 – $20, 000 180, 000 $248, 000 – $20, 000 $1, 900, 000 = $1.27 = 12.0% EXERCISE 14-17 (a) $241,000 – $16,000 = $2.25 100,000 (b) $241,000 – $16,000 = $2.50 90,000* *100,000 – 10,000 = 90,000. 14-18 SOLUTIONS TO PROBLEMS PROBLEM 14-1A (a) Feb. Mar. 1 1 Retained Earnings (60,000 X $1)............. Dividends Payable.............................. 60,000 Dividends Payable....................................... Cash ........................................................ 60,000 Apr. 1 Memo—two-for-one stock split increases number of shares to 120,000 = (60,000 X 2) and reduces par value to $10 per share. July 1 Retained Earnings (12,000 X $13) .......... Common Stock Dividends Distributable (12,000 X $10) ........ Paid-in Capital in Excess of Par Value (12,000 X $3)................. 31 Dec. 1 31 Common Stock Dividends Distributable.............................................. Common Stock .................................... 60,000 60,000 156,000 120,000 36,000 120,000 120,000 Retained Earnings (132,000 X $.50) ....... Dividends Payable.............................. 66,000 Income Summary......................................... Retained Earnings .............................. 350,000 66,000 350,000 (b) Common Stock Date Jan. Apr. 1 1 July 31 Explanation Balance 2 for 1 split—new par $10 Ref. Debit Credit Balance 1,200,000 120,000 1,320,000
14-19 PROBLEM 14-1A (Continued) Common Stock Dividends Distributable Date July Explanation Ref. 1 31 Debit Credit 120,000 Balance 120,000 0 Credit Balance 200,000 236,000 120,000 Paid-in Capital in Excess of Par Value Date Jan. July 1 1 Explanation Balance Ref. Debit
36,000 Retained Earnings Date Jan. Feb. July Dec. (c) 1 1 1 1 31 Explanation Balance Cash dividend Stock dividend Cash dividend Net income Ref. Debit Credit
60,000 156,000 66,000 350,000 Balance 600,000 540,000 384,000 318,000 668,000 CAROLINAS CORPORATION Balance Sheet (Partial) December 31, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, $10 par value, 132,000 shares issued and outstanding.................. Additional paid-in capital In excess of par value ........................................ Total paid-in capital.................................... Retained earnings ................................................................. Total stockholders’ equity ....................... 14-20 $1,320,000 236,000 1,556,000 668,000 $2,224,000 PROBLEM 14-2A (a) July 1 Aug. 1 Sept. 1 Dec. 1 15 31 Retained Earnings ....................................... [($800,000 ÷ $5) X $.50] Dividends Payable—Common Stock................................................... 80,000 Retained Earnings ....................................... Accumulated Depreciation .............. 25,000 Dividends Payable—Common Stock............................................................ Cash ........................................................ 80,000 25,000 80,000 80,000 Retained Earnings (16,000 X $18) .......... Common Stock Dividends Distributable (16,000 X $5) .......... Paid-in Capital in Excess of Par Value—Common Stock......... (16,000 X $13) 288,000 Retained Earnings (12,000 X $3)............. Dividends Payable—Preferred Stock................................................... 36,000 Income Summary......................................... Retained Earnings .............................. 355,000 80,000 208,000 36,000 355,000 (b) Preferred Stock Date Jan. 1 Explanation Balance Ref. Debit Credit Balance 600,000 Debit Credit Balance 800,000
Common Stock Date Jan. 1 Explanation Balance Ref.
14-21 PROBLEM 14-2A (Continued) Common Stock Dividends Distributable Date Dec. Explanation Ref. Debit 1 Credit 80,000 Balance 80,000 Credit Balance 200,000 Credit Balance 300,000 508,000 Paid-in Capital in Excess of Par Value—Preferred Stock Date Jan. 1 Explanation Balance Ref. Debit
Paid-in Capital in Excess of Par Value—Common Stock Date Jan. Dec. 1 1 Explanation Balance Ref. Debit
208,000 Retained Earnings Date Jan. July Aug. Dec. 1 1 1 1 Dec. 15 Dec. 31 Explanation Balance Cash dividend— common Prior period adjustment— depreciation Stock dividend— common Cash dividend— preferred Net income Ref. Debit Credit
80,000 720,000 25,000 695,000 288,000 407,000 36,000 371,000 726,000 355,000 14-22 Balance 800,000 PROBLEM 14-2A (Continued) (c) HASHMI COMPANY Retained Earnings Statement For the Year Ended December 31, 2008 Balance, January 1, as reported ........................ Correction of 2007 depreciation......................... Balance, January 1, as adjusted ........................ Add: Net income ................................................... Less: Cash dividends—preferred..................... Stock dividends—common..................... Cash dividends—common...................... Balance, December 31........................................... (d) $ 800,000 25,000 775,000 355,000 1,130,000 $ 36,000 288,000 80,000 404,000 $ 726,000 HASHMI COMPANY Balance Sheet (Partial) December 31, 2008 Stockholders’ equity Paid-in capital Capital stock 6% Preferred stock, $50 par value, 12,000 shares issued..... Common stock, $5 par value, 160,000 shares issued ............... Common stock dividends distributable (16,000 shares) ............................. Total capital stock ................... Additional paid-in capital In excess of par value— preferred stock............................. In excess of par value— common stock.............................. Total additional paid-in capital...................................... Total paid-in capital................. Retained earnings (see Note B) .................. Total stockholders’ equity....................................... $ 600,000 $800,000 80,000 880,000 1,480,000 200,000 508,000 708,000 2,188,000 726,000 $2,914,000 Note B: Retained earnings is restricted for plant expansion, $200,000. 14-23 PROBLEM 14-3A (a) (b) Retained Earnings Sept. 1 Prior Per. Adj. 63,000 Jan. 1 Balance Oct. 1 Cash Dividend 250,000 Dec. 31 Net Income Dec. 31 Stock Dividend 400,000 Dec. 31 Balance 1,042,000 DOLD CORPORATION Retained Earnings Statement For the Year Ended December 31, 2008 Balance, January 1, as reported....................... Correction of overstatement of 2007 net income because of understatement of depreciation ........................................................ Balance, January 1, as adjusted....................... Add: Net income.................................................. Less: Cash dividends.......................................... Stock dividends ........................................ Balance, December 31 ......................................... (c) 1,170,000 585,000 $1,170,000 (63,000) 1,107,000 585,000 1,692,000 $250,000 400,000 650,000 $1,042,000 DOLD CORPORATION Partial Balance Sheet December 31, 2008 Stockholders’ equity Paid-in capital Capital stock 6% Preferred stock, $50 par value, cumulative, 20,000 shares authorized, 15,000 shares issued and outstanding.................................. 14-24 $ 750,000 PROBLEM 14-3A (Continued) DOLD CORPORATION (Continued) Common stock, $10 par value, 500,000 shares authorized, 250,000 shares issued and outstanding ................................ Common stock dividends distributable ............................... Total capital stock................. Additional paid-in capital In excess of par value— preferred stock .......................... In excess of par value— common stock........................... Total additional paid-in capital ................................... Total paid-in capital.............. Retained earnings (see Note X)................ Total stockholders’ equity.................................... $2,500,000 250,000 2,750,000 3,500,000 250,000 400,000 650,000 4,150,000 1,042,000 $5,192,000 Note X: Retained earnings is restricted for plant expansion, $200,000. (d) $585,000 – $45,000 = $2.25 240,000 *15,000 X $3 = $45,000 (e) Total cash dividend .............................................. Allocated to preferred stock Dividend in arrears—2007 ......................... (15,000 X $3) 2008 dividend................................................. Remainder to common stock ............................ 14-25 $250,000 $45,000 45,000 90,000 $160,000 PROBLEM 14-4A (a) PATTINI CORPORATION Partial Balance Sheet March 31, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, no-par value, 90,000 shares issued and outstanding........ Retained earnings ................................................................... Total stockholders’ equity............................... (b) PATTINI CORPORATION Partial Balance Sheet June 30, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, no-par value, 360,000 shares issued and outstanding ..... Retained earnings ................................................................... Total stockholders’ equity............................... (c) $1,400,000 410,000 $1,810,000 $1,400,000 410,000 $1,810,000 PATTINI CORPORATION Partial Balance Sheet September 30, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, no-par value, 378,000 shares issued and outstanding ............ $1,634,000* Retained earnings .................................................................... 176,000** Total stockholders’ equity............................... $1,810,000 *$1,400,000 + [(360,000 X .05) X $13] 14-26 **$410,000 – $234,000 PROBLEM 14-4A (Continued) (d) PATTINI CORPORATION Partial Balance Sheet December 31, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, no-par value, 378,000 shares issued and outstanding........ Retained earnings ................................................................... Total stockholders’ equity............................... *$176,000 – ($.50 X 378,000) + $350,000 14-27 $1,634,000 337,000* $1,971,000 PROBLEM 14-5A Preliminary analysis (in thousands)—NOT REQUIRED Common Stock $1,500 Balance, Jan. 1 1. Issued 50,000 shares for stock dividend 2. Issued 30,000 shares for cash 3. Corrected error in 2006 net income 4. Declared cash dividend 5. Net income for year Balance, Dec. 31 Common Stock Dividends Distributable $200 200 Retained Earnings $600 (200) Total $2,300 0 180 180 70 $1,880 $ 0 (80) 300 $890 70 (80) 300 $2,770 YADIER INC. Stockholders’ Equity Section of Balance Sheet December 31, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, no-par value, 580,000 shares issued and outstanding ......... Retained earnings ................................................................... Total stockholders’ equity ................................ 14-28 $1,880,000 890,000 $2,770,000 PROBLEM 14-1B (a) Jan. 15 Feb. 15 Apr. 15 May 15 Retained Earnings (100,000 X $1) .......... Dividends Payable.............................. 100,000 Dividends Payable....................................... Cash ........................................................ 100,000 Retained Earnings (10,000 X $15) .......... Common Stock Dividends Distributable (10,000 X $10) ........ Paid-in Capital in Excess of Par Value (10,000 X $5)................. 150,000 Common Stock Dividends Distributable.............................................. Common Stock (10,000 X $10)........ 100,000 100,000 100,000 50,000 100,000 100,000 July 1 Memo—two-for-one stock split increases the number of shares outstanding to 220,000, or (110,000 X 2) and reduces par value to $5 per share. Dec. 1 Retained Earnings (220,000 X $.50) ....... Dividends Payable.............................. 110,000 Income Summary......................................... Retained Earnings .............................. 250,000 31 110,000 250,000 (b) Common Stock Date Jan. 1 May 15 July 1 Explanation Balance Ref. Debit Credit
100,000 2 for 1 stock split— new par value = $5 14-29 Balance 1,000,000 1,100,000 PROBLEM 14-1B (Continued) Common Stock Dividends Distributable Date Apr. 15 May 15 Explanation Ref. Debit Credit 100,000 Balance 100,000 0 Credit Balance 200,000 250,000 100,000 Paid-in Capital in Excess of Par Value Date Jan. 1 Apr. 15 Explanation Balance Ref. Debit
50,000 Retained Earnings Date Jan. 1 15 Apr. 15 Dec. 1 31 (c) Explanation Balance Cash dividends Stock dividends Cash dividends Net income Ref. Debit Credit
100,000 150,000 110,000 250,000 Balance 540,000 440,000 290,000 180,000 430,000 VERLIN CORPORATION Balance Sheet (Partial) December 31, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, $5 par value, 220,000 shares issued and outstanding.................. Additional paid-in capital In excess of par value ........................................ Total paid-in capital.................................... Retained earnings ................................................................. Total stockholders’ equity ....................... 14-30 $1,100,000 250,000 1,350,000 430,000 $1,780,000 PROBLEM 14-2B (a) July 1 Aug. 1 Sept. 1 Dec. 1 15 31 Retained Earnings ....................................... [($800,000 ÷ $10) X $.50] Dividends Payable—Common Stock................................................... 40,000 Accumulated Depreciation ....................... Retained Earnings .............................. 72,000 Dividends Payable—Common Stock............................................................ Cash ........................................................ 40,000 72,000 40,000 40,000 Retained Earnings (8,000 X $16)............. Common Stock Dividends Distributable (8,000 X $10) .......... Paid-in Capital in Excess of Par Value—Common Stock......... (8,000 X $6) 128,000 Retained Earnings (5,000 X $7) ............... Dividends Payable—Preferred Stock................................................... 35,000 Income Summary......................................... Retained Earnings .............................. 350,000 80,000 48,000 35,000 350,000 (b) Preferred Stock Date Jan. 1 Explanation Balance Ref. Debit Credit Balance 500,000 Debit Credit Balance 800,000
Common Stock Date Jan. 1 Explanation Balance Ref.
14-31 PROBLEM 14-2B (Continued) Common Stock Dividends Distributable Date Dec. Explanation Ref. Debit 1 Credit 80,000 Balance 80,000 Credit Balance 100,000 Credit Balance 200,000 248,000 Paid-in Capital in Excess of Par Value—Preferred Stock Date Jan. 1 Explanation Balance Ref. Debit
Paid-in Capital in Excess of Par Value—Common Stock Date Jan. Dec. 1 1 Explanation Balance Ref. Debit
48,000 Retained Earnings Date Jan. July Aug. Dec. 1 1 1 1 15 31 Explanation Balance Cash dividends— common Prior period adjustment Stock dividends— common Cash dividends— preferred Net income Ref. Debit Credit
40,000 460,000 72,000 532,000 128,000 404,000 35,000 369,000 719,000 350,000 14-32 Balance 500,000 PROBLEM 14-2B (Continued) (c) HOLMES, INC. Retained Earnings Statement For the Year Ended December 31, 2008 Balance, January 1, as reported .......................... Correction of 2007 depreciation........................... Balance, January 1, as adjusted .......................... Add: Net income ..................................................... Less: Cash dividends—preferred....................... Stock dividends—common....................... Cash dividends—common........................ Balance, December 31............................................. (d) $500,000 72,000 572,000 350,000 922,000 $ 35,000 128,000 40,000 203,000 $719,000 HOLMES, INC. Balance Sheet (Partial) December 31, 2008 Stockholders’ equity Paid-in capital Capital stock 7% Preferred stock, $100 par value, 5,000 shares issued ...... Common stock, $10 par value, 80,000 shares issued................. Common stock dividends distributable ................................. Total capital stock .................. Additional paid-in capital In excess of par value— preferred stock............................ In excess of par value— common stock............................. Total additional paid-in capital..................................... Total paid-in capital................ Retained earnings........................................... Total stockholders’ equity...................................... 14-33 $ 500,000 $800,000 80,000 880,000 1,380,000 100,000 248,000 348,000 1,728,000 719,000 $2,447,000 PROBLEM 14-3B (a) Nov. 1 Cash Dividend Dec. 31 Stock Dividend (b) Retained Earnings 600,000 Jan. 1 Balance 360,000 Dec. 31 Dec. 31 Balance TAGUCI CORPORATION Retained Earnings Statement For the Year Ended December 31, 2008 Balance, January 1................................................. Add: Net income................................................... Less: Cash dividends .......................................... Stock dividends ........................................ Balance, December 31 .......................................... (c) 2,450,000 840,000 2,330,000 $2,450,000 840,000 3,290,000 $600,000 360,000 960,000 $2,330,000 TAGUCI CORPORATION Partial Balance Sheet December 31, 2008 ___________________________________________________________ Stockholders’ equity Paid-in capital Capital stock 6% Preferred stock, $100 par value, noncumulative, callable at $125, 20,000 shares authorized, 10,000 shares issued and outstanding ........................................ $1,000,000 Common stock, no par, $5 stated value, 600,000 shares authorized, 400,000 shares issued and outstanding .......... $2,000,000 Common stock dividends distributable................................ 200,000 2,200,000 Total capital stock ................. 3,200,000 14-34 PROBLEM 14-3B (Continued) TAGUCI CORPORATION (Continued) Additional paid-in capital In excess of par value— preferred stock .......................... In excess of stated value— common stock........................... Total additional paid-in capital ................................... Total paid-in capital.............. Retained earnings (see Note A)................ Total stockholders’ equity.................................... $ 200,000 1,180,000 1,380,000 4,580,000 2,330,000 $6,910,000 Note A: Retained earnings is restricted for plant expansion, $100,000. (d) $840,000 – $60,000 * = $2.40 325,000 *10,000 X $6 = $60,000 (e) Total dividend...................................................................................... Allocated to preferred stock—current year only ..................... Remainder to common stock ......................................................... 14-35 $600,000 60,000 $540,000 PROBLEM 14-4B (a) ERWIN CORPORATION Partial Balance Sheet March 31, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, no-par value, 150,000 shares issued and outstanding......... Retained earnings ................................................................... Total stockholders’ equity.............................. (b) ERWIN CORPORATION Partial Balance Sheet JUNE 30, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, no-par value, 600,000 shares issued and outstanding ........ Retained earnings ................................................................... Total stockholders’ equity.............................. (c) $2,800,000 850,000 $3,650,000 $2,800,000 850,000 $3,650,000 ERWIN CORPORATION Partial Balance Sheet September 30, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, no-par value, 630,000 shares issued and outstanding............ $3,190,000* Retained earnings ................................................................... 460,000** Total stockholders’ equity.............................. $3,650,000 *$2,800,000 + [(600,000 X .05) X $13] 14-36 **$850,000 – $390,000 PROBLEM 14-4B (Continued) (d) ERWIN CORPORATION Partial Balance Sheet December 31, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, no-par value, 630,000 shares issued and outstanding......... Retained earnings .................................................................... Total stockholders’ equity ............................. *$460,000 – ($.50 X 630,000) + $700,000 14-37 $3,190,000 845,000* $4,035,000 PROBLEM 14-5B Preliminary analysis (in thousands)—NOT REQUIRED Common Stock $3,000 Balance, Jan. 1 1. Issued 100,000 shares for stock dividend 2. Issued 40,000 shares for cash 3. Corrected error in 2006 net income 4. Declared cash dividend 5. Net income for year Balance, Dec. 31 Common Stock Dividends Distributable $400 400 Retained Earnings $1,200 (400) Total $4,600 0 200 200 140 $3,600 $ 0 (500) 600 $1,440 140 (500) 600 $5,040 MORALES INC. Stockholders’ Equity Section of Balance Sheet December 31, 2008 Stockholders’ equity Paid-in capital Capital stock Common stock, no-par value, 1,140,000 shares issued and outstanding....... Retained earnings ................................................................... Total stockholders’ equity.................................. 14-38 $3,600,000 1,440,000 $5,040,000 BYP 14-1 FINANCIAL REPORTING PROBLEM According to the Consolidated Statement of Common Shareholders’ Equity, the company declared dividends on common stock of $1,684 million during the year-ended December 31, 2005. The company declared dividends on common stock of $1,438 million during the year ended December 25, 2004. 14-39 BYP 14-2 COMPARATIVE ANALYSIS PROBLEM (a) PepsiCo Earnings per share $4, 078 – $3 Coca-Cola $4, 872 – $0 = $2.44 1, 669 Return on common stockholders’ equity $4, 078 – $3 = $2.04 2, 392 = 29.2% ($13, 572 + $14, 320) ÷ 2 $4, 872 – $0 = 30.2% ($15, 935 + $16, 355) ÷ 2 The return on common stockholders’ equity can be used to compare the profitability of two companies. It shows how many dollars of net income were earned for each dollar invested by the owners. Since this ratio is expressed as a percent instead of a dollar amount like earnings per share, it can be used to compare PepsiCo and Coca-Cola. During 2005, Coca-Cola was slightly (3%) more profitable than PepsiCo based on their respective returns on common stockholders’ equity. Earnings per share measures cannot be compared across companies because they may use vastly different numbers of shares to finance the company. (b) PepsiCo paid cash dividends of $1,642 million and Coca-Cola paid $2,678 million of cash dividends in 2005. 14-40 BYP 14-3 EXPLORING THE WEB Answers will vary depending on the company chosen by the student. 14-41 BYP 14-4 DECISION MAKING ACROSS THE ORGANIZATION Journal entries—NOT REQUIRED July Aug. Sept. Dec. 1 1 1 1 15 31 (a) Retained Earnings ................................... (140,000 X $0.50) Dividends Payable ............................ 70,000 Accumulated Depreciation ................... Retained Earnings............................. 72,000 Dividends Payable ................................... Cash....................................................... 70,000 Retained Earnings (14,000 X $12)....... Common Stock Dividends Distributable........................................ 168,000 Retained Earnings (4,000 X $9) ........... Dividends Payable ............................ 36,000 Income Summary ..................................... Retained Earnings............................. 320,000 70,000 72,000 70,000 168,000 36,000 320,000 FERNANDEZ, INC. Retained Earnings Statement For the Year Ended December 31, 2008 Balance, January 1, as previously reported................. Correction of 2007 depreciation ....................................... Balance, January 1, as corrected..................................... Add: Net income ................................................................. Less: Cash dividends—preferred................................... Stock dividends—common................................... Cash dividends—common.................................... Balance, December 31 ......................................................... 14-42 $500,000 72,000 572,000 320,000 892,000 $ 36,000 168,000 70,000 274,000 $618,000 BYP 14-4 (Continued) (b) Treating the overstatement of 2007 depreciation expense as an adjustment of 2008 income would be incorrect because it applies to the prior year’s income statement and would distort depreciation expense for 2008. (c) Companies issue stock dividends instead of cash dividends to satisfy stockholders’ dividend expectations without spending cash and to increase the marketability of the corporation’s stock. 14-43 BYP 14-5 COMMUNICATION ACTIVITY Dear Mom and Dad, Thanks for calling me about your investments in Cormier Corporation and Fegan, Inc. The effect to you as stockholders is the same for both a stock dividend and a stock split. In each case, the number of shares you own will increase. Following the stock dividend, you will own 110 shares of Cormier [100 + (100 X 10%)]. After the stock split, you will own 200 shares of Fegan (100 X 2). The total value of your investments should remain approximately the same as before the stock dividend and stock split. The reason is that the market value per share will likely decrease in proportion to the additional shares that you will own. If there is a change in value, it is more likely to be higher than lower. The effects of the stock dividend and stock split on the corporations are limited entirely to the stockholders’ equity sections as follows: Stockholders’ Equity Item After Stock Dividend After Stock Split Total capital stock Par value per share Total paid-in capital Total retained earnings Total stockholders’ equity Increase No change Increase Decrease No change No change Decrease No change No change No change I hope this answers your questions, Mom and Dad. If you have any additional questions, please give me a call. Love, P.S. Please send money. 14-44 BYP 14-6 ETHICS CASE (a) The stakeholders in this situation are:
Tom Henson, president of Garcia Corporation.
Andrea Lane, financial vice-president.
The stockholders of Garcia Corporation. (b) There is nothing unethical in issuing a stock dividend. But the president’s order to write a press release convincing the stockholders that the stock dividend is just as good as a cash dividend is unethical. A stock dividend is not a cash dividend and does not necessarily place the stockholder in the same position. A stock dividend is a “paper” dividend—the issuance of a stock certificate, not a check (cash). (c) The stock dividend results in a decrease in retained earnings and an increase of the same amount in paid-in capital with no change in total stockholders’ equity. There is no change in total assets and no change in total liabilities and stockholders’ equity. As a stockholder, preference for a cash dividend versus a stock dividend is dependent upon one’s investment objective—income (cash flow) or growth (reinvestment). 14-45 Chapter 15 Service Department Costing: An Activity Approach Solutions to Questions 15-1 Operating departments are the units in an organization within which the central purposes of the organization are carried out; these departments usually generate revenue. By contrast, service departments provide support or assistance to the operating departments. Examples of service departments include laundry services, internal auditing, airport maintenance services (ground crews), cafeteria, personnel, cost accounting, and so on. 15-4 15-2 15-6 Service department costs are allocated to products and services in two stages. Service department costs are f irst allocated to the operating departments. These allocated costs are then included in the operating departments’ overhead rates, which are used to cost products and services. 15-3 I nterdepartmental service costs exist whenever two service departments perform services for each other. Under the step method, the costs of the service department performing the greatest amount of service for the other service departments are allocated f irst, the costs of the service department performing the next greatest amount of service are allocated next, and so forth through all the service departments. Once a service department’s costs have been allocated, costs are not reallocated back to it under the step method. Under the direct method, costs are not allocated from one service department to another. Rather, all service department costs are allocated directly to operating departments. 15-5 I f a service department generates revenues, these revenues should be offset against the department’s costs and only the net amount of cost remaining after this offset should be allocated to other departments. Two general guidelines govern the allocation of f ixed service department costs to other departments: (1) allocate only budgeted costs, and (2) allocate f ixed costs in predetermined, lump-sum amounts, according to how much of the service department’s capacity is acquired to serve each of the other departments. Two general guidelines also govern the allocation of variable service department costs to other departments: (1) allocate at budgeted rates, and (2) allocate the costs according to whatever activity (direct labor-hours, pounds of laundry, etc.) causes their incurrence. 15-7 I f a variable base is used to allocate f ixed costs, the costs allocated to one department will depend in large part on what is happening in other departments. As a consequence, the amount of service department cost allocated to a department will increase or decrease depending on the activity in other departments. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 915 Exercise 15-1 (15 minutes) Service Departments AdminiFacility stration Services Departmental costs before allocations ...................... $2,400,000 Allocations: Administration costs (20/ 25, 5/ 25) .............. (2,400,000) Facility Services costs (70/ 100, 30/ 100)* ...... Total costs after allocation . $ 0 $1,600,000 (1,600,000) $ 0 Operating Departments Undergraduate Graduate Programs Programs $26,800,000 $5,700,000 1,920,000 480,000 1,120,000 $29,840,000 480,000 $6,660,000 Total $36,500,000 $36,500,000 * Based on the space occupied by the two operating departments, which is 100,000 square feet. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 916 Managerial Accounting, 11th Edition Exercise 15-2 (15 minutes) Service Departments Administration Janitorial Departmental costs before allocations ..... $150,000 Allocations: Administration costs (160/ 4,000, 3,100/ 4,000, 740/ 4,000)* ................................... (150,000) Janitorial costs (4,000/ 5,000, 1,000/ 5,000)† ............ Total costs after allocation ..................... $ 0 $40,000 6,000 (46,000) $ 0 Operating Departments Groceries Gifts $2,320,000 $950,000 116,250 Total $3,460,000 27,750 36,800 9,200 $2,473,050 $986,950 $3,460,000 * Based on employee hours in the other three departments, 160 + 3,100 + 740 = 4,000. †Based on space occupied by the two operating departments, 4,000 + 1,000 = 5,000. Both the Janitorial Department costs of $40,000 and the Administration costs of $6,000 that have been allocated to the Janitorial Department are allocated to the two operating departments. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 917 Exercise 15-3 (10 minutes) Northern Plant Southern Plant Variable costs: $0.25 per ton × 120,000 tons........... $ 30,000 $0.25 per ton × 60,000 tons............. Fixed costs: 70% × $300,000 ............................. 210,000 30% × $300,000 ............................. Total allocated costs ........................... $240,000 $ 15,000 90,000 $105,000 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 918 Managerial Accounting, 11th Edition Exercise 15-4 (20 minutes) 1. and 2. End-of-year allocations of variable costs should be based on the actual level of activity multiplied by the budgeted rate. End-of-year allocations of f ixed costs should be based on the same predetermined lump-sum amounts as at the beginning of the year. Actual costs in excess of (or less than) the budgeted rate for variable costs or the budgeted total f ixed costs should not be allocated to the plants. Therefore, the allocations of transport services cost at the end of the year would be: Northern Plant Variable costs: $0.25 per ton × 130,000 tons... $0.25 per ton × 50,000 tons .... Fixed costs: 70% × $300,000 ..................... 30% × $300,000 ..................... Total cost .................................. Southern Plant Total $ 32,500 $ 12,500 $ 45,000 90,000 $102,500 300,000 $345,000 210,000 $242,500 3. Part of the $364,000 in total cost will not be allocated to the plants, as follows: Variable Cost Total cost incurred...................... Total cost allocated (above) ........ Amount of cost not allocated....... $54,000 45,000 $ 9,000 Fixed Cost Total $310,000 300,000 $ 10,000 $364,000 345,000 $ 19,000 The cost not allocated represents cost incurred in excess of the budgeted $0.25 per ton variable cost and budgeted $300,000 in f ixed costs. This $19,000 in unallocated cost is the responsibility of the Transport Services Department and is a cost variance for the year. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 919 Exercise 15-5 (20 minutes) Service Departments Administration Janitorial Operating Departments Maintenance Overhead costs .................................. $140,000 $105,000 $ 48,000 Allocations: Administration costs: (5% , 20% , 45% , 30% )* ................ (140,000) 7,000 28,000 Janitorial costs: (1/ 8, 2/ 8, 5/ 8) ......... (112,000) 14,000 Maintenance costs: (1/ 3, 2/ 3) ........... (90,000) Total overhead costs after allocations... $ 0 $ 0 $ 0 Binding Printing Total $275,000 $430,000 $998,000 63,000 42,000 28,000 70,000 30,000 60,000 $396,000 $602,000 $998,000 * Allocations can be shown in percentages, in fractions, or as a rate per unit of activity. For example, Administration allocations have been shown as percentages, but they could have been shown as 1/ 20; 4/ 20; 9/ 20; and 6/ 20 or they could have been shown as $200 per employee. Fractions should be used if percentages result in rounding errors. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 920 Managerial Accounting, 11th Edition Exercise 15-5 (continued) Supporting computations: Administration costs allocated on the basis of: Janitorial.................. 35 employees Maintenance ............ 140 employees Binding .................... 315 employees Printing ................... 210 employees Total........................ 700 employees 5% 20 45 30 100 % Janitorial costs allocated on the basis of: Maintenance ............ 20,000 square feet Binding .................... 40,000 square feet Printing ................... 100,000 square feet Total........................ 160,000 square feet 1/ 8 2/ 8 5/ 8 8/ 8 Maintenance costs allocated on the basis of: Binding .................... 30,000 hours Printing ................... 60,000 hours Total........................ 90,000 hours 1/ 3 2/ 3 3/ 3 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 921 Exercise 15-6 (20 minutes) Service Departments Administration Janitorial Operating Departments Maintenance Overhead costs ........................... $140,000 $105,000 $ 48,000 Allocation: Administration costs: (3/ 5, 2/ 5) . (140,000) Janitorial costs: (2/ 7, 5/ 7) ......... (105,000) Maintenance costs: (1/ 3, 2/ 3) .... (48,000) Total overhead costs after allocations ........................................ $ 0 $ 0 $ 0 Binding Printing Total $275,000 $430,000 $998,000 84,000 30,000 16,000 56,000 75,000 32,000 $405,000 $593,000 $998,000 Supporting computations: Binding .. Printing . Total...... Administration Janitorial 315 employees 3/ 5 210 employees 2/ 5 525 employees 5/ 5 40,000 square feet 2/ 7 100,000 square feet 5/ 7 140,000 square feet 7/ 7 Maintenance 30,000 hours 1/ 3 60,000 hours 2/ 3 90,000 hours 3/ 3 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 922 Managerial Accounting, 11th Edition Exercise 15-7 (20 minutes) Restaurants Rick’s I mperial Harborside Garden 1. Percentage of 2005 sales..................... Allocation of 2005 f ixed administrative expenses (based on the above percentages) .................................... 2. 2005 allocation (above) ....................... 2004 allocation ................................... I ncrease (decrease) in allocation .......... 32% $640,000 50% $1,000,000 $640,000 $1,000,000 800,000 750,000 $(160,000) $ 250,000 Ginger Wok Total 18% 100% $360,000 $2,000,000 $360,000 $2,000,000 450,000 2,000,000 $(90,000) $ 0 The manager of the I mperial Garden undoubtedly will be upset about the increased allocation of f ixed administrative expense. Such an increased allocation may be viewed as a penalty for an outstanding performance. 3. Sales dollars is not ordinarily a good base for allocating f ixed costs. The departments with the greatest sales will be allocated the greatest amount of cost and the costs allocated to a department will be affected by the sales in other departments. I n our illustration above, the sales in two restaurants remained static and the sales in the third increased. As a result, less cost was allocated to the restaurants with static sales and more cost was allocated to the one restaurant that showed improvement during the period. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 923 Exercise 15-8 (15 minutes) The budgeted rate of $18 per X-ray should be multiplied by the actual number of X-rays provided for each operating department for the end-ofyear allocations. (2) (1) Actual Budgeted Number of Rate X-rays Pediatrics...................... OB Care ....................... General Hospital............ Total ............................ $18 $18 $18 6,000 3,000 15,000 24,000 (1) × (2) Total Allocation $108,000 54,000 270,000 $432,000 The difference between the budgeted and actual cost per X-ray is the responsibility of the Radiology Department and is not allocated to the operating departments. This variance totals $48,000 for the year. 24,000 X-rays × ($20 – $18 = $2 per X-ray) = $48,000. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 924 Managerial Accounting, 11th Edition Exercise 15-9 (15 minutes) Janitorial Services 1. Cost to be allocated ............................ Allocations: Janitorial Services: (4% , 20% , 16% , 60% ) .................. Radiology: (3/ 10, 2/ 10, 5/ 10) ............ Total overhead costs after allocations ... Radiology Pediatrics $375,000 $590,000 (375,000) 15,000 $ 75,000 (605,000) 181,500 $ 0 $256,500 $ 0 OB Care General Hospital $ 60,000 121,000 $181,000 $225,000 302,500 $527,500 Supporting computations: Janitorial Services: Radiology ............. Pediatrics ............. OB Care ............... General Hospital ... 6,000 30,000 24,000 90,000 150,000 sq. sq. sq. sq. sq. ft. 4% ft. 20 ft. 16 ft. 60 ft. 100 % Radiology: Pediatrics ............ OB Care .............. General Hospital .. 9,000 6,000 15,000 30,000 X-rays 3/ 10 X-rays 2/ 10 X-rays 5/ 10 X-rays 10/ 10 2. The allocations would be the same as in Part 1, since budgeted f ixed costs are always allocated to consuming departments. Thus, $6,000 of the actual f ixed costs in Janitorial Services ($381,000 – $375,000) and $10,000 of the actual f ixed costs in Radiology ($600,000 – $590,000) would not be allocated to other departments. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 925 Problem 15-10 (60 minutes) (Thousands of ¥) 1. Factory Administration Custodial Services Personnel Maintenance Machining Assembly Step method Operating department costs...... Costs to be allocated ................ ¥270,000 Allocations: Factory Administration @ ¥1,800 per labor-hour ..... (270,000) Custodial Services @ ¥720 per square foot....... Personnel @ ¥320,000 per employee ... Maintenance @ ¥1,250 per machinehour .................................. Total overhead after allocations ............................ ¥ 0 Divide by machine-hours (thousands) .......................... Divide by direct labor-hours (thousands) .......................... Overhead rate ......................... ¥376,300 ¥175,900 ¥ 68,760 ¥ 28,840 ¥ 45,200 5,400 9,000 39,600 54,000 162,000 2,160 7,200 50,400 14,400 8,000 12,800 19,200 87,500 12,500 ¥581,000 ¥384,000 (74,160) (40,000) (100,000) ¥ 0 ¥ 0 ¥ 0 ÷ 70 ¥ 8,300 ÷ 80 ¥ 4,800 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 926 Managerial Accounting, 11th Edition Problem 15-10 (continued) (Thousands of ¥) 2. Factory Administration Custodial Services Personnel Maintenance Machining Assembly Direct method Operating department costs...... Costs to be allocated ................ ¥270,000 Allocations: Factory Administration (1/ 4, 3/ 4) ........................... (270,000) Custodial Services (7/ 9, 2/ 9) .. Personnel (2/ 5, 3/ 5) .............. Maintenance (7/ 8, 1/ 8) .......... Total overhead after allocations..................................... ¥ 0 Divide by machine-hours (thousands) .......................... Divide by direct labor-hours (thousands) .......................... Overhead rate.......................... ¥68,760 ¥28,840 ¥376,300 ¥175,900 67,500 53,480 11,536 39,550 202,500 15,280 17,304 5,650 ¥548,366 ¥416,634 ¥45,200 (68,760) (28,840) (45,200) ¥ 0 ¥ 0 ¥ 0 ÷ ¥ 70 7,834 ¥ ÷ 80 5,208 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 927 Problem 15-10 (continued) 3. Plantwide rate Overhead rate= = Total overhead cost Total direct labor-hours ¥965,000,000 = ¥9,650 per DLH 100,000 DLHs 4. The amount of overhead cost assigned to the job would be: Step method: Machining Department: ¥8,300 per machine-hour × 190 machine-hours ................................................ ¥1,577,000 Assembly Department: ¥4,800 per direct labor-hour × 75 direct labor-hours........................................... 360,000 Total overhead cost ..................................................... ¥1,937,000 Direct method: Machining Department: ¥7,834 per machine-hour × 190 machine-hours ................................................ ¥1,488,460 Assembly department: ¥5,208 per direct labor-hour × 75 direct labor-hours .............................................. 390,600 Total overhead cost ..................................................... ¥1,879,060 Plantwide method: ¥9,650 per direct labor-hour × 100 direct labor-hours . ¥ 965,000 The plantwide method, which is based on direct-labor hours, assigns very little overhead cost to the job since it requires little labor time. Assuming that Factory Administrative costs really do vary in proportion to labor-hours, Custodial Services with square feet occupied, and so on, the company will tend to undercost such jobs if a plantwide overhead rate is used (and it will tend to overcost jobs requiring large amounts of labor time). The direct method is better than the plantwide method, but the step method will generally provide the most accurate overhead rates of the three methods. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 928 Managerial Accounting, 11th Edition Problem 15-11 (45 minutes) 1. Auto Division Variable costs: $3 per meal × 35,000 meals .... $3 per meal × 20,000 meals .... Fixed costs: 65% × $40,000....................... 35% × $40,000....................... Total cost allocated .................... Truck Division $105,000 $60,000 26,000 $131,000 14,000 $74,000 The variable costs are allocated by multiplying the budgeted rate per meal by the budgeted number of meals that will be served in each division during the month. The f ixed costs are allocated in predetermined, lump-sum amounts based on the peak-period need for meals in each division. 2. Auto Division Variable costs: $3 per meal × 20,000 meals .... $3 per meal × 20,000 meals .... Fixed costs: 65% × $40,000....................... 35% × $40,000....................... Total cost allocated .................... Truck Division $60,000 $60,000 26,000 $86,000 14,000 $74,000 The variable costs are allocated according to the budgeted rate per meal and not according to the actual rate. The f ixed costs are again allocated in predetermined, lump-sum amounts, based on budgeted f ixed costs. Any difference between budgeted and actual costs is not allocated, but rather is treated as a spending variance of the cafeteria: Total actual costs for the month ............... Total cost allocated above ........................ Spending variance—not allocated ............. Variable Fixed $128,000 120,000 $ 8,000 $42,000 40,000 $ 2,000 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 929 Problem 15-11 (continued) 3. Actual variable costs.............. Actual f ixed costs.................. Total actual costs .................. $128,000 42,000 $170,000 One-half of the cost, or $85,000, would be allocated to each division, since an equal number of meals were served in each division during the month. 4. This method has two major problems. First, the spending variances should not be allocated, since this forces the ineff iciencies of the service department onto the using departments. Second, the f ixed costs should not be allocated according to month-by-month usage of services, since this causes the allocation to one division to be affected by what happens in another division. 5. Their strategy probably will be to underestimate their peak period requirements in order to force a greater proportion of any allocation onto other departments. Top management can control ploys of this type by careful follow-up, with rewards being given to those managers who estimate accurately, and severe penalties assessed against those managers who underestimate their peak period requirements. For example, departments whose managers underestimate their peak period requirements may be denied access to the cafeteria once their estimates have been exceeded. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 930 Managerial Accounting, 11th Edition Problem 15-12 (30 minutes) 1. Yes, there is merit to the complaint. The company is using a variable base (hours of hangar use) to allocate costs that are largely f ixed. Thus, the amount of cost that is charged to a division during a given month will depend to a large extent on usage in other divisions. A reduction in usage in one division can result in shifts of costs from it onto the other divisions, even though the other divisions receive no more service. 2. Hours of Use 1st quarter activity ................ 2nd quarter activity ............... Difference ............................ Variable cost element = = 3,000 2,000 1,000 Total Cost $172,000 168,000 $ 4,000 Change in cost Change in activity $4,000 = $4 per hour 1,000 hours Fixed cost per quarter: Total cost, 1st quarter................................................ Less variable cost ($4 per hour × 3,000 hours)............ Fixed cost ................................................................. $172,000 12,000 $160,000 Thus, the cost formula is $160,000 f ixed cost plus $4 per hour variable cost. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 931 Problem 15-12 (continued) 3. Even though the peak-period level of activity will not be reached until the fourth quarter, it should still be used to allocate the f ixed costs of the hangar. The reason is that peak-period requirements determine the present level of f ixed costs. The fact that the divisions do not need a peak-period level of servicing every quarter is immaterial. I f the divisions require such servicing at certain times, then the capacity to deliver it must be available, and it is the responsibility of the divisions to bear the cost of that capacity. Domestic Overseas Freight Passenger Passenger 1st quarter allocation: Variable cost: $4 per hour × 900 hours ................. $4 per hour × 1,800 hours .............. $4 per hour × 300 hours ................. $ 3,600 $ 7,200 $ 1,200 Fixed cost: 30% × $160,000 ............................ 48,000 50% × $160,000 ............................ 20% × $160,000 ............................ Total cost allocation ........................... $51,600 2nd quarter allocation: Variable cost: $4 per hour × 800 hours ................. $4 per hour × 700 hours ................. $4 per hour × 500 hours ................. 80,000 $87,200 32,000 $33,200 $ 3,200 $ 2,800 $ 2,000 Fixed cost: 30% × $160,000 ............................ 48,000 50% × $160,000 ............................ 20% × $160,000 ............................ Total cost allocation ........................... $51,200 80,000 $82,800 32,000 $34,000 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 932 Managerial Accounting, 11th Edition Problem 15-13 (45 minutes) Housekeeping Services Variable costs.............................. $ 0 Food Services allocation: $2.70 per meal × 800 meals...... $2.70 per meal × 2,000 meals ... $2.70 per meal × 1,000 meals ... $2.70 per meal × 68,000 meals . Admin. Services allocation: $3.50 per f ile × 14,000 f iles ...... $3.50 per f ile × 7,000 f iles ........ $3.50 per f ile × 25,000 f iles ...... Total variable costs ...................... $ Food Services $193,860 $158,840 (2,160) (5,400) (2,700) (183,600) 0 Administrative Services Laboratory Radiology $ 0 $243,600 General Hospital $304,800 $ 74,500 2,160 5,400 2,700 183,600 (49,000) 49,000 (24,500) (87,500) $ 0 $298,000 24,500 87,500 $332,000 $345,600 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 933 Problem 15-13 (continued) Housekeeping Services Food Services Fixed costs.................................. $87,000 $107,200 Housekeeping Services allocation @ $0.60 per square foot: $0.60 × 13,000 square feet ....... $0.60 × 6,500 square feet ......... $0.60 × 10,000 square feet ....... $0.60 × 7,500 square feet ......... $0.60 × 108,000 square feet ..... (7,800) (3,900) (6,000) (4,500) (64,800) Food Services allocation: 0.8% × $115,000................... 2.4% × $115,000................... 1.6% × $115,000................... 95.2% × $115,000 .................. Admin. 30% 20% 50% Administrative Services Laboratory Radiology $90,180 $162,300 General Hospital $215,700 $401,300 7,800 3,900 6,000 4,500 64,800 (920) (2,760) (1,840) (109,480) Services allocation: × $95,000 ....................... × $95,000 ....................... × $95,000 ....................... 920 2,760 1,840 109,480 (28,500) (19,000) (47,500) 28,500 19,000 47,500 Total f ixed costs .......................... $ 0 $ 0 $ 0 $199,560 $241,040 $623,080 Total overhead costs.................... $ 0 $ 0 $ 0 $497,560 $573,040 $968,680 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 934 Managerial Accounting, 11th Edition Problem 15-13 (continued) Computation of allocation rates: Variable Food Services: Allocation rate= = Variable food services costs Meals served $193,860 71,800 meals = $2.70 per meal Variable Administrative Services: Allocation rate= = Variable administrative services costs Files processed $158,840 + $2,160 46,000 files = $3.50 per file Fixed Housekeeping Services: Allocation rate= = Fixed housekeeping services costs Square feet $87,000 150,000 square feet - 5,000 square feet = $0.60 per square foot © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 935 Problem 15-14 (30 minutes) 1. Beginning-of-year allocations of variable costs are computed by multiplying the budgeted rate by the budgeted level of activity. Fixed costs are allocated in lump-sum amounts based on the peak-period needs of the using departments. The computations are: Forming Assembly Department Department Variable costs: $0.40 per machine-hour × 160,000 machine-hours ....... $0.40 per machine-hour × 80,000 machine-hours......... Fixed costs: 70% × $150,000 ................... 30% × $150,000 ................... Total cost allocated................... Total $ 64,000 $32,000 $ 96,000 45,000 $77,000 150,000 $246,000 105,000 $169,000 2. a. End-of-year allocations of variable costs are computed by multiplying the budgeted rate by the actual level of activity. Fixed costs are again allocated in predetermined lump-sum amounts based on budgeted costs. The computations are: Forming Assembly Department Department Variable costs: $0.40 per machine-hour × 190,000 machine-hours ....... $0.40 per machine-hour × 70,000 machine-hours......... Fixed costs: 70% × $150,000 ................... 30% × $150,000 ................... Total cost allocated................... Total $ 76,000 $28,000 $104,000 45,000 $73,000 150,000 $254,000 105,000 $181,000 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 936 Managerial Accounting, 11th Edition Problem 15-14 (continued) b. Any difference between the budgeted and actual variable cost per machine-hour or between the budgeted and actual total f ixed cost would not be allocated to the other departments. The amount not allocated would be: Variable Cost Fixed Cost Total Actual cost incurred during the year ... $110,000 $153,000 $263,000 Cost allocated (above) ....................... 104,000 150,000 254,000 Cost not allocated (spending variance) ....................................... $ 6,000 $ 3,000 $ 9,000 The costs not allocated are spending variances of the Maintenance Department and are the responsibility of the Maintenance Department’s manager. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 937 Problem 15-15 (60 minutes) 1. and 2. Building & Grounds Variable costs to be allocated ..................... R 0 Administration: R20 per employee × 30 employees .......... R20 per employee × 450 employees ........ R20 per employee × 630 employees ........ Administration (600) (9,000) (12,600) 0 Finishing 600 R 9,000 R12,600 (7,000) (10,500) R Fabrication R22,200 R16,900 Equipment maintenance: R0.10 per MH × 70,000 MHs ................... R0.10 per MH × 105,000 MHs.................. Totals ....................................................... Equipment Maintenance R 0 R 0 7,000 10,500 R16,000 R23,100 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 938 Managerial Accounting, 11th Edition Problem 15-15 (continued) Building & Grounds Administration Fixed costs to be allocated ..................... R88,200 R60,000 Building & Grounds: R3 per sq. ft. × 500 sq. ft.................... R3 per sq. ft. × 1,400 sq. ft. ................ R3 per sq. ft. × 12,000 sq. ft. .............. R3 per sq. ft. × 15,500 sq. ft. .............. (1,500) (4,200) (36,000) (46,500) Administration: 3% × R61,500 ................................. 38% × R61,500.................................. 59% × R61,500.................................. Equipment Maintenance: 40% × R30,045.................................. 60% × R30,045.................................. Total f ixed costs .................................... Total allocated costs .............................. Other budgeted costs ............................ Total overhead costs (a)......................... Budgeted machine-hours (b) .................. Predetermined overhead rate (a) ÷ (b) ... Equipment Maintenance Fabrication Finishing R24,000 1,500 4,200 R36,000 R46,500 (1,845) (23,370) (36,285) 1,845 23,370 36,285 R 0 R 0 (12,018) (18,027) R 0 R 0 R 0 R 0 12,018 R 71,388 18,027 R100,812 R 87,388 566,000 R653,388 70,000 R9.33 R123,912 810,000 R933,912 105,000 R8.89 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 939 Problem 15-15 (continued) Computation of allocation rates: Variable Administration: Allocation rate= = Variable administrative costs Employees R22,200 30+ 450+ 630= 1,110 employees = R20 per employee Variable Equipment Maintenance: Allocation rate= = Variable equipment maintenance costs Machine-hours R16,900 + R600 70,000+ 105,000= 175,000 MHs = R0.10 per MH Fixed Building & Grounds: Fixed building and grounds costs Allocation rate= Square feet = R88,200 500+ 1,400+ 12,000+ 15,500= 29,400 square feet = R3 per square foot © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 940 Managerial Accounting, 11th Edition Problem 15-15 (continued) Fixed Administration: Department f ixed costs........................ Allocated from Building & Grounds........ Costs to be allocated ........................... R60,000 1,500 R61,500 Employees at full capacity: Equipment Maintenance .................... Fabrication ....................................... Finishing .......................................... Total ................................................ 45 570 885 R1,500 Fixed Equipment Maintenance: Department f ixed costs ..................... Allocated from Building & Grounds ..... Allocated from Administration ............ Costs to be allocated......................... R24,000 4,200 1,845 R30,045 3% 38 59 100 % Allocation percentages are given in the problem. 3. Equipment Maintenance Variable cost allocation: R20 per employee × 32 employees..................... R20 per employee × 460 employees.................... R20 per employee × 625 employees.................... Total cost allocated ................... Actual variable administration cost ...................................... Total cost allocated—above ....... Spending variance—not allocated ............................... Fabrication Finishing R640 Total R R9,200 640 9,200 R12,500 12,500 R22,340 R23,800 22,340 R 1,460 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 941 Problem 15-16 (45 minutes) General Administration Variable costs........................... Cost $5 $5 $5 $5 $ 0 Accounting allocation: per item × 800 items......... per item × 1,200 items...... per item × 3,000 items...... per item × 9,000 items...... Cost Accounting $70,000 $143,000 (4,000) (6,000) (15,000) (45,000) Laundry allocation: $0.60 per pound × 20,000 pounds............................... $0.60 per pound × 15,000 pounds............................... $0.60 per pound × 210,000 pounds............................... Total variable costs ................... Laundry Convention Center $ 0 Food Services Guest Lodging $52,000 $ 24,000 4,000 6,000 15,000 45,000 (12,000) 12,000 (9,000) 9,000 (126,000) $ 0 $ 0 $ 0 126,000 $18,000 $76,000 $195,000 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 942 Managerial Accounting, 11th Edition Problem 15-16 (continued) General Administration Fixed costs............................... $200,000 General Administration allocation: 10% × $200,000 ................... 4% × $200,000 ................... 30% × $200,000 ................... 16% × $200,000 ................... 40% × $200,000 ................... Cost Accounting $110,000 (20,000) (8,000) (60,000) (32,000) (80,000) Cost Accounting allocation: 7% × $130,000 ................... 13% × $130,000 ................... 20% × $130,000 ................... 60% × $130,000 ................... Laundry $65,900 Convention Center Food Services $ 95,000 $375,000 Guest Lodging $486,000 20,000 8,000 60,000 32,000 80,000 (9,100) (16,900) (26,000) (78,000) Laundry allocation: 10% × $83,000 ..................... 6% × $83,000..................... 84% × $83,000 ..................... 9,100 16,900 26,000 78,000 (8,300) (4,980) (69,720) 8,300 4,980 69,720 Total f ixed costs ....................... $ 0 $ 0 $ 0 $180,200 $437,980 $713,720 Total overhead costs................. $ 0 $ 0 $ 0 $198,200 $513,980 $908,720 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 943 Problem 15-16 (continued) Computations of allocation rates: Variable Cost Accounting: Allocation rate= = Variable cost accounting costs I tems processed $70,000 15,000-1,000= 14,000 items = $5 per item Variable Laundry: Allocation rate= = Variable laundry costs Pounds processed $143,000+ $4,000 245,000 pounds = $0.60 per pound © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 944 Managerial Accounting, 11th Edition Case 15-17 (90 minutes) 1. The plantwide rate would include overhead costs for both the service departments and the manufacturing departments. I t would be computed as follows: Manufacturing Departments Molding Component Assembly Variable overhead..... $ 210,500 Fixed overhead ........ 1,750,000 Total overhead ......... $1,960,500 $1,000,000 620,000 $1,620,000 $1,650,000 749,500 $2,399,500 Total $2,860,500 3,119,500 $5,980,000 Service department overhead costs: Power department ($500,000 + $140,000 + $1,200,000) ... Maintenance department ($25,000 + $375,000)................. Total company overhead costs............................................. 1,840,000 400,000 $8,220,000 Estimated direct labor-hours: Molding........................................................................... Component ..................................................................... Assembly ........................................................................ Total hours ...................................................................... 50,000 200,000 150,000 400,000 Plantwide overhead rate= = Estimated overhead cost Estimated direct labor-hours $8,220,000 400,000 DLHs = $20.55 per DLH © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 945 Case 15-17 (continued) 2. a. Allocation rates for the service department costs would be as follows: Variable power costs: $500,000 + $140,000 = $8 per kwh 80,000 kwhs Variable maintenance costs: $25,000 = $2 per hour 12,500 hours © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 946 Managerial Accounting, 11th Edition Case 15-17 (continued) Given the above data, the allocations by the direct method would be as follows: Power Maintenance Variable cost ....................................... $ 640,000 Power allocation: $8 per kwh × 36,000 kwh ................. (288,000) $8 per kwh × 32,000 kwh ................. (256,000) $8 per kwh × 12,000 kwh ................. (96,000) Maintenance allocations: $2 per hour × 9,000 hours ................ $2 per hour × 2,500 hours ................ $2 per hour × 1,000 hours ................ Total variable costs .............................. $ 0 $ 25,000 Fixed costs.......................................... $1,200,000 Power allocations: 50% × $1,200,000 ........................... (600,000) 35% × $1,200,000 ........................... (420,000) 15% × $1,200,000 ........................... (180,000) Maintenance allocations: 70% × $375,000 .............................. 20% × $375,000 .............................. 10% × $375,000 .............................. Total f ixed costs .................................. $ 0 $375,000 Total allocated costs ............................ Molding Component Assembly $ 288,000 $256,000 $ 96,000 (18,000) (5,000) (2,000) $ 0 18,000 5,000 306,000 261,000 2,000 98,000 600,000 420,000 180,000 (262,500) (75,000) (37,500) $ 0 262,500 75,000 862,500 495,000 37,500 217,500 $1,168,500 $756,000 $315,500 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 947 Case 15-17 (continued) 2. b. Molding Component Assembly Allocated service department costs (above) ...................... $1,168,500 $ 756,000 $ 315,500 Manufacturing department overhead costs: Variable ........................... 210,500 1,000,000 1,650,000 620,000 749,500 Fixed ............................... 1,750,000 Total overhead costs .............. $3,129,000 $2,376,000 $2,715,000 Divide by machine-hours ........ ÷ 87,500 ÷ 200,000 ÷ 150,000 Divide by direct labor-hours .... Predetermined overhead rate.. $ 35.76 $ 11.88 $ 18.10 3. a. Overhead cost allocated under the plantwide rate: 7,500 direct labor-hours × $20.55 per direct labor-hour = $154,125 Overhead cost allocated under the departmental rates: Molding department: $35.76 per machine-hour × 3,000 machine-hours........... $107,280 Component department: $11.88 per direct labor-hour × 2,500 direct labor-hours .. 29,700 Assembly department: $18.10 per direct labor-hour × 4,000 direct labor-hours .. 72,400 Total cost allocated ......................................................... $209,380 © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 948 Managerial Accounting, 11th Edition Case 15-17 (continued) b. The use of a plantwide rate is resulting in too little overhead cost being allocated to products that require a large proportion of machinehours as compared to direct labor-hours. I n part 3a above, for example, the attaché case (which requires a large proportion of machinehours) is allocated only $154,125 in overhead cost if a plantwide rate is used, whereas it is allocated $209,380 in overhead cost if departmental rates are used. Since Hobart Products is using a plantwide rate, it is not surprising that the company is pricing this attaché case well below the price of competitors. On the other hand, use of a plantwide rate is resulting in too much overhead cost being allocated to products that require a large proportion of direct labor time as compared to machine time. This probably accounts for the fact that Hobart’s prices for some products are well above the prices of competitors. 4. Hobart Products could take two additional steps to improve its overhead costing. First, it could use the step method to allocate service department overhead costs. And second, it could use activity-based costing (as discussed earlier in the book) to assign overhead costs from operating departments to products. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 949 Case 15-18 (75 minutes) 1. Step method: Personnel Custodial Services Maintenance Printing Total cost before allocations ............................ $360,000 $141,000 $201,000 $525,000 Allocations: Personnel (@ $1,800 per employee)* ............ (360,000) 27,000 45,000 72,000 Custodial services (@ $1.20 per square foot)* * ...................... (168,000) 24,000 96,000 (270,000) 225,000 Maintenance (5/ 6, 1/ 6) ................................ Total overhead cost after allocations ................ $ 0 $ 0 $ 0 $918,000 Divide by machine-hours................................. ÷150,000 Divide by direct labor-hours ............................ Predetermined overhead rate .......................... $ 6.12 Binding $373,500 216,000 48,000 45,000 $682,500 ÷175,000 $ 3.90 * Based on 15 + 25 + 40 + 120 = 200 employees. * * Based on 20,000 + 80,000 + 40,000 = 140,000 square feet. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 950 Managerial Accounting, 11th Edition Case 15-18 (continued) 2. Direct method: Personnel Custodial Services Maintenance Printing Total costs before allocations........................... $360,000 $141,000 $201,000 $525,000 Allocations: Personnel (1/ 4, 3/ 4)* ................................... (360,000) 90,000 Custodial Services (2/ 3, 1/ 3)* * ..................... (141,000) 94,000 (201,000) 167,500 Maintenance (5/ 6, 1/ 6) ................................ Total overhead cost after allocations ................ $ 0 $ 0 $ 0 $876,500 Divide by machine-hours................................. ÷150,000 Divide by direct labor-hours ............................ Predetermined overhead rate .......................... $ 5.84 Binding $373,500 270,000 47,000 33,500 $724,000 ÷175,000 $ 4.14 * Based on 40 + 120 = 160 employees. * * Based on 80,000 + 40,000 = 120,000 square feet. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 951 Case 15-18 (continued) 3. a. The amount of overhead cost assigned to the job would be: Step method: Printing department: $6.12 per machine-hour × 15,400 machine-hours ...... $ 94,248 Binding department: $3.90 per direct labor-hour × 2,000 direct labor-hours 7,800 Total overhead cost..................................................... $102,048 Direct method: Printing department: $5.84 per machine-hour × 15,400 machine-hours ...... Binding department: $4.14 per direct labor-hour × 2,000 direct labor-hours Total overhead cost..................................................... $ 89,936 8,280 $ 98,216 b. The step method provides a better basis for computing predetermined overhead rates than the direct method because it gives recognition to services provided between service departments. I f this interdepartmental service is not recognized, then either too much or too little of a service department’s costs may be allocated to a producing department. The result will be an inaccuracy in the producing department’s predetermined overhead rate. For example, using the direct method and ignoring interdepartmental services causes the predetermined overhead rate in the Printing Department to fall to only $5.84 per MH (from $6.12 per MH when the step method is used), and causes the predetermined overhead rate in the Binding Department to rise to $4.14 per DLH (from $3.90 per DLH when the step method is used). These inaccuracies in the predetermined overhead rate can cause corresponding inaccuracies in bids for jobs. Since the direct method in this case understates the rate in the Printing Department and overstates the rate in the Binding Department, it is not surprising that the company tends to bid low on jobs requiring a lot of printing work and tends to bid too high on jobs that require a lot of binding work. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. 952 Managerial Accounting, 11th Edition Group Exercise 15-19 1. The answer to this part will depend on the industry the group selects. 2. The answer to this part will depend on the industry the group selects. 3. The answer to this part will depend on the industry the group selects. 4. & 5. Generally speaking, the wider the range of products made or services offered, the greater the support costs. More products and services require additional support resources for scheduling, planning, billing, shipping, and so on. As the resources demanded of the support departments increase, their costs increase as well. 6. Service department costs are reduced by decreasing spending on the resources the service departments consume. This can be accomplished by: (1) decreasing the activities the service departments are required to perform—perhaps by reducing the range and complexity of products and services offered by the company; (2) improving the business processes in the service departments so that fewer resources are required to carry out those activities; or (3) spending less on the resources— perhaps by negotiating for better prices from suppliers. © The McGraw-Hill Companies, I nc., 2006. All rights reserved. Solutions Manual, Chapter 15 953 CHAPTER 16 Investments ASSIGNMENT CLASSIFICATION TABLE Brief Exercises Study Objectives Questions 1. Discuss why corporations invest in debt and stock securities. 1 2. Explain the accounting for debt investments. 2, 3, 4 1 3. Explain the accounting for stock investments. 5, 6, 7, 8, 9, 10 2, 3 4. Describe the use of consolidated financial statements. 11 5. Indicate how debt and stock investments are reported in the financial statements. 12, 13, 14, 15, 16, 17, 18 4, 5, 6, 7, 8 6. Distinguish between short-term and long-term investments. 19 5, 7, 8 A Problems B Problems 2, 3 1A, 2A 1B, 2B 4, 5, 6, 7, 8 2A, 3A, 4A, 5A 2B, 3B, 4B, 5B 10, 11, 12 1A, 2A, 3A, 5A, 6A 1B, 2B, 3B, 5B, 6B 10, 11, 12 1A, 2A, 3A, 5A, 6A 1B, 2B, 3B, 5B, 6B Exercises 1 9 16-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Journalize debt investment transactions and show financial statement presentation. Moderate 30–40 2A Journalize investment transactions, prepare adjusting entry, and show statement presentation. Moderate 30–40 3A Journalize transactions and adjusting entry for stock investments. Moderate 30–40 4A Prepare entries under the cost and equity methods, and tabulate differences. Simple 20–30 5A Journalize stock investment transactions and show statement presentation. Moderate 40–50 6A Prepare a balance sheet. Moderate 30–40 1B Journalize debt investment transactions and show financial statement presentation. Moderate 30–40 2B Journalize investment transactions, prepare adjusting entry, and show statement presentation. Moderate 30–40 3B Journalize transactions and adjusting entry for stock investments. Moderate 30–40 4B Prepare entries under the cost and equity methods, and tabulate differences. Simple 20–30 5B Journalize stock investment transactions and show statement presentation. Moderate 40–50 6B Prepare a balance sheet. Moderate 30–40 16-2 Study Objective Knowledge Comprehension Application Analysis Discuss why corporations invest in debt and stock securities. Q16-1 E16-1 2. Explain the accounting for debt investments. Q16-2 Q16-3 Q16-4 BE16-1 E16-2 E16-3 P16-1A P16-2A P16-1B P16-2B 3. Explain the accounting for stock investments. Q16-7 Q16-5 Q16-8 Q16-9 Q16-10 Q16-6 BE16-2 BE16-3 E16-4 E16-5 E16-6 E16-7 E16-8 P16-2A P16-3A P16-4A P16-5A P16-2B P16-3B P16-4B P16-5B 4. Describe the use of consolidated financial statements. Q16-11 E16-9 5. Indicate how debt and stock investments are reported in the financial statements. Q16-12 Q16-17 Q16-13 Q16-18 Q16-14 Q16-16 BE16-4 BE16-7 BE16-8 P16-6A P16-6B Q16-15 BE16-5 BE16-6 E16-10 E16-11 E16-12 P16-1A P16-2A P16-3A P16-5A P16-1B P16-2B P16-3B P16-5B 6. Distinguish between short-term and long-term investments. Q16-19 BE16-7 BE16-8 P16-6A P16-6B BE16-5 E16-10 E16-11 E16-12 P16-1A P16-2A P16-3A P16-5A P16-1B P16-2B P16-3B P16-5B 16-3 1. Broadening Your Perspective Financial Reporting Exploring the Web Decision Making Across the Organization Communication All About You Comparative Analysis Exploring the Web Synthesis Evaluation Ethics Case BLOOM'S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. The reasons corporations invest in securities are: (1) excess cash not needed for operations that can be invested, (2) for additional earnings, and (3) strategic reasons. 2. (a) The cost of an investment in bonds consists of all expenditures necessary to acquire the bonds, such as the market price of the bonds plus any brokerage fees. (b) Interest is recorded as it is earned; that is, over the life of the investment in bonds. 3. (a) Losses and gains on the sale of debt investments are computed by comparing the amortized cost of the securities to the net proceeds from the sale. (b) Losses are reported in the income statement under other expenses and losses whereas gains are reported under other revenues and gains. 4. Olindo Company is incorrect. The gain is the difference between the net proceeds, exclusive of interest, and the cost of the bonds. The correct gain is $4,500, or [($45,000 – $500) – $40,000]. 5. The cost of an investment in stock includes all expenditures necessary to acquire the investment. These expenditures include the actual purchase price plus any commissions or brokerage fees. 6. Brokerage fees are part of the cost of the investment. Therefore, the entry is: Stock Investments ..................................................................................................... Cash .................................................................................................................... 63,200 63,200 7. (a) Whenever the investor’s influence on the operating and financial affairs of the investee is significant, the equity method should be used. The major factor in determining significant influence is the percentage of ownership interest held by the investor in the investee. The general guideline for use of the equity method is 20% or more ownership interest. Companies are required to use judgment, however, rather than blindly follow the 20% guideline. (b) Revenue is recognized as it is earned by the investee. 8. Since Rijo Corporation uses the equity method, the income reported by Pippen Packing ($80,000) should be multiplied by Rijo’s ownership interest (30%) and the result ($24,000) should be debited to Stock Investments and credited to Revenue from Investment in Pippen Packing. Also, of the total dividend declared and paid by Pippen ($10,000) Rijo will receive 30% or $3,000. This amount should be debited to Cash and credited to Stock Investments. 9. Significant influence over an investee may result from representation on the board of directors, participation in policy-making processes, material intercompany transactions. One must also consider whether the stock held by other stockholders is concentrated or dispersed. An investment (direct or indirect) of 20% or more of the voting stock of an investee constitutes significant influence unless there exists evidence to the contrary. 16-4 Questions Chapter 16 (Continued) 10. Under the cost method, an investment is originally recorded and reported at cost. Dividends are recorded as revenue. In subsequent periods, it is adjusted to fair value and an unrealized holding gain or loss is recognized and included in income (trading security) or as a separate component of stockholders’ equity (available-for-sale security). Under the equity method, the investment is originally recorded and reported at cost; subsequently, the investment account is adjusted during each period for the investor’s share of the earnings or losses of the investee. The investor’s share of the investee’s earnings is recognized in the earnings of the investor. Dividends received from the investee are reductions in the carrying amount of the investment. 11. Consolidated financial statements present the details of the assets and liabilities controlled by the parent company and the total revenues and expenses of the affiliated companies. Consolidated financial statements are especially useful to the stockholders, board of directors, and management of the parent company. Conversely, they are of limited use to minority stockholders and the creditors of the subsidiary company. 12. The valuation guidelines for investments is as follows: Category Trading Available-for-sale Held-to-maturity Valuation and Reporting At fair value with changes reported in net income At fair value with changes reported in stockholders’ equity At amortized cost Investments recorded under the equity method are reported at their carrying value. The carrying value is the cost adjusted for the investor’s share of the investee’s income and dividends received. 13. Tina should report as follows: (1) (2) 14. (2) Under investments in the balance sheet: Investment in stock of less than 20% owned companies, at fair value.......... Under stockholders’ equity in the balance sheet: Less: Unrealized loss on available-for-sale securities ..................................... $ 4,000 $70,000 $ (4,000) The entry is: Market Adjustment—Available-for-Sale ................................................................ Unrealized Gain or Loss—Equity .................................................................. 16. $70,000 Tina should report as follows: (1) 15. Under current assets in the balance sheet: Short-term investment, at fair value...................................................................... Under other expenses and losses in the income statement: Unrealized loss on trading securities.................................................................... 10,000 10,000 The entry is: Market Adjustment—Trading................................................................................... Unrealized Gain—Income............................................................................... 16-5 10,000 10,000 Questions Chapter 16 (Continued) 17. Unrealized Loss—Equity is reported as a deduction from stockholders’ equity. The unrealized loss is not included in the computation of net income. 18. Reporting Unrealized Gains (Losses)—Equity in the stockholders’ equity section serves two important purposes: (1) it reduces the volatility of net income due to fluctuations in fair value, and (2) it still informs the financial statement user of the gain or loss that would occur if the securities were sold at fair value. 19. The investment in Key Corporation stock is a long-term investment because there is no intent to convert the stock into cash within a year or the operating cycle, whichever is longer. 16-6 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 16-1 Jan. 1 July 1 Debt Investments...................................................... Cash ..................................................................... 52,000 Cash .............................................................................. Interest Revenue.............................................. 2,340 52,000 2,340 BRIEF EXERCISE 16-2 Aug. 1 Dec. 1 Stock Investments.................................................... Cash ..................................................................... 35,700 Cash .............................................................................. Stock Investments........................................... Gain on Sale of Stock Investments .................................................. 40,000 35,700 35,700 4,300 BRIEF EXERCISE 16-3 Dec. 31 31 Stock Investments.................................................... Revenue from Investment in Fort Company (25% X $180,000) ..................... 45,000 Cash (25% X $50,000).............................................. Stock Investments........................................... 12,500 45,000 12,500 BRIEF EXERCISE 16-4 Dec. 31 Unrealized Loss—Income...................................... Market Adjustment—Trading....................... ($62,000 – $59,000) 16-7 3,000 3,000 BRIEF EXERCISE 16-5 Balance Sheet Current assets Short-term investments, at fair value ................................... $59,000 Income Statement Other expenses and losses Unrealized loss on trading securities................................... 3,000 BRIEF EXERCISE 16-6 Dec. 31 Unrealized Gain or Loss—Equity .............................. Market Adjustment—Available-for-Sale ......... 6,000 6,000 BRIEF EXERCISE 16-7 Balance Sheet Investments Investment in stock of less than 20% owned companies, at fair value .............................................................. $66,000 Stockholders’ equity Less unrealized loss on available-for-sale securities............ $ (6,000) BRIEF EXERCISE 16-8 Investments Investment in stock of less than 20% owned companies, at fair value .............................................................. Investment in stock of 20–50% owned companies, at equity ............................................................................................ Total investments...................................................................... 16-8 $115,000 270,000 $385,000 SOLUTIONS TO EXERCISES EXERCISE 16-1 1. Companies purchase investments in debt or stock securities because they have excess cash, to generate earnings from investment income, or for strategic reasons. 2. A corporation would have excess cash that it does not need for operations due to seasonal fluctuations in sales and as a result of economic cycles. 3. The typical investment when investing cash for short periods of time is low-risk, high liquidity, short-term securities such as government-issued securities. 4. The typical investments when investing cash to generate earnings are debt securities and stock securities. 5. A company would invest in securities that provide no current cash flows for speculative reasons. They are speculating that the investment will increase in value. 6. The typical investments when investing cash for strategic reasons are stocks of companies in a related industry or in an unrelated industry that the company wishes to enter. EXERCISE 16-2 (a) Jan. July 1 1 1 Debt Investments............................................. Cash ($50,000 + $900) ........................... 50,900 Cash ($50,000 X 8% X 1/2) ............................ Interest Revenue..................................... 2,000 Cash ($34,000 – $500) .................................... Debt Investments.................................... ($50,900 X 3/5) Gain on Sale of Debt Investments ($33,500 – $30,540) ............... 33,500 16-9 50,900 2,000 30,540 2,960 EXERCISE 16-2 (Continued) (b) Dec. 31 Interest Receivable.......................................... Interest Revenue ..................................... ($20,000 X 8% X 1/2) 800 800 EXERCISE 16-3 January 1,2008 Debt Investments ......................................................................... Cash......................................................................................... 73,500 July 1,2008 Cash ($70,000 X 12% X 6/12) .................................................... Interest Revenue ................................................................. 4,200 December 31,2008 Interest Receivable ...................................................................... Interest Revenue ................................................................. 4,200 January 1,2009 Cash.................................................................................................. Interest Receivable ............................................................. 4,200 January 1,2009 Cash.................................................................................................. Loss On Sale of Debt Investments......................................... Debt Investments (40/70 X $73,500) .............................. 40,100 1,900 16-10 73,500 4,200 4,200 4,200 42,000 EXERCISE 16-4 (a) Feb. 1 July 1 Sept. 1 Dec. 1 Stock Investments........................................... Cash ($6,000 + $200).............................. 6,200 Cash (600 X $1)................................................. Dividend Revenue .................................. 600 Cash ($4,400 – $100)...................................... Stock Investments................................. ($6,200 X 3/6) Gain on Sale of Stock Investments ($4,300 – $3,100) ................................ 4,300 Cash (300 X $1)................................................ Dividend Revenue ................................. 300 6,200 600 3,100 1,200 300 (b) Dividend revenue and the gain on sale of stock investments are reported under other revenues and gains in the income statement. EXERCISE 16-5 Jan. 1 July 1 Dec. 1 Dec. 31 Stock Investments................................................... Cash ($140,000 + $2,100).............................. 142,100 Cash (2,500 X $3) ..................................................... Dividend Revenue .......................................... 7,500 Cash ($32,000 – $800) ............................................ Stock Investments ($142,100 X 1/5).......... Gain on Sale of Stock Investments .......... 31,200 Cash (2,000 X $3) ..................................................... Dividend Revenue .......................................... 6,000 16-11 142,100 7,500 28,420 2,780 6,000 EXERCISE 16-6 February 1 Stock Investments ....................................................................... Cash [(500 X $30) + $400] ................................................. 15,400 March 20 Cash ($2,900 – $50)...................................................................... Loss on Sale of Stock Investments ....................................... Stock Investments ($15,400 X 100/500) ....................... 2,850 230 April 25 Cash (400 X $1.00) ....................................................................... Dividend Revenue............................................................... 400 June 15 Cash ($7,400 – $90)...................................................................... Stock Investments ($15,400 X 200/500) ....................... Gain on Sale of Stock Investments............................... 15,400 3,080 400 7,310 6,160 1,150 July 18 Cash (200 X $1.25) ....................................................................... Dividend Revenue............................................................... 250 250 EXERCISE 16-7 (a) Jan. 1 Dec. 31 31 Stock Investments .......................................... Cash............................................................ 180,000 Cash ($60,000 X 25%) .................................... Stock Investments ................................. 15,000 Stock Investments .......................................... Revenue from Investment in Connors Corp. ..................................... ($200,000 X 25%) 50,000 180,000 15,000 (b) Investment in Connors, January 1 ............................................. Less: Dividend received ............................................................... Plus: Share of reported income .............................................. Investment in Connors, December 31....................................... 16-12 50,000 $180,000 (15,000) 50,000 $215,000 EXERCISE 16-8 (a) 2008 Mar. 18 Stock Investments.......................................... Cash (200,000 X 15% X $13)............... 390,000 Cash.................................................................... Dividend Revenue................................. ($60,000 X 15%) 9,000 June 30 Dec. 31 (b) Jan. 1 June 15 Dec. 31 Market Adjustment—Available-forSale................................................................. Unrealized Gain—Equity..................... ($450,000 – $390,000) 390,000 9,000 60,000 60,000 Stock Investments ......................................... Cash (30,000 X 30% X $9) ................... 81,000 Cash.................................................................... Stock Investments ................................ ($30,000 X 30%) 9,000 Stock Investments ......................................... Revenue from Investment in Parks Corp.......................................... ($80,000 X 30%) 24,000 81,000 9,000 24,000 EXERCISE 16-9 (a) Since Ryan owns more than 50% of the common stock of Wayne Corporation, Ryan is called the parent company. Wayne is the subsidiary (affiliated) company. Because of its stock ownership, Ryan has a controlling interest in Wayne. (b) When a company owns more than 50% of the common stock of another company, consolidated financial statements are usually prepared. Consolidated financial statements present the total assets and liabilities controlled by the parent company. They also present the total revenues and expenses of the affiliated companies. (c) Consolidated financial statements are useful because they indicate the magnitude and scope of operations of the companies under common control. 16-13 EXERCISE 16-10 (a) Dec. 31 Unrealized Loss—Income................................... Market Adjustment—Trading.................... (b) 4,000 4,000 Balance Sheet Current assets Short-term investments, at fair value ......................... $49,000 Income Statement Other expenses and losses Unrealized loss on trading securities......................... $ 4,000 EXERCISE 16-11 (a) Dec. 31 (b) Unrealized Gain or Loss—Equity.................... Market Adjustment—Availablefor-Sale ....................................................... 4,000 4,000 Balance Sheet Investments Investment in stock of less than 20% owned companies, at fair value .............................................. $49,000 Stockholders’ equity Less: Unrealized loss on available-for-sale securities............................................................. $ (4,000) 16-14 EXERCISE 16-11 (Continued) (c) Dear Mr. Linquist: Investments which are classified as trading (held for sale in the near term) are reported at fair value in the balance sheet, with unrealized gains or losses reported in net income. Investments which are classified as available-for-sale (held longer than trading but not to maturity) are also reported at fair value, but unrealized gains or losses are reported in the stockholders’ equity section. Fair value is used as a reporting basis because it represents the cash realizable value of the securities. Unrealized gains or losses on trading investments are reported in the income statement because of the likelihood that the securities will be sold at fair value in the near term. Unrealized gains or losses on available-for-sale securities are reported in stockholders’ equity rather than in income because there is a significant chance that future changes in fair value will reverse unrealized gains or losses. So as to not distort income with these fluctuations, they are reported directly in stockholders’ equity. I hope that the preceding discussion clears up any misunderstandings. Please contact me if you have any questions. Sincerely, Student 16-15 EXERCISE 16-12 (a) Market Adjustment—Trading .................................................... ($124,000 – $120,000) Unrealized Gain—Income .................................................. 4,000 Unrealized Gain or Loss—Equity............................................. Market Adjustment—Available-for-Sale........................ 6,000 (b) 4,000 6,000 Balance Sheet Current assets Short-term investments, at fair value ............................ Investments Investment in stock of less than 20% owned companies, at fair value ................................................ Stockholders’ equity Less: Unrealized loss on available-for-sale securities............................................................... $124,000 94,000 $ (6,000) Income Statement Other revenues and gains Unrealized gain on trading securities ........................... 16-16 $ 4,000 SOLUTIONS TO PROBLEMS PROBLEM 16-1A (a) 2008 Jan. 1 July 1 Dec. 31 2011 Jan. 1 1 July 1 Dec. 31 (b) 2008 Dec. 31 Debt Investments........................................ 2,000,000 Cash ....................................................... 2,000,000 Cash ($2,000,000 X .08 X 1/2).................. Interest Revenue................................ 80,000 Interest Receivable .................................... Interest Revenue................................ 80,000 Cash ................................................................ Interest Receivable............................ 80,000 80,000 80,000 80,000 Cash [($1,000,000 X 1.06) – $6,000] ...... 1,054,000 Debt Investments............................... 1,000,000 Gain on Sale of Debt Investments..................................... 54,000 Cash ($1,000,000 X .08 X 1/2).................. Interest Revenue................................ 40,000 Interest Receivable .................................... Interest Revenue................................ 40,000 Market Adjustment—Availablefor-Sale ...................................................... Unrealized Gain or Loss—Equity...... 16-17 40,000 40,000 200,000 200,000 PROBLEM 16-1A (Continued) (c) Balance Sheet Current assets Interest receivable.................................................................. $ Investments Debt investments, at fair value .......................................... $2,200,000 80,000 The unrealized gain of $200,000 would be reported in the stockholders’ equity section of the balance sheet as an addition to total paid-in capital and retained earnings. 16-18 PROBLEM 16-2A (a) Feb. 1 Mar. 1 Apr. 1 July 1 Aug. 1 Sept. 1 Oct. 1 1 Stock Investments........................................... Cash ($31,800 + $600) ........................... 32,400 Stock Investments........................................... Cash ($20,000 + $400) ........................... 20,400 Debt Investments............................................. Cash ($50,000 + $1,000)........................ 51,000 Cash ($.60 X 600) ............................................. Dividend Revenue .................................. 360 Cash ($11,600 – $200) .................................... Stock Investments.................................. [($32,400 ÷ 600) X 200] Gain on Sale of Stock Investments.......................................... 11,400 Cash ($1 X 800)................................................. Dividend Revenue .................................. 800 Cash ($50,000 X 7% X 1/2) ............................ Interest Revenue..................................... 1,750 Cash ($50,000 – $1,000)................................. Loss on Sale of Debt Investments............. ($51,000 – $49,000) Debt Investments.................................... 49,000 2,000 Stock Investments Feb. 1 32,400 Aug. 1 Mar. 1 20,400 Dec. 31 Bal. 42,000 10,800 Apr. 1 Dec. 31 Bal. 16-19 32,400 20,400 51,000 360 10,800 600 800 1,750 51,000 Debt Investments 51,000 Oct. 1 0 51,000 PROBLEM 16-2A (Continued) (b) Dec. 31 Unrealized Loss—Income .............................. Market Adjustment—Trading ............... ($42,000 – $41,200) Security Hiens common Pryce common Cost Fair Value $21,600 20,400 $42,000 $22,000 19,200 $41,200 800 800 (400 X $55) (800 X $24) (c) Current assets Short-term investment, at fair value ...................................... $41,200 (d) Other revenues and gains: Dividend Revenue, Interest Revenue, and Gain on Sale of Stock Investments. Other expenses and losses: Loss on Sale of Debt Investments, and Unrealized Loss—Income. 16-20 PROBLEM 16-3A (a) July 1 Aug. 1 Sept. 1 Oct. 1 Nov. 1 Dec. 15 31 2009 Cash (5,000 X $1) ............................................. Dividend Revenue .................................. 5,000 5,000 Cash (2,000 X $.50).......................................... Dividend Revenue .................................. 1,000 Cash [(1,500 X $8) – $300]............................. Loss on Sale of Stock Investments........... ($13,500 – $11,700) Stock Investments (1,500 X $9).......... 11,700 1,800 Cash [(800 X $33) – $500].............................. Stock Investments (800 X $30)........... Gain on Sale of Stock Investments ($25,900 – $24,000) ............................ 25,900 Cash (1,500 X $1) ............................................. Dividend Revenue .................................. 1,500 Cash (1,200 X $.50).......................................... Dividend Revenue .................................. 600 Cash (3,500 X $1) ............................................. Dividend Revenue .................................. 3,500 2009 Jan. 1 Balance 2009 Dec. 31 Balance Stock Investments 2009 135,000 Sept. 1 Oct. 1 97,500 16-21 1,000 13,500 24,000 1,900 1,500 600 3,500 13,500 24,000 PROBLEM 16-3A (Continued) (b) Dec. 31 Unrealized Gain or Loss—Equity .................... ($97,500 – $93,400) Market Adjustment—Availablefor-Sale........................................................ Security Hurst Co. common Pine Co. common Scott Co. common Cost Fair Value $36,000 31,500 30,000 $97,500 $38,400 28,000 27,000 $93,400 4,100 4,100 (1,200 X $32) (3,500 X $ 8) (1,500 X $18) (c) Investments Investment in stock of less than 20% owned companies, at fair value............................................................ Stockholders’ equity Common stock ............................................. Retained earnings ....................................... Total paid-in capital and retained earnings........................... Less: Unrealized loss on availablefor-sale securities...................... Total stockholders’ equity............... 16-22 $ 93,400 $1,500,000) 1,000,000) 2,500,000) (4,100) $2,495,900 PROBLEM 16-4A (a) Jan. 1 Mar. 15 June 15 Sept. 15 Dec. 15 31 (b) Jan. 1 Mar. 15 June 15 Sept. 15 Dec. 15 Stock Investments ...................................... Cash........................................................ 800,000 Cash................................................................. Dividend Revenue.............................. (45,000 X $.30) 13,500 Cash................................................................. Dividend Revenue.............................. 13,500 Cash................................................................. Dividend Revenue.............................. 13,500 Cash................................................................. Dividend Revenue.............................. 13,500 Market Adjustment—Trading .................. Unrealized Gain—Income................ [$800,000 – ($24 X 45,000)] 280,000 Stock Investments ...................................... Cash........................................................ 800,000 Cash................................................................. Stock Investments ............................. 13,500 Cash................................................................. Stock Investments ............................. 13,500 Cash................................................................. Stock Investments ............................. 13,500 Cash................................................................. Stock Investments ............................. 13,500 16-23 800,000 13,500 13,500 13,500 13,500 280,000 800,000 13,500 13,500 13,500 13,500 PROBLEM 16-4A (Continued) Dec. 31 Stock Investments...................................... Revenue from Investment in Nickels Company .......................... ($320,000 X 30%) (c) 96,000 96,000 Cost Method Stock Investments Common stock Unrealized Gain—Income Dividend revenue Revenue from investment in Nickels Company **$24 X 45,000 shares **$800,000 + $96,000 – $54,000 16-24 Equity Method $1,080,000 * 280,000 54,000 0 $842,000 ** 0 96,000 PROBLEM 16-5A (a) Jan. 20 28 30 Feb. 8 18 July 30 Sept. 6 Dec. 1 (b) Cash ($55,000 – $600) .................................... Investment in Abel Corp. Common Stock ................................... Gain on Sale of Stock Investments.......................................... Investment in Rosen Corporation Common Stock ............................................ Cash [(400 X $78) + $480]..................... 54,400 52,000 2,400 31,680 31,680 Cash ..................................................................... Dividend Revenue .................................. ($1.15 X 1,400) 1,610 Cash ..................................................................... Dividend Revenue ($.40 X 1,200) ....... 480 Cash [($27 X 1,200) – $360] .......................... Loss on Sale of Preferred Stock................. Investment in Weiss Corp. Preferred Stock................................... 32,040 1,560 Cash ..................................................................... Dividend Revenue ($1.00 X 1,400)..... 1,400 Investment in Rosen Corporation Common Stock ............................................ Cash [($82 X 900) + $1,200] ................. Cash ..................................................................... Dividend Revenue .................................. ($1.50 X 1,300) Investment in Abel Corp. Common Stock 1/1 Bal. 52,000 1/20 52,000 12/31 Bal. 0 16-25 1,610 480 33,600 1,400 75,000 75,000 1,950 1,950 Investment in Frey Corporation Common Stock 1/1 Bal. 84,000 12/31 Bal. 84,000 PROBLEM 16-5A (Continued) Investment in Weiss Corp. Preferred Stock 1/1 Bal. 33,600 2/18 33,600 12/31 Bal. (c) Dec. 31 Investment in Rosen Corporation Common Stock 1/28 31,680 9/6 75,000 12/31 Bal. 106,680 0 Unrealized Gain or Loss—Equity .................... Market Adjustment—Availablefor-Sale ($190,680 – $183,200)............. Security Cost Fair Value Frey Corporation common Rosen Corporation common $ 84,000 106,680 $190,680 $ 89,600 93,600 $183,200 7,480 (d) Investments Investment in stock of less than 20% owned companies, at fair value ................................................... Stockholders’ equity Total paid-in capital and retained earnings.................... Less: Unrealized loss on available-for-sale securities.................................................................. Total stockholders’ equity........................................... 16-26 7,480 (1,400 X $64) (1,300 X $72) $183,200 xxxxx (7,480) $ xxxxx PROBLEM 16-6A URBINA CORPORATION Balance Sheet December 31, 2008 Assets Current assets Cash ............................................................................ Short-term stock investment, at fair value........................................................... Accounts receivable .............................................. Less: Allowance for doubtful accounts................................................... Merchandise inventory ......................................... Prepaid insurance .................................................. Total current assets ...................................... Investments Investment in Flott common stock (10% ownership), at fair value........................ Investment in Portico common stock (30% ownership), at equity.............................. Total investments .......................................... Property, plant, and equipment Land............................................................. Buildings.................................................... $950,000 Less: Accumulated depreciation.......... 180,000 Equipment ................................................. 275,000 Less: Accumulated depreciation.......... 52,000 Total property, plant, and equipment ........................................... $ 42,000 180,000 $140,000 6,000 134,000 170,000 16,000 542,000 286,000 380,000 666,000 390,000 770,000 223,000 1,383,000 Intangible assets Goodwill..................................................................... 200,000 Total assets ....................................................................... $2,791,000 16-27 PROBLEM 16-6A (Continued) URBINA CORPORATION Balance Sheet (Continued) December 31, 2008 Liabilities and Stockholders’ Equity Current liabilities Notes payable............................................................ Accounts payable .................................................... Income taxes payable ............................................. Dividends payable ................................................... Total current liabilities................................... Long-term liabilities Bonds payable, 10%, due 2016............................ Plus: Premium on bonds payable ..................... Total long-term liabilities.............................. Total liabilities .................................................. Stockholders’ equity Paid-in capital Common stock, $10 par value, 500,000 shares authorized, 150,000 shares issued and outstanding................................................... Paid-in capital in excess of par value........... Total paid-in capital ............................... Retained earnings Total paid-in capital and retained earnings ......................................................... Add: Unrealized gain on available-forsale securities ........................................... Total stockholders’ equity............................ Total liabilities and stockholders’ equity .............................................................. 16-28 $ 70,000 240,000 120,000 80,000 510,000 $ 500,000 40,000 540,000 1,050,000 1,500,000 130,000 1,630,000 103,000 1,733,000 8,000 1,741,000 $2,791,000 PROBLEM 16-1B (a) 2008 Jan. 1 July 1 Dec. 31 2011 Jan. 1 1 July 1 Dec. 31 (b) 2008 Dec. 31 Debt Investments........................................ Cash ....................................................... 600,000 Cash ($600,000 X .09 X 1/2) ..................... Interest Revenue................................ 27,000 Interest Receivable .................................... Interest Revenue................................ 27,000 Cash ................................................................ Interest Receivable............................ 27,000 Cash [($300,000 X 1.14) – $7,000].......... Debt Investments............................... Gain on Sale of Debt Investments..................................... 335,000 Cash ($300,000 X .09 X 1/2) ..................... Interest Revenue................................ 13,500 Interest Receivable .................................... Interest Revenue................................ 13,500 Unrealized Gain or Loss—Equity .......... Market Adjustment— Available-for-Sale.......................... 20,000 16-29 600,000 27,000 27,000 27,000 300,000 35,000 13,500 13,500 20,000 PROBLEM 16-1B (Continued) (c) Balance Sheet Current assets Interest receivable................................................................. $ 27,000 Investments Debt investments, at fair value ......................................... $580,000 The unrealized loss of $20,000 would be reported in the stockholders’ equity section of the balance sheet as a deduction from total paid-in capital and retained earnings. 16-30 PROBLEM 16-2B (a) Feb. 1 Mar. 1 Apr. 1 July 1 Aug. 1 Sept. 1 Oct. 1 1 Stock Investments............................................. Cash ($40,000 + $800) ............................. 40,800 Stock Investments............................................. Cash ($15,000 + $300) ............................. 15,300 Debt Investments............................................... Cash ($60,000 + $1,200).......................... 61,200 Cash ($.60 X 600) ............................................... Dividend Revenue .................................... 360 Cash ($21,600 – $350) ...................................... Gain on Sale of Stock Investments .... Stock Investments.................................... [($40,800 ÷ 600) X 300] 21,250 Cash ($1 X 500)................................................... Dividend Revenue .................................... 500 Cash ($60,000 X 9% X 1/2) .............................. Interest Revenue....................................... 2,700 Cash ($64,000 – $1,000)................................... Debt Investments...................................... Gain on Sale of Debt Investments ($63,000 – $61,200) ................. 63,000 Stock Investments Feb. 1 40,800 Aug. 1 Mar. 1 15,300 Dec. 31 Bal. 35,700 20,400 Apr. 1 Dec. 31 Bal. 16-31 40,800 15,300 61,200 360 850 20,400 500 2,700 Debt Investments 61,200 Oct. 1 0 61,200 1,800 61,200 PROBLEM 16-2B (Continued) (b) Dec. 31 Unrealized Loss—Income ............................ Market Adjustment—Trading ............. Security Cost Fair Value EMP common SEK common $20,400 15,300 $35,700 $19,800 14,500 $34,300 1,400 1,400 (300 X $66) (500 X $29) (c) Current assets Trading securities, at fair value............................................... $34,300 (d) Other revenues and gains: Dividend Revenue, Interest Revenue, Gain on Sale of Stock Investments, and Gain on Sale of Debt Investments. Other expenses and losses: Unrealized Loss—Income. 16-32 PROBLEM 16-3B (a) July 1 Aug. 1 Sept. 1 Oct. 1 Nov. 1 Dec. 15 31 2009 Cash (6,000 X $1) ............................................. Dividend Revenue .................................. 6,000 6,000 Cash (3,000 X $.50).......................................... Dividend Revenue .................................. 1,500 Cash [(2,000 X $8) – $300]............................. Stock Investments (2,000 X $6).......... Gain on Sale of Stock Investments.......................................... 15,700 Cash [(600 X $28) – $600].............................. Stock Investments (600 X $20)........... Gain on Sale of Stock Investments.......................................... [$16,200 – ($12,000)] 16,200 Cash (1,200 X $1) ............................................. Dividend Revenue .................................. 1,200 Cash (2,400 X $.50).......................................... Dividend Revenue .................................. 1,200 Cash (4,000 X $1) ............................................. Dividend Revenue .................................. 4,000 2009 Jan. 1 Balance 2009 Dec. 31 Balance Stock Investments 2009 120,000 Sept. 1 Oct. 1 96,000 16-33 1,500 12,000 3,700 12,000 4,200 1,200 1,200 4,000 12,000 12,000 PROBLEM 16-3B (Continued) (b) Dec. 31 Unrealized Gain or Loss—Equity .................... ($96,000 – $90,000) Market Adjustment—Availablefor-Sale........................................................ Security Agee Co. common Burns Co. common Corea Co. common Cost Fair Value $48,000 24,000 24,000 $96,000 $43,200 24,000 22,800 $90,000 6,000 6,000 (2,400 X $18) (4,000 X $6) (1,200 X $19) (c) Investments Investment in stock of less than 20% owned companies, at fair value.......................................................... Stockholders’ equity Common stock ........................................... Retained earnings ..................................... Total paid-in capital and retained earnings......................... Less: Unrealized loss on availablefor-sale securities.................... Total stockholders’ equity............. 16-34 $ 90,000 $2,000,000 1,200,000 3,200,000 (6,000) $3,194,000 PROBLEM 16-4B (a) 2008 Jan. 1 June 30 Dec. 31 31 (b) 2008 Jan. 1 June 30 Dec. 31 31 Stock Investments ................................. 1,600,000 Cash................................................... Cash............................................................ Dividend Revenue......................... (60,000 X $.50) 30,000 Cash............................................................ Dividend Revenue......................... (60,000 X $.50) 30,000 Market Adjustment— Available-for-Sale .............................. Unrealized Gain or Loss— Equity............................................ [$1,600,000 – ($30 X 60,000)] 30,000 30,000 200,000 200,000 Stock Investments ................................. 1,600,000 Cash................................................... Cash............................................................ Stock Investments ........................ 30,000 Cash............................................................ Stock Investments ........................ 30,000 Stock Investments ................................. Revenue from Investment in Washburn, Inc....................... ($600,000 X 30%) 180,000 16-35 1,600,000 1,600,000 30,000 30,000 180,000 PROBLEM 16-4B (Continued) (c) Cost Method Stock Investments Common stock Unrealized Gain—Equity Dividend revenue Revenue from investment in Washburn, Inc. Equity Method $1,800,000 * $1,720,000 ** 200,000 60,000 0 0 **$30 X 60,000 shares **$1,600,000 + $180,000 – $60,000 16-36 180,000 PROBLEM 16-5B (a) Jan. 7 10 26 Feb. 2 10 July 1 Sept. 1 Dec. 15 (b) Cash ($28,000 – $700) ....................................... Investment in Bonds Corp. Common Stock ...................................... Gain on Sale of Stock Investment............................................... Investment in Petengill Corporation Common Stock ............................................... Cash [(200 X $78) + $240]........................ 27,300 26,000 1,300 15,840 15,840 Cash ........................................................................ Dividend Revenue ($1.15 X 700) ........... 805 Cash ........................................................................ Dividend Revenue ($.40 X 600) ............. 240 Cash [($26 X 600) – $180]................................. Loss on Sale of Preferred Stock.................... Investment in Dukakis Corporation Preferred Stock...................................... 15,420 1,380 Cash ........................................................................ Dividend Revenue ..................................... ($1.00 X 700) 700 Investment in Petengill Corporation Common Stock ............................................... Cash [($75 X 600) + $900]........................ Cash ........................................................................ Dividend Revenue ($1.50 X 800) ........... Investment in Bonds Corporation Common Stock 1/1 Bal. 26,000 1/7 26,000 12/31 Bal. 0 16-37 805 240 16,800 700 45,900 45,900 1,200 Investment in Mays Corporation Common Stock 1/1 Bal. 42,000 12/31 Bal. 42,000 1,200 PROBLEM 16-5B (Continued) Investment in Dukakis Corporation Preferred Stock 1/1 Bal. 16,800 2/10 16,800 12/31 Bal. (c) Dec. 31 Investment in Petengill Corporation Common Stock 1/10 15,840 9/1 45,900 12/31 Bal. 61,740 0 Unrealized Gain or Loss—Equity ....................... Market Adjustment—Availablefor-Sale ($103,740 – $101,700)................ Security Mays Corporation common Petengill Corporation common Cost $ 42,000 61,740 $103,740 2,040 Fair Value $ 44,100 57,600 $101,700 (d) Investments Investment in stock of less than 20% owned companies, at fair value ..................................................... Stockholders’ equity Total paid-in capital and retained earnings...................... Less: Unrealized loss on available-for-sale securities.................................................................... Total stockholders’ equity............................................. 16-38 2,040 (700 X $63) (800 X $72) $101,700 xxxxx (2,040) $ xxxxx PROBLEM 16-6B MANNING CORPORATION Balance Sheet December 31, 2008 Assets Current assets Cash .................................................................................. Short-term stock investment, at fair value.................................................................. Accounts receivable.................................................... Less: Allowance for doubtful accounts ......................................................... Merchandise inventory ............................................... Prepaid insurance ........................................................ Total current assets.............................................. $ 142,000 185,000 $ 90,000 6,000 Investments Investment in Tabares Inc. stock (30% ownership), at equity..................................... Property, plant, and equipment Land ................................................................ Buildings ....................................................... $900,000 Less: Accumulated depreciation ......... 180,000 Equipment..................................................... 275,000 Less: Accumulated depreciation ......... 52,000 Total property, plant, and equipment............................................................. 84,000 170,000 16,000 597,000 600,000 520,000 720,000 223,000 1,463,000 Intangibles Goodwill........................................................................... 200,000 Total assets ........................................................................... $2,860,000 16-39 PROBLEM 16-6B (Continued) MANNING CORPORATION Balance Sheet (Continued) December 31, 2008 Liabilities and Stockholders’ Equity Current liabilities Notes payable.................................................................................. Accounts payable .......................................................................... Income taxes payable ................................................................... Dividends payable ......................................................................... Total current liabilities......................................................... Long-term liabilities Bonds payable, 10%, due 2018........................... Less: Discount on bonds payable.................... Total long-term liabilities............................ Total liabilities .................................................................. Stockholders’ equity Paid-in capital Common stock, $5 par value, 500,000 shares authorized, 300,000 shares issued and outstanding.................................................. In excess of par value................................... Total paid-in capital .............................. Retained earnings................................................... Total stockholders’ equity........................... Total liabilities and stockholders’ equity ................. 16-40 $ 70,000 250,000 120,000 50,000 490,000 $ 400,000 20,000 380,000 870,000 $1,500,000 200,000 1,700,000 290,000 1,990,000 $2,860,000 COMPREHENSIVE PROBLEM: CHAPTERS 12 TO 16 Part I (a) To: Mindy Feldkamp, Oscar Lopez, and Lori Melton From: Joe Student Date: 5/26/2007 Re: Analysis of Partnership vs. Corporate Form of Business Organization I have examined your situation regarding the establishment of your business. Before discussing my recommendations, I would like to briefly review the advantages and disadvantages of partnerships and corporations. The primary advantages of a partnership over a corporation are: 1. Partnerships are more easily formed than corporations. Partnerships can be formed simply by the voluntary agreement of two or more individuals. Forming a corporation requires preparing and filing documents with governmental agencies, paying incorporation fees, etc. 2. Income from a partnership is subject to less tax than income from a corporation. Even though partnerships are required to file information tax returns (returns that show financial information, but do not require any payment of taxes), they are not considered taxable entities. A partner’s share of partnership income is taxed only on the partner’s personal income tax return. Corporations are taxable entities and pay taxes on corporate income. In addition, any dividends distributed by corporations to individuals are subject to personal income tax on the personal income tax return. This is known as double taxation. 3. Partnerships have more flexibility in decision making. The decisionmaking process used in a partnership is determined by the partners, whereas some decisions required in corporations must follow formal procedures described in the bylaws of the corporation. 16-41 COMPREHENSIVE PROBLEM (Continued) The primary advantages of a corporation over a partnership are: 1. Mutual agency does not exist in a corporation. This means that the owners of a corporation (stockholders) do not have the power to bind the corporation beyond their authority. For example, a stockholder who is not employed by the firm cannot enter into contracts or other agreements on behalf of the corporation. Owners of a partnership (partners) are bound by the actions of their partners, even when partners act beyond the scope of their authority. This is true as long as the actions seem appropriate for the business. 2. The owners of a corporation have limited liability. When the corporation’s assets are not sufficient to pay creditors’ claims, the personal assets of the stockholders are protected from the corporation’s creditors. In a partnership, once the assets of the partnership have been used to pay creditors’ claims, the personal assets of the partners can be taken to satisfy the creditors’ demands. A special type of partnership, a limited partnership, protects the personal assets of limited partners, but at least one partner’s assets are still at risk. This partner is called a general partner. 3. The life of a corporation is unlimited. When ownership changes occur (e.g., stockholders buy or sell stock), the corporation continues to exist as a legal entity. When ownership changes occur in a partnership (e.g., existing partner leaves, new partner is added), the old partnership no longer exists as a legal entity. A new partnership can be formed and the business can continue, but the original partnership must be dissolved. After examining your situation, I believe that you would be wise to choose the corporate form of business organization. There are two reasons for this recommendation. The first reason is that the venture you are about to undertake will require significant capital and, generally, capital is more easily raised via a corporation than a partnership. The other reason is that you will be protected from unlimited liability if you incorporate as opposed to forming a partnership. Given the potential risk of starting a venture of this kind, I believe it is in your best interest to protect your personal assets by using the corporate form of organization. I wish you the best in your new endeavor and please call upon me when you are in need of further assistance. 16-42 COMPREHENSIVE PROBLEM (Continued) Part II (b) Equity financing option: Positives No fixed interest payments required Negatives Control of the corporation is lost Difficulty of finding an interested investor Earnings per share are lower Debt financing option: Negatives Interest payments quickly drain cash Positives Control stays with three incorporators No need for additional investor Earnings per share are higher Shares outstanding before financing Income before interest and taxes Interest expense Income before taxes Tax expense Net income Shares outstanding after financing Earnings per share 60,000 shares Equity Financing $300,000 — 300,000 96,000 $204,000 200,000 $ 1.02 Debt Financing $300,000 126,000 174,000 55,680 $118,320 60,000 $ 1.97 Part III (c) (1) 6/12/07 Cash...................................................... Building ............................................... Common Stock......................... Paid-in Capital in Excess of Par Value .......................... 16-43 100,000 200,000 120,000 180,000 COMPREHENSIVE PROBLEM (Continued) 7/21/07 7/27/08 Cash ...................................................... Common Stock......................... Paid-in Capital in Excess of Par Value........................... Retained Earnings (150,000 X .10 X $3) ..................... Common Stock Dividends Distributable ......................... Paid-in Capital in Excess of Par Value........................... 900,000 180,000 720,000 45,000 30,000 15,000 7/31/08 No entry 8/15/08 Common Stock Dividends Distributable .................................. Common Stock......................... 30,000 Retained Earnings (165,000 X $.05)............................. Dividends Payable................... 8,250 12/4/08 30,000 8,250 12/14/08 No entry 12/24/08 Dividends Payable............................. Cash .............................................. 8,250 8,250 (2) Shares Issued and Outstanding Date Total Shares Number of Issued and Shares Issued Outstanding Event 6/12/07 Issuance to Incorporators 7/21/07 Issuance to Marino 8/15/08 Stock dividend issuance 60,000 90,000 15,000 60,000 150,000 165,000 Part IV (d) (1) 6/1/09 Cash ..................................................... Discount on Bonds Payable ........ Bonds Payable......................... 16-44 548,000 52,000 600,000 COMPREHENSIVE PROBLEM (Continued) (2) 12/1/09 Interest Expense .......................................... 20,600 Discount on Bonds Payable ($52,000 ÷ 20) ................... Cash ($600,000 X .03).......................... (3) 12/31/09 Interest Expense .......................................... Discount on Bonds Payable............. [($52,000 ÷ 20) ÷ 6] Interest Payable.................................... [($600,000 X .03) ÷ 6] (4) 6/1/10 2,600 18,000 3,433 433 3,000 Interest Payable ........................................... 3,000 Interest Expense ($20,600 – $3,433)...... 17,167 Cash ......................................................... Discount on Bonds Payable ($2,600 – $433)................. 18,000 2,167 Part V (e) (1) 2007 2008 Investment in LifePath ......................... Cash .................................................. 900,000 Investment in LifePath ......................... Investment Revenue .................... (.6 X $30,000) 18,000 Cash .......................................................... Investment in LifePath ............... (.6 X $2,100) 1,260 Investment in LifePath ........................ Investment Revenue ................... (.6 X $70,000) 42,000 Cash .......................................................... Investment in LifePath ............... (.6 X $20,000) 12,000 16-45 900,000 18,000 1,260 42,000 12,000 COMPREHENSIVE PROBLEM (Continued) 2009 (2) Investment in LifePath ...................... Investment Revenue ................. (.6 X $105,000) 63,000 Cash......................................................... Investment in LifePath.............. (.6 X $50,000) 30,000 Investment in LifePath 900,000 18,000 1,260 42,000 12,000 63,000 30,000 979,740 16-46 63,000 30,000 BYP 16-1 FINANCIAL REPORTING PROBLEM (a) PepsiCo made the following statement about what was included on its consolidated financial statement: “Our financial statements include the consolidated accounts of PepsiCo, Inc. and the affiliates that we control. In addition, we include our share of the results of certain other affiliates based on our economic ownership interest. We do not control these other affiliates as our ownership in these other affiliates is generally less than fifty percent. Our share of the net income of noncontrolled bottling affiliates is reported in our income statement as bottling equity income. Bottling equity income also includes any changes in our ownership interests of these affiliates. In 2005, bottling equity includes $126 million of pre-tax gains on our sales of PBG stock. See Note 8 for additional information on our noncontrolled bottling affiliates. Our share of other noncontrolled affiliates is included in division operating profit. Intercompany balances and transactions are eliminated.” (b) PepsiCo’s Consolidated Statement of Cash Flows shows that $1,736 million was spent for capital acquisitions during the year. 16-47 BYP 16-2 (a) COMPARATIVE ANALYSIS PROBLEM (in millions) 1. Cash used for investing activities 2. Cash used for capital expenditures PepsiCo $3,517 1,736 Coca-Cola $1,496 899 (b) In its Note 1 to the consolidated financial statements, PepsiCo states that its financial statements include the consolidated accounts of PepsiCo Inc. and the affiliates that it controls. In addition, PepsiCo includes its share of the results of certain other affiliates based on its ownership interest. As for specific corporations consolidated, PepsiCo lists the following companies as its principal divisions. Frito-Lay North America PepsiCo Beverages North America Quaker Foods North America PepsiCo International 16-48 BYP 16-3 EXPLORING THE WEB Answers will vary depending on company chosen. The following sample solution is provided for Medtronic, Inc. (a) (b) (c) (d) (e) (f) 30 analysts rated this company. 10/30 or 33% of the analysts rated it a strong buy. Average rating 2.0 on a scale of 1.0 (strong buy) to 5.0 (strong sell). Average rating: No change. Analysts rank this company 16 of 52. Earnings surprise 0%. 16-49 BYP 16-4 DECISION MAKING ACROSS THE ORGANIZATION The dollar amount received upon the sale of the UMW Company stock was $1,468,000. Since Kemper Corporation has a 30% interest in UMW, the equity method should be used to report dividends and net income. A reconstruction of the correct entries can be prepared for the acquisition, the equity method treatment of dividends and revenue, and the sale. A plug figure for cash will balance the entry for the sale. These entries are provided below. Both the stockholder and the president are correct. Since the equity method adjusts the investment account for the earnings of the investee, the “very profitable” UMW investment balance has increased during the period the stock was held. The stock was sold at less than its current investment balance and thus a loss was recognized. Stockholder Kerwin is correct in labeling this a very profitable company and in noting that a loss was recognized on its sale. President Chavez is correct in that the investment was sold at a higher figure than the $1,300,000 purchase price. The key to the dilemma is to note that the selling price was less than the carrying amount of the investment. The carrying amount has increased due to the recognition of UMW income during the time the stock was held. Entries for the investment in UMW Company: Acquisition Stock Investments ............................................................. Cash............................................................................... 1,300,000 1,300,000 Previous Years—Equity Method Stock Investments ............................................................. 372,000 Revenue from Investment in UMW Company ($1,240,000 X 30%) ........................... 372,000 Cash........................................................................................ Stock Investments ($440,000 X 30%).................. 132,000 16-50 132,000 BYP 16-4 (Continued) This Year—Equity Method Stock Investments........................................................... Revenue from Investment in UMW Company ($520,000 X 30%) ............................ Cash ..................................................................................... Stock Investments ($160,000 X 30%) ............... 156,000 156,000* 48,000 Sale of the UMW Company Stock Cash (Cash is a plug.) .................................................... 1,468,000 Loss on Sale of Investments ....................................... 180,000 Stock Investments.................................................. *$1,300,000 + ($372,000 + $156,000) – ($132,000 + $48,000) 16-51 48,000* 1,648,000* BYP 16-5 COMMUNICATION ACTIVITY Dear Mr. Scholes: I am writing this memo to make suggestions regarding the appropriate treatment for the two securities you are holding in your portfolio. Assuming that your investment in Longley Corporation does not represent a significant interest in that firm, it should be accounted for as an available-for-sale security because it is a stock investment that you do not intend on selling in the near future. You will not report any gains or losses on this investment in your income statement until you sell it. On the other hand, your debt investment should be accounted for as a trading security since you purchased it with the intent to generate a short-term profit. Unrealized gains and losses at your balance sheet date should be reported directly in income. 16-52 BYP 16-6 ETHICS CASE (a) Classifying the securities as they propose will indeed have the effect on net income that they say it will. Classifying all the gains as trading securities will cause all the gains to flow through the income statement this year and classifying the losses as available-for-sale securities will defer the losses from this year’s income statement. Classifying the gains and losses just the opposite will have the opposite effect. (b) What each proposes is unethical since it is knowingly not in accordance with GAAP. The financial statements are fraudulently, not fairly, stated. The affected stakeholders are other members of the company’s officers and directors, the independent auditors (who may detect these misstatements), the stockholders, and prospective investors. (c) The act of selling certain securities (those with gains or those with losses) is management’s choice and is not per se unethical. Generally accepted accounting principles allow the sale of selected securities so long as the method of assigning cost adopted by the company is consistently applied. If the officers act in the best interest of the company and its stakeholders, and in accordance with GAAP, and not in their self-interest, their behavior is probably ethical. Knowingly engaging in unsound and poor business and accounting practices that waste assets or that misstate financial statements is unethical behavior. 16-53 BYP 16-7 ALL ABOUT YOU ACTIVITY (a)
Ask—The lowest price at which a market maker will sell a specified number of shares of a stock at any given time.
Margin Account—A type of account with a broker-dealer, in which the broker agrees to lend the customer part of the amount due for the purchase of securities.
Prospectus—A document that contains important information about an investment company’s fees and expenses, investment objectives, investment strategies, risks, performance, pricing, and more.
Index Fund—A type of mutual fund or Unit Investment Trust whose investment objective typically is to achieve the same return as a particular market index, such as the S & P 500 Composite Stock Price Index. (b)&(c) The SEC quiz is interactive, thus students are provided with feedback regarding their answers. 16-54 CHAPTER 17 The Statement of Cash Flows ASSIGNMENT CLASSIFICATION TABLE Brief Exercises Exercises A Problems B Problems 3, 4, 5, 6, 7, 8, 9, 16 1, 2, 3 1, 2, 3 1A 1B 10, 11, 12, 13, 14 4, 5, 6, 7 4, 5, 6, 7, 8, 9 2A, 3A, 5A, 7A, 9A, 11A 2B, 3B, 5B, 7B, 9B, 11B 8, 9, 10, 11 7, 8, 9 7A, 8A 7B, 8B 17 12 10 12A 8, 18, 19, 20, 21 13, 14, 15 11, 12, 13, 14 4A, 6A, 8A, 10A Study Objectives Questions *1. Indicate the usefulness of the statement of cash flows. 1, 2, 6, 15 *2. Distinguish among operating, investing, and financing activities. *3. Prepare a statement of cash flows using the indirect method. *4. Analyze the statement of cash flows. *5. Explain how to use a worksheet to prepare the statement of cash flows using the indirect method. *6. Prepare a statement of cash flows using the direct method. 4B, 6B, 8B, 10B *Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix*to the chapter. 17-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Distinguish among operating, investing, and financing activities. Simple 10–15 2A Determine cash flow effects of changes in equity accounts. Simple 10–15 3A Prepare the operating activities section—indirect method. Simple 20–30 Prepare the operating activities section—direct method. Simple 20–30 Prepare the operating activities section—indirect method. Simple 20–30 Prepare the operating activities section—direct method. Simple 20–30 Prepare a statement of cash flows—indirect method, and compute free cash flow. Moderate 40–50 Prepare a statement of cash flows—direct method, and compute free cash flow. Moderate 40–50 Prepare a statement of cash flows—indirect method. Moderate 40–50 Prepare a statement of cash flows—direct method. Moderate 40–50 Prepare a statement of cash flows—indirect method. Moderate 40–50 Prepare a worksheet—indirect method. Moderate 40–50 *4A 5A *6A 7A *8A 9A *10A 11A *12A 1B Distinguish among operating, investing, and financing activities. Simple 10–15 2B Determine cash flow effects of changes in plant asset accounts. Simple 10–15 3B Prepare the operating activities section—indirect method. Simple 20–30 Prepare the operating activities section—direct method. Simple 20–30 Prepare the operating activities section—indirect method. Simple 20–30 Prepare the operating activities section—direct method. Simple 20–30 Moderate 40–50 *4B 5B *6B 7B Prepare a statement of cash flows—indirect method, and compute free cash flow. 17-2 ASSIGNMENT CHARACTERISTICS TABLE (Continued) Problem Number *8B 9B *10B 11B Difficulty Level Time Allotted (min.) Prepare a statement of cash flows—direct method, and compute free cash flow. Moderate 40–50 Prepare a statement of cash flows—indirect method. Moderate 40–50 Prepare a statement of cash flows—direct method. Moderate 40–50 Prepare a statement of cash flows—indirect method. Moderate 40–50 Description 17-3 Study Objective Knowledge Comprehension Application 17-4 1. Indicate the usefulness of the statement of cash flows. Q17-6 Q17-1 Q17-2 Q17-15 2. Distinguish among operating, investing, and financing activities. Q17-4 Q17-6 BE17-1 Q17-3 Q17-5 Q17-7 Q17-8 Q17-9 Q17-16 BE17-2 BE17-3 E17-1 E17-2 E17-2 E17-3 P17-1A P17-1B 3. Prepare a statement of cash flows using the indirect method. Q17-13 Q17-10 Q17-11 Q17-12 Q17-14 BE17-4 BE17-5 BE17-6 E17-4 E17-5 E17-7 4. Analyze the statement of cash flows. *5 Explain how to use a worksheet to prepare the statement of cash flows using the indirect method. *6. Prepare a statement of cash flows using the direct method. Broadening Your Perspective E17-8 E17-9 P17-3A P17-5A P17-7A P17-9A Q17-18 BE17-12 E17-10 P17-12A Q17-8 Q17-20 Q17-21 Q17-19 BE17-13 BE17-14 BE17-15 E17-11 E17-12 E17-13 E17-14 P17-4A P17-6A P17-8A P17-10A Synthesis Evaluation BE17-7 E17-6 P17-2A P17-2B P17-7A P17-7B P17-7B BE17-8 P17-8B BE17-9 BE17-10 BE17-11 E17-7 E17-9 P17-7A P17-8A Q17-17 P17-11A P17-3B P17-5B P17-7B P17-9B P17-11B Analysis P17-7A P17-8A P17-7B P17-8B P17-4B P17-8A P17-6B P17-8B P17-8B P17-10B Exploring the Web Comparative Analysis Decision Making Across the Organization Communication Decision Making Across the Organization Ethics Case Comp. Analysis All About You BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. (a) The statement of cash flows reports the cash receipts, cash payments, and net change in cash resulting from the operating, investing, and financing activities of a company during a period in a format that reconciles the beginning and ending cash balances. (b) Disagree. The statement of cash flows is required. It is the fourth basic financial statement. 2. The statement of cash flows answers the following questions about cash: (a) Where did the cash come from during the period? (b) What was the cash used for during the period? and (c) What was the change in the cash balance during the period? 3. The three activities are: Operating activities include the cash effects of transactions that create revenues and expenses and thus enter into the determination of net income. Investing activities include: (a) purchasing and disposing of investments and productive long-lived assets and (b) lending money and collecting loans. Financing activities include: (a) obtaining cash from issuing debt and repaying amounts borrowed and (b) obtaining cash from stockholders, repurchasing shares, and paying them dividends. 4. (a) Major sources of cash in a statement of cash flows include cash from operations; issuance of debt; collection of loans; issuance of capital stock; sale of investments; and the sale of property, plant, and equipment. (b) Major uses of cash include purchase of inventory, payment of cash dividends; redemption of debt; purchase of investments; making loans; redemption of capital stock; and the purchase of property, plant, and equipment. 5. The statement of cash flows presents investing and financing activities so that even noncash transactions of an investing and financing nature are disclosed in the financial statements. If they affect financial conditions significantly, the FASB requires that they be disclosed in either a separate schedule at the bottom of the statement of cash flows or in a separate note or supplementary schedule to the financial statements. 6. Examples of significant noncash activities are: (1) issuance of stock for assets, (2) conversion of bonds into common stock, (3) issuance of bonds or notes for assets, and (4) noncash exchanges of property, plant, and equipment. 7. Comparative balance sheets, a current income statement, and certain transaction data all provide information necessary for preparation of the statement of cash flows. Comparative balance sheets indicate how assets, liabilities, and equities have changed during the period. A current income statement provides information about the amount of cash provided or used by operations. Certain transactions provide additional detailed information needed to determine how cash was provided or used during the period. 8. The advantage of the direct method is that it presents the major categories of cash receipts and cash payments in a format that is similar to the income statement and familiar to statement users. Its principal disadvantage is that the necessary data can be expensive and time-consuming to accumulate. The advantage of the indirect method is it is often considered easier to prepare, and it provides a reconciliation of net income to net cash provided by operating activities. It also tends to reveal less company information to competitors. Its primary disadvantage is the difficulty in understanding the adjustments that comprise the reconciliation. Both methods are acceptable but the FASB expressed a preference for the direct method. Yet, the indirect method is the overwhelming favorite of companies. 17-5 Questions Chapter 17 (Continued) 9. When total cash inflows exceed total cash outflows, the excess is identified as a “net increase in cash” near the bottom of the statement of cash flows. 10. The indirect method involves converting accrual net income to net cash provided by operating activities. This is done by starting with accrual net income and adding or subtracting noncash items included in net income. Examples of adjustments include depreciation and other noncash expenses, gains and losses on the sale of noncurrent assets, and changes in the balances of current asset and current liability accounts from one period to the next. 11. It is necessary to convert accrual-based net income to cash-basis income because the unadjusted net income includes items that do not provide or use cash. An example would be an increase in accounts receivable. If accounts receivable increased during the period, revenues reported on the accrual basis would be higher than the actual cash revenues received. Thus, accrual-basis net income must be adjusted to reflect the net cash provided by operating activities. 12. A number of factors could have caused an increase in cash despite the net loss. These are (1) high cash revenues relative to low cash expenses; (2) sales of property, plant, and equipment; (3) sales of investments; (4) issuance of debt or capital stock, and (5) differences between cash and accrual accounting, e.g. depreciation. 13. Depreciation expense. Gain or loss on sale of a noncurrent asset. Increase/decrease in accounts receivable. Increase/decrease in inventory. Increase/decrease in accounts payable. 14. Under the indirect method, depreciation is added back to net income to reconcile net income to net cash provided by operating activities because depreciation is an expense but not a cash payment. 15. The statement of cash flows is useful because it provides information to the investors, creditors, and other users about: (1) the company’s ability to generate future cash flows, (2) the company’s ability to pay dividends and meet obligations, (3) the reasons for the difference between net income and net cash provided by operating activities, and (4) the cash investing and financing transactions during the period. 16. This transaction is reported in the note or schedule entitled “Noncash investing and financing activities” as follows: “Retirement of bonds payable through issuance of common stock, $1,700,000.” *17. A worksheet is desirable because it allows the accumulation and classification of data that will appear on the statement of cash flows. It is an optional but efficient device that aids in the preparation of the statement of cash flows. *18. Net cash provided by operating activities under the direct approach is the difference between cash revenues and cash expenses. The direct approach adjusts the revenues and expenses directly to reflect the cash basis. This results in cash net income, which is equal to “net cash provided by operating activities.” 17-6 Questions Chapter 17 (Continued) *19. (a) Cash receipts from customers = Revenues from sales (b) Purchases = Cost of goods sold + Decrease in accounts receivable – Increase in accounts receivable + Increase in inventory – Decrease in inventory Cash payments to suppliers = Purchases + Decrease in accounts payable – Increase in accounts payable *20. Sales ........................................................................................................................................... Add: Decrease in accounts receivables.............................................................................. Cash receipts from customers ............................................................................................... $2,000,000 200,000 $2,200,000 *21. Depreciation expense is not listed in the direct method operating activities section because it is not a cash flow item—it does not affect cash. 17-7 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 17-1 (a) (b) (c) (d) Cash inflow from financing activity, $200,000. Cash outflow from investing activity, $150,000. Cash inflow from investing activity, $20,000. Cash outflow from financing activity, $50,000. BRIEF EXERCISE 17-2 (a) Investing activity. (b) Investing activity. (c) Financing activity. (d) Operating activity. (e) Financing activity. (f) Financing activity. BRIEF EXERCISE 17-3 Cash flows from financing activities Proceeds from issuance of bonds payable............................ Payment of dividends .................................................................... Net cash provided by financing activities...................... $300,000) (50,000) $250,000) BRIEF EXERCISE 17-4 Net income..................................................................... $2,500,000 Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense ....................................... $160,000 Accounts receivable decrease....................... 350,000 230,000 Accounts payable decrease ........................... (280,000) Net cash provided by operating activities...... $2,730,000 17-8 BRIEF EXERCISE 17-5 Cash flows from operating activities Net income....................................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense.......................................... Loss on sale of plant assets ............................. Net cash provided by operating activities......... $280,000 $ 70,000 12,000 82,000 $362,000 BRIEF EXERCISE 17-6 Net income................................................................................ Adjustments to reconcile net income to net cash provided by operating activities Decrease in accounts receivable ............................. Increase in prepaid expenses ................................... Increase in inventories ................................................ Net cash provided by operating activities ............ $200,000 $ 80,000) (28,000) (30,000) 22,000 $222,000 BRIEF EXERCISE 17-7 Original cost of equipment sold .......................................................... Less: Accumulated depreciation ....................................................... Book value of equipment sold ............................................................. Less: Loss on sale of equipment....................................................... Cash received from sale of equipment ............................................. $22,000 5,500 16,500 5,500 $11,000 BRIEF EXERCISE 17-8 Free cash flow = $155,793,000 – $132,280,000 – $0 = $23,513,000 BRIEF EXERCISE 17-9 Free cash flow = $360,000 – $200,000 – $0 = $160,000 BRIEF EXERCISE 17-10 Free cash flow = $45,600,000 – $1,600,000 = $44,000,000 17-9 BRIEF EXERCISE 17-11 Free cash flow is cash provided by operations less capital expenditures and cash dividends paid. For Radar Inc. this would be $384,000 ($734,000 – $280,000 – $70,000). Since it has positive free cash flow that far exceeds its dividend, an increase in the dividend might be possible. However, other factors should be considered. For example, it must have adequate retained earnings, and it should be convinced that a larger dividend can be sustained over future years. It should also use the free cash flow to expand its operations or pay down its debt. *BRIEF EXERCISE 17-12 Balance 1/1/08 Balance Sheet Accounts Prepaid expenses Accrued expenses payable Reconciling Items Debit 18,600 8,200 Credit Balance 12/31/08 (a) 6,600 (b) 2,400 12,000 10,600 Statement of Cash Flow Effects Operating activities Decrease in prepaid expenses Increase in accrued expenses payable (a) 6,600 (b) 2,400 9,000 0,000 9,000 *BRIEF EXERCISE 17-13 Receipts from Sales = customers revenues + Decrease in accounts receivable – Increase in accounts receivable $1,033,678,000 = $1,095,307,000 – $61,629,000 (Increase in accounts receivable) 17-10 *BRIEF EXERCISE 17-14 + Decrease in income taxes payable Cash payment Income Tax = for income taxes Expense – Increase in income taxes payable $95,000,000 = $340,000,000 – $245,000,000* *$522,000,000 – $277,000,000 = $245,000,000 (Increase in income taxes payable) *BRIEF EXERCISE 17-15 Cash Operating payments for expenses, = operating excluding expenses depreciation + Increase in prepaid expenses – Decrease in prepaid expenses and + Decrease in accrued expenses payable – Increase in accrued expenses payable $69,000 = $80,000 – $6,600 – $4,400 17-11 SOLUTIONS TO EXERCISES EXERCISE 17-1 (a) (b) (c) (d) (e) (f) (g) Financing activities. Noncash investing and financing activities. Noncash investing and financing activities. Financing activities. Investing activities. Operating activities. Operating activities. EXERCISE 17-2 (a) Operating activity. (b) Noncash investing and financing activity. (c) Investing activity. (d) Financing activity. (e) Operating activity. (f) Operating activity. (g) Operating activity. (h) Financing activity. (i) Operating activity. (j) Noncash investing and financing activity. (k) Investing activity. (l) Noncash investing and financing activity. (m) Operating activity (loss); investing activity (cash proceeds from sale). (n) Financing activity. EXERCISE 17-3 1. (a) Cash............................................................... 15,000 Land ...................................................... 12,000 Gain on Disposal .............................. 3,000 (b) The cash receipt ($15,000) is reported in the investing section. The gain ($3,000) is deducted from net income in the operating section. 2. (a) Cash............................................................... 20,000 Common Stock.................................. 20,000 (b) The cash receipt ($20,000) is reported in the financing section. 3. (a) Depreciation Expense.............................. 17,000 Accumulated Depreciation............ 17,000 (b) Depreciation expense ($17,000) is added to net income in the operating section. 17-12 EXERCISE 17-3 (Continued) 4. (a) Salaries Expense ............................................................. Cash............................................................................ 9,000 9,000 (b) Salaries expense is not reported separately on the statement of cash flows. It is part of the computation of net income in the income statement, and is included in the net income amount on the statement of cash flows. 5. (a) Equipment.......................................................................... Common Stock ....................................................... Paid-in Capital in Excess of Par Value............ 8,000 1,000 7,000 (b) The issuance of common stock for equipment ($8,000) is reported as a noncash financing and investing activity at the bottom of the statement of cash flows. 6. (a) Cash..................................................................................... Loss on Disposal............................................................. Accumulated Depreciation........................................... Equipment....................................................... 1,200 1,800 7,000 10,000 (b) The cash receipt ($1,200) is reported in the investing section. The loss ($1,800) is added to net income in the operating section. EXERCISE 17-4 VILLA COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income.......................................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense............................................. Loss on sale of equipment ................................... Decrease in accounts receivable ....................... Decrease in prepaid expenses............................ Increase in accounts payable.............................. Net cash provided by operating activities.......... 17-13 $195,000 $45,000 5,000 15,000 4,000 17,000 86,000 $281,000 EXERCISE 17-5 BELLINHAM INC. Partial Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income...................................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense ........................................ Increase in accounts receivable..................... Decrease in inventory........................................ Increase in prepaid expenses ......................... Increase in accrued expenses payable........ Decrease in accounts payable........................ Net cash provided by operating activities ...... 17-14 $153,000 $24,000) (21,000) 14,000) (5,000) 10,000) (7,000) 15,000 $168,000 EXERCISE 17-6 CESAR CORP Partial Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income.................................................................. Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense..................................... Loss on sale of equipment ........................... Net cash provided by operating activities ......................................................... Cash flows from investing activities Sale of equipment..................................................... Purchase of equipment .......................................... Construction of equipment ................................... Net cash used by investing activities ....... $ 67,000) $ 28,000) 5,000) 100,000) 14,000* (70,000) (53,000) (109,000) Cash flows from financing activities Payment of cash dividends................................... *Cost of equipment sold......................................... *Accumulated depreciation................................... *Book value................................................................. *Loss on sale of equipment .................................. *Cash proceeds......................................................... 17-15 33,000) (14,000) $ 49,000) (30,000) 19,000) (5,000) $ 14,000) EXERCISE 17-7 (a) SCULLY CORPORATION Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income..................................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense........................................ Loss on sale of land........................................... Decrease in accounts receivable .................. Decrease in accounts Payable ....................... Net cash provided by operating activities .......... $ 22,630) $ 5,000) 1,100 2,200 (18,730) Cash flows from investing activities Sale of land.................................................................... Cash flows from financing activities Issuance of common stock...................................... Payment of dividends ................................................ Net cash used by financing activities................... Net increase in cash .......................................................... Cash at beginning of period............................................ Cash at end of period ........................................................ (b) $12,200 – $0 – $19,500 = ($7,300) 17-16 (10,430) 12,200 4,900 $ 6,000 (19,500) (13,500) 3,600) 10,700 ) $ 14,300 EXERCISE 17-8 TAGUCHI COMPANY Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income ........................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense.............................. Increase in accounts receivable .......... Decrease in inventory ............................. Decrease in accounts payable ............. Net cash provided by operating activities .................................................. Cash flows from investing activities Sale of land .......................................................... Purchase of equipment.................................... Net cash used by investing activities .................................................. Cash flows from financing activities Issuance of common stock ............................ Redemption of bonds....................................... Payment of cash dividends............................ Net cash used by financing activities .................................................. Net increase in cash .................................................. Cash at beginning of period ................................... Cash at end of period................................................ 17-17 $103,000) $34,000) (9,000) 19,000) (8,000) 36,000) 139,000) 25,000) (60,000) (35,000) 42,000) (50,000) (45,000) (53,000) 51,000) 22,000) $ 73,000) EXERCISE 17-9 (a) MULDUR CORPORATION Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income............................................................. Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense ................................ $ 5,200* Loss on sale of equipment....................... 5,500** Increase in accounts payable ................. 3,500) Increase in accounts receivable............. (2,900) Net cash provided by operating activities ....... Cash flows from investing activities Sale of equipment ............................................... Purchase of investments.................................. Net cash used by investing activities............... 3,300) (4,000) Cash flows from financing activities Issuance of common stock.............................. Retirement of bonds........................................... Payment of dividends ........................................ Net cash used by financing activities .............. $ 5,000) (20,000) (16,400) Net increase in cash................................................ Cash at beginning of period ................................. Cash at end of period ............................................. *[$14,000 – ($10,000 – $1,200)] $ 18,300) ) 11,300) 29,600) (700) (31,400) (2,500)) 17,700 $ 15,200 **[$3,300 – ($10,000 – $1,200)] (b) $29,600 – $0 – $16,400 = $13,200 17-18 *EXERCISE 17-10 EDDIE MURPHY COMPANY Worksheet Statement of Cash Flows For the Year Ended December 31, 2008 Balance Sheet Accounts Reconciling Items Balance 12/31/07 Debit Credit Balance 12/31/08 Debits Cash Accounts receivable Inventories Land Equipment Total 22,000 76,000 189,000 100,000 200,000 587,000 (k) (a) (f) 41,000 9,000 (b) (e) 9,000 25,000 (d) 24,000 (i) (j) 50,000 125,000 (a) 9,000 (c) 13,000 (f) 60,000 (g) (h) 60,000 50,000 60,000 63,000 85,000 180,000 75,000 260,000 663,000 Credits Accumulated depreciation—equipment Accounts payable Bonds payable Common stock Retained earnings Total 42,000 47,000 200,000 164,000 134,000 587,000 (c) (h) 13,000 50,000 (g) 60,000 (j) 125,000 Statement of Cash Flow Effects Operating activities Net income Increase in accounts receivable Decrease in inventories Decrease in accounts payable Depreciation expense Investing activities Sale of land Purchase of equipment Financing activities Payment of dividends Redemption of bonds Issuance of common stock Totals Increase in cash Totals (b) 9,000 (d) 24,000 (e) 25,000 (i) 50,000 466,000 466,000 17-19 425,000 (k) 41,000 466,000 66,000 34,000 150,000 214,000 199,000 663,000 *EXERCISE 17-11 Revenues .............................................................................. Deduct: Increase in accounts receivable.................. Cash receipts from customers*............................ Operating expenses .......................................................... Deduct: Increase in accounts payable....................... Cash payments for operating expenses** ........ Net cash provided by operating activities ................. ** $192,000) (60,000) $132,000 78,000) (23,000) 55,000 $ 77,000 Accounts Receivable Balance, Beginning of year 0 Revenues for the year 192,000 Cash receipts for year Balance, End of year 60,000 ** Payments for the year Accounts Payable Balance, Beginning of year 55,000 Operating expenses for year Balance, End of year 132,000 0 78,000 23,000 *EXERCISE 17-12 (a) Cash payments to suppliers Cost of goods sold ........................................ Add: Increase in inventory.......................... Cost of purchases.......................................... Deduct: Increase in accounts payable........ Cash payments to suppliers....................... $4,852.7 million 18.1 $4,870.8 million (136.9) $4,733.9 million (b) Cash payments for operating expenses Operating expenses exclusive of depreciation............................................ $9,470.5 million ($10,671.5 – $1,201) Add: Increase in prepaid expenses.......... $ 56.3) Deduct: Increase in accrued expenses payable...................................... (160.9) (104.6) Cash payments for operating expenses...... $9,365.9 million 17-20 *EXERCISE 17-13 Cash flows from operating activities Cash receipts from Customers............................................................ Dividend revenue............................................... $230,000* 18,000* $248,000* Less cash payments: To suppliers for merchandise ....................... For operating expenses................................... For salaries and wages.................................... For interest........................................................... For income taxes ............................................... Net cash provided by operating activities...... 115,000 28,000 53,000 10,000 12,000 218,000* $ 30,000* *$48,000 + $182,000 *EXERCISE 17-14 Cash payments for rentals Rent expense ............................................................... Add: Increase in prepaid rent................................. Cash payments for rent ............................................ $ 40,000* 3,100* $ 43,100* Cash payments for salaries Salaries expense......................................................... Add: Decrease in salaries payable ....................... Cash payments for salaries .................................... $ 54,000* 2,000* $ 56,000* Cash receipts from customers Revenue from sales ................................................... Add: Decrease in accounts receivable................ Cash receipts from customers............................... $170,000* 9,000* $179,000* 17-21 SOLUTIONS TO PROBLEMS PROBLEM 17-1A Transaction Where Reported Cash Inflow, Outflow, or No Effect? O No cash flow effect (a) Recorded depreciation expense on the plant assets. (b) Recorded and paid interest expense. (c) Recorded cash proceeds from a sale of plant assets. (d) Acquired land by issuing common stock. (e) Paid a cash dividend to preferred stockholders. (f) Distributed a stock dividend to common stockholders. (g) Recorded cash sales. (h) Recorded sales on account. (i) Purchased inventory for cash. (j) Purchased inventory on account. O Cash outflow I Cash inflow NC F 17-22 No cash flow effect Cash outflow NC No cash flow effect O O O O Cash inflow No cash flow effect Cash outflow No cash flow effect PROBLEM 17-2A (a) Net income can be determined by analyzing the retained earnings account. Retained earnings beginning of year ............................. Add: Net income (plug) ....................................................... Less: Cash dividends .......................................................... Stock dividends ......................................................... Retained earnings, end of year ......................................... $260,000 65,500* 325,500 15,000 10,500 $300,000 *($300,000 + $10,500 + $15,000 – $260,000) (b) Cash inflow from the issue of stock was $9,500 ($160,000 – $140,000 – $10,500). Common Stock 140,000 10,500 9,500 160,000 Stock Dividend Shares Issued for Cash Cash outflow for dividends was $15,000. The stock dividend does not use cash. (c) Both of the above activities (issue of common stock and payment of dividends) would be classified as financing activities on the statement of cash flows. 17-23 PROBLEM 17-3A ELBERT COMPANY Partial Statement of Cash Flows For the Year Ended November 30, 2008 Cash flows from operating activities Net income....................................................................... $1,650,000 Adjustments to reconcile net income to net cash provided by operating activities activities Depreciation expense ............................... $ 90,000 Increase in accounts receivable ........... (250,000) Decrease in inventory ............................... 500,000 Increase in prepaid expenses ................ (150,000) Decrease in accounts payable ............... (340,000) Decrease in accrued expenses payable....................................................... (100,000) (250,000) Net cash provided by operating activities ................................................. $1,400,000 17-24 *PROBLEM 17-4A ELBERT COMPANY Partial Statement of Cash Flows For the Year Ended November 30, 2008 Cash flows from operating activities Cash receipts from customers........... Less cash payments: To suppliers..................................... For operating expenses............... Net cash provided by operating activities ................................................ $7,450,000 (1) $4,740,000 (2) 1,310,000 (3) 6,050,000 $1,400,000 Computations: (1) Cash receipts from customers Sales.............................................................................. Deduct: Increase in accounts receivable ........ Cash receipts from customers............................. $7,700,000 (250,000) $7,450,000 (2) Cash payments to suppliers Cost of goods sold................................................... Deduct: Decrease in inventories ........................ Cost of purchases .................................................... Add: Decrease in accounts payable ................. Cash payments to suppliers ................................. $4,900,000 (500,000) 4,400,000 340,000 $4,740,000 (3) Cash payments for operating expenses Operating expenses, exclusive of depreciation .................................... Add: Increase in prepaid expenses...................................... Decrease in accrued expenses payable ..................... Cash payments for operating expenses............................................... *$450,000 + ($700,000 – $90,000) 17-25 $1,060,000* $150,000 100,000 250,000 $1,310,000 PROBLEM 17-5A GRANIA COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income...................................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense ........................................ $ 60,000 Loss on sale of equipment............................... 16,000 Increase in accounts receivable..................... (15,000) Increase in accounts payable ......................... 13,000 Increase in income taxes payable ................. 4,000 Net cash provided by operating activities....... 17-26 $230,000 78,000 $308,000 *PROBLEM 17-6A GRANIA COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Cash receipts from customers............ Less cash payments: For operating expenses................ For income taxes ............................ Net cash provided by operating activities ................................................. $955,000 (1) $611,000 (2) 36,000 (3) (1) Computation of cash receipts from customers Revenues.............................................................................. Deduct: Increase in accounts receivable .................. ($75,000 – $60,000) Cash receipts from customers...................................... (2) Computation of cash payments for operating expenses Operating expenses per income statement.............. Deduct: Increase in accounts payable ....................... ($41,000 – $28,000) Cash payments for operating expenses.................... (3) Computation of cash payments for income taxes Income tax expense per income statement.............. Deduct: Increase in income taxes payable ............... ($11,000 – $7,000) Cash payments for income taxes................................. 17-27 647,000 $308,000 $970,000 (15,000) $955,000 $624,000 (13,000) $611,000 $ 40,000 (4,000) $ 36,000 PROBLEM 17-7A (a) WELLER COMPANY Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income..................................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense ....................................... Increase in accounts receivable.................... Increase in merchandise inventory.............. Increase in accounts payable ........................ Decrease in income taxes payable............... Net cash provided by operating activities ..... $32,000 $ 14,500* (19,000) (7,000) 14,000 (1,000) Cash flows from investing activities Sale of equipment ....................................................... Cash flows from financing activities Issuance of common stock...................................... Payment of dividends ................................................ Redemption of bonds ................................................ Net cash used by financing activities ............. Net increase in cash............................................................ Cash at beginning of period ............................................. Cash at end of period ......................................................... 1,500 33,500 8,500 4,000 (25,000) (6,000) (27,000) 15,000 20,000 $35,000 *$29,000 – ($24,000 – $9,500(A)) = $14,500 (A) $18,000 (cost of equipment) – $8,500 (book value) = $9,500 (accumulated depreciation for equipment sold) (b) $33,500 – $0 – $25,000 = $8,500 17-28 *PROBLEM 17-8A (a) WELLER COMPANY Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Cash receipts from customers........ Less cash payments: To suppliers.................................. For operating expenses............ For interest.................................... For income taxes ........................ Net cash provided by operating activities ................ $223,000 (1) $168,000 (2) 9,500 (3) 3,000 9,000 (4) 33,500 Cash flows from investing activities Sale of equipment................................ Cash flows from financing activities Issuance of common stock .............. Payment of dividends......................... Redemption of bonds......................... Net cash used by financing activities .................................... 189,500 8,500 4,000 (25,000) (6,000 ) Net decrease in cash ................................... Cash at beginning of period ..................... Cash at end of period.................................. (27,000) 15,000 20,000 $ 35,000 Computations: (1) Cash receipts from customers Sales .................................................................................... Deduct: Increase in accounts receivable ................ Cash receipts from customers............................................. 17-29 $242,000 (19,000) $223,000 *PROBLEM 17-8A (Continued) (2) Cash payments to suppliers Cost of goods sold ................................................................ Add: Increase in inventory................................................. Cost of purchases.................................................................. Deduct: Increase in accounts payable........................... Cash payments to suppliers............................................... (3) Cash payments for operating expenses Operating expenses .............................................................. Deduct: Depreciation ........................................................... $29,000 – ($24,000 – $9,500*) Cash payments for operating expenses......................... $175,000 7,000 182,000 14,000 $168,000 $ 24,000 14,500 $ 9,500 $ 8,000 1,000 9,000 *$18,000 – $8,500 = $9,500 (4) Cash payments for income taxes Income tax expense............................................................... Add: Decrease in income taxes payable ........................ Cash payments for income taxes ..................................... (b) $33,500 – $0 – $25,000 = $8,500 17-30 $ PROBLEM 17-9A ARMA INC. Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income.................................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense....................................... Loss on sale of plant assets .......................... Increase in accounts receivable................... Increase in inventory........................................ Increase in prepaid expenses........................ Increase in accounts payable........................ Decrease in accrued expenses payable ....... Net cash provided by operating activities...... $158,900 $ 46,500 7,500 (59,800) (9,650) (2,400) 44,700 (500) Cash flows from investing activities Sale of plant assets.................................................... Purchase of plant assets ......................................... Purchase of investments ......................................... Net cash used by investing activities............. 1,500 (85,000) (24,000) Cash flows from financing activities Sale of common stock .............................................. Payment of cash dividends..................................... Redemption of bonds................................................ Net cash used by financing activities........... 45,000 (40,350) (40,000) Net increase in cash ........................................................... Cash at beginning of period ............................................ Cash at end of period......................................................... 17-31 26,350 185,250 (107,500) (35,350) 42,400 48,400 $ 90,800 *PROBLEM 17-10A ARMA INC. Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Cash receipts from customers ................ Less cash payments: To suppliers .......................................... For operating expenses .................... For income taxes................................. For interest ............................................ Net cash provided by operating activities............................................. Cash flows from investing activities Sale of plant assets ..................................... Purchase of plant assets ........................... Purchase of investments........................... Net cash used by investing activities............................................. Cash flows from financing activities Sale of common stock................................ Payment of cash dividends ...................... Redemption of bonds ................................. Net cash used by financing activities............................................. $332,980 (1) $100,410 (2) 15,310 (3) 27,280 4,730 147,730 185,250 1,500 (85,000) (24,000) (107,500) 45,000 (40,350) (40,000) Net increase in cash............................................. Cash at beginning of period .............................. Cash at end of period .......................................... (35,350) 42,400 48,400 $ 90,800 Computations: (1) Cash receipts from customers Sales ........................................................................ Deduct: Increase in accounts receivable....... Cash receipts from customers ....................... 17-32 $392,780 (59,800) $332,980 *PROBLEM 17-10A (Continued) (2) Cash payments to suppliers Cost of goods sold................................................................... Add: Increase in inventory ................................................... Cost of purchases .................................................................... Deduct: Increase in accounts payable ............................. Cash payments to suppliers ................................................. (3) Cash payments for operating expenses Operating expenses exclusive of depreciation........................................................................ Add: Increase in prepaid expenses.................... $2,400 Decrease in accrued expenses payable ................................................................ 500 Cash payment for operating expenses .............. 17-33 $135,460 9,650 145,110 44,700 $100,410 $ 12,410 2,900 $ 15,310 PROBLEM 17-11A RAMIREZ COMPANY Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income...................................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense ........................................ Loss on sale of equipment............................... Decrease in accounts receivable................... Increase in inventory ......................................... Decrease in prepaid expenses........................ Increase in accounts payable ......................... Net cash provided by operating activities ...... $ 37,000 $42,000 4,000* 18,000 (9,450) 5,720 7,730 Cash flows from investing activities Sale of land..................................................................... Sale of equipment ........................................................ Purchase of equipment .............................................. Net cash used by investing activities........... 25,000 6,000 (95,000) Cash flows from financing activities Payment of cash dividends ...................................... Net cash used by financing activities .......... (15,000) 68,000 105,000 (64,000) (15,000) Net increase in cash............................................................. Cash at beginning of period .............................................. Cash at end of period .......................................................... 26,000 45,000 $ 71,000 Noncash investing and financing activities Conversion of bonds by issuance of common stock................................................. $ 40,000 *($6,000 – $10,000) 17-34 *PROBLEM 17-12A OPRAH COMPANY Worksheet—Statement of Cash Flows For the Year Ended December 31, 2008 Balance Sheet Accounts Reconciling Items Debit Credit Balance 12/31/07 Balance 12/31/08 Debits Cash Accounts receivable Inventories Investments Plant assets Totals Credits Accumulated depreciation—plant assets Accounts payable Accrued expenses payable Bonds payable Common stock Retained earnings Totals 47,250 57,000 102,650 87,000 205,000 498,900 (m) (a) (b) 45,450 33,800 19,250 (f) 92,000 40,000 48,280 18,830 70,000 200,000 121,790 498,900 (h) 40,200 (d) 6,730 (l) 83,400 (e) (h) 2,500 47,000 (g) (c) 49,700 9,420 (i) 30,000 (j) 50,000 (k) 132,210 Statement of Cash Flow Effects Operating activities Net income Increase in accounts receivable Increase in inventories Increase in accounts payable Decrease in accrued expenses payable Depreciation expense Gain on sale of plant assets Investing activities Sale of investments Sale of plant assets Purchase of plant assets Financing activities Sale of common stock Issuance of bonds Payment of dividends Totals Increase in cash Totals (k) 132,210 (c) 9,420 (g) 49,700 (e) (h) (j) (i) (a) (b) 33,800 19,250 (d) 6,730 (h) 8,750 (f) 92,000 2,500 15,550 50,000 30,000 (l) 610,210 610,210 17-35 83,400 564,760 (m) 45,450 610,210 92,700 90,800 121,900 84,500 250,000 639,900 49,500 57,700 12,100 100,000 250,000 170,600 639,900 PROBLEM 17-1B Transaction O Cash inflow, outflow, or no cash flow effect? No cash flow effect O No cash flow effect I F Cash outflow Cash outflow F I Cash inflow Cash outflow F Cash outflow O No cash flow effect O O No cash flow effect Cash outflow Where reported? (a) Recorded depreciation expense on the plant assets. (b) Incurred a loss on disposal of plant assets. (c) Acquired a building by paying cash. (d) Made principal repayments on a mortgage. (e) Issued common stock (f) Purchased shares of another company to be held as a long-term equity investment. (g) Paid dividends to common stockholders. (h) Sold inventory on credit. The company uses a perpetual inventory system. (i) Purchased inventory on credit. (j) Paid wages to employees. 17-36 PROBLEM 17-2B (a) Cash inflows (outflows) related to plant assets 2008: Equipment purchase Land purchase Proceeds from equipment sales ($85,000) (30,000) 6,000* *Cost of equipment sold $240,000 + $85,000 – $300,000 = $25,000 Accumulated depreciation removed from accounts for sale of equipment Accumulated depreciation— Equipment 96,000 Plug 16,000 64,000 Depreciation Expense 144,000 Cash proceeds = Cost $25,000 – accumulated depreciation $16,000 – loss $3,000 = $6,000 Note to instructor—some students may find journal entries helpful in understanding this exercise. Equipment ......................................................................... Cash ........................................................................... 85,000 Land .................................................................................... Cash ........................................................................... 30,000 Cash (plug) ....................................................................... Accumulated depreciation .......................................... Loss on sale of equipment .......................................... Equipment ................................................................ 6,000 16,000 3,000 (b) Equipment purchase Land purchase Proceeds from equipment sale 85,000 30,000 25,000 Investing activities (outflow) Investing activities (outflow) Investing activities (inflow) 17-37 PROBLEM 17-3B MARQUETTE COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income.................................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense ...................................... $105,000 Amortization expense...................................... 20,000 Decrease in accounts receivable................. 520,000 Increase in inventory ....................................... (140,000) Increase in prepaid expenses ....................... (175,000) Increase in accounts payable ....................... 50,000 Increase in accrued expenses payable ......... 165,000 Net cash provided by operating activities...... 17-38 $1,040,000 545,000 $1,585,000 *PROBLEM 17-4B MARQUETTE COMPANY Partial Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Cash receipts from customers........... Less cash payments: To suppliers..................................... For operating expenses............... Net cash provided by operating activities ................................................ $5,920,000 (1) $3,380,000 (2) 955,000 (3) 4,335,000 $1,585,000 Computations: (1) Cash receipts from customers Sales.............................................................................. Add: Decrease in accounts receivable.............. Cash receipts from customers............................. $5,400,000 520,000 $5,920,000 (2) Cash payments to suppliers Cost of goods sold................................................... Add: Increase in inventories................................. Cost of purchases .................................................... Deduct: Increase in accounts payable .............. Cash payments to suppliers ................................. $3,290,000 140,000 3,430,000 (50,000) $3,380,000 (3) Cash payments for operating expenses Operating expenses...................... ($420,000 + $525,000) Add: Increase in prepaid expenses...................................... $ 175,000 Deduct: Increase in accrued expenses payable ..................... (165,000) Cash payments for operating expenses...................................... 17-39 $ 945,000 10,000 $ 955,000 PROBLEM 17-5B SHAPIRO INC. Partial Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income..................................................................... Adjustments to reconcile net income to net cash provided by operating activities Decrease in accounts receivable.................. Decrease in accounts payable....................... Increase in income taxes payable ................ Net cash provided by operating activities................................................................. 17-40 $ 98,000 $ 25,000 (21,000) 6,000 10,000 $108,000 *PROBLEM 17-6B SHAPIRO INC. Partial Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Cash receipts from customers................ Less cash payments: For operating expenses.................... For income taxes ................................ Net cash provided by operating activities ..................................................... $570,000 (1) $421,000 (2) 41,000 (3) (1) Computation of cash receipts from customers Revenues....................................................................................... Add: Decrease in accounts receivable................................ ($75,000 – $50,000) Cash receipts from customers............................................... (2) Computation of cash payments for operating expenses Operating expenses................................................................... Add: Decrease in accounts payable..................................... ($51,000 – $30,000) Cash payments for operating expenses............................. (3) Income tax expense................................................................... Deduct: Increase in income taxes payable ........................ ($10,000 – $4,000) Cash payments for income taxes.......................................... 17-41 462,000 $108,000 $545,000 25,000 $570,000 $400,000 21,000 $421,000 $ 47,000 (6,000) $ 41,000 PROBLEM 17-7B (a) MOLINA COMPANY Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income.............................................................. Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense ................................ Increase in accounts receivable............. Increase in inventory.................................. Decrease in accounts payable................ Increase in income taxes payable ......... Net cash provided by operating activities..................................................... Cash flows from investing activities Sale of equipment ............................................... Purchase of equipment ..................................... Net cash provided by investing activities.................................................... Cash flows from financing activities Issuance of bonds............................................... Payment of cash dividends.............................. Net cash used by financing activities.................................................... Net decrease in cash................................................... Cash at beginning of period ..................................... Cash at end of period ................................................. (b) $13,000 – $5,000 – $33,000 = ($25,000) 17-42 $ 38,000 $ 6,000 (9,000) (16,000) (12,000) 6,000 (25,000) 13,000 10,000 (5,000) 5,000 10,000 (33,000) (23,000) (5,000) 33,000 $ 28,000 *PROBLEM 17-8B (a) MOLINA COMPANY Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Cash receipts from customers.......... Less cash payments: To suppliers.................................... For operating expenses.............. ($37,000 – $6,000) For interest...................................... For income taxes .......................... Net cash provided by operating activities .................. Cash flows from investing activities Sale of equipment.................................. Purchase of equipment........................ Net cash provided by investing activities................... Cash flows from financing activities Issuance of bonds ................................. Payment of cash dividends................ Net cash used by financing activities ...................................... $277,000 (1) $222,000 (2) 31,000 7,000 4,000 (3) 264,000 13,000 10,000 (5,000) 5,000 10,000 (33,000) Net decrease in cash ..................................... Cash at beginning of period ....................... Cash at end of period.................................... (23,000) (5,000) 33,000 $ 28,000 Computations: (1) Cash receipts from customers Sales..................................................................................... Deduct: Increase in accounts receivable ............... Cash receipts from customers.................................... 17-43 $286,000 (9,000) $277,000 *PROBLEM 17-8B (Continued) (2) Cash payments to suppliers Cost of goods sold ................................................................ Add: Increase in inventory................................................. Cost of purchases.................................................................. Add: Decrease in accounts payable ............................... Cash payments to suppliers............................................... $194,000 16,000 210,000 12,000 $222,000 (3) Cash payments for income taxes Income tax expense............................................................... Deduct: Increase in income taxes payable................... Cash payments for income taxes ..................................... $ 10,000 (6,000) $ 4,000 (b) $13,000 – $5,000 – $33,000 = ($25,000) 17-44 PROBLEM 17-9B YAEGER COMPANY Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income.................................................................. Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense..................................... Gain on sale of plant assets......................... Increase in accounts receivable................. Increase in inventory...................................... Increase in accounts payable...................... Decrease in accrued expenses payable ........................................................... Net cash provided by operating activities ......................................................... Cash flows from investing activities Sale of investments ................................................. Sale of plant assets.................................................. Purchase of plant assets ....................................... Net cash used by investing activities ......................................................... Cash flows from financing activities Issuance of bonds.................................................... Sale of common stock ............................................ Payment of cash dividends................................... Net cash provided by financing activities ......................................................... Net increase in cash ......................................................... Cash at beginning of period .......................................... Cash at end of period....................................................... 17-45 $ 122,660 $ 35,500 (5,000) (33,800) (19,250) 14,420 (3,730) (11,860) 110,800 17,500 15,000 (141,000) (108,500) 70,000 50,000 (58,000) 62,000 64,300 33,400 $ 97,700 *PROBLEM 17-10B YAEGER COMPANY Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Cash receipts from customers ................ Less cash payments: To suppliers .......................................... For operating expenses .................... For income taxes................................. For interest ............................................ Net cash provided by operating activities............................................. Cash flows from investing activities Sale of investments..................................... Sale of plant assets ..................................... Purchase of plant assets ........................... Net cash used by investing activities............................................. Cash flows from financing activities Issuance of bonds ....................................... Sale of common stock................................ Payment of cash dividends ...................... Net cash provided by financing activities ......................... Net increase in cash............................................. Cash at beginning of period .............................. Cash at end of period .......................................... 17-46 $263,700 (1) $ 104,290 (2) 18,400 (3) 27,270 2,940 152,900 110,800 17,500 15,000 (141,000) (108,500) 70,000 50,000 (58,000) 62,000 64,300 33,400 $ 97,700 *PROBLEM 17-10B (Continued) Computations: (1) Cash receipts from customers Sales.............................................................................................. Deduct: Increase in accounts receivable ........................ Cash receipts from customers............................................. $297,500 (33,800) $263,700 (2) Cash payments to suppliers Cost of goods sold................................................................... Add: Increase in inventory ................................................... Cost of purchases .................................................................... Deduct: Increase in accounts payable ............................. Cash payments to suppliers ................................................. $ 99,460 19,250 118,710 (14,420) $104,290 (3) Cash payments for operating expenses Operating expenses................................................................. Add: Decrease in accrued expenses payable................ Cash payments for operating expenses ........................... $ 14,670 3,730 $ 18,400 17-47 PROBLEM 17-11B LEWIS COMPANY Statement of Cash Flows For the Year Ended December 31, 2008 Cash flows from operating activities Net income....................................................................... Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense ......................................... Gain on sale of equipment ................................ Increase in accounts receivable...................... Increase in inventory .......................................... Decrease in prepaid expenses......................... Increase in accounts payable .......................... Net cash provided by operating activities ....... Cash flows from investing activities Sale of land...................................................................... Sale of equipment ......................................................... Purchase of equipment ............................................... Net cash used by investing activities............ $32,890 $ 65,000 (2,000)* (13,000) (52,000) 4,400 13,000 15,400 48,290 50,000 25,000 (80,000) (5,000) Cash flows from financing activities Payment of cash dividends ....................................... (69,290) Net decrease in cash............................................................. Cash at beginning of period ............................................... Cash at end of period ........................................................... (26,000) 57,000 $31,000 Noncash investing and financing activities Conversion of bonds by issuance of stock.......... $30,000 *($25,000 – $23,000) 17-48 BYP 17-1 FINANCIAL REPORTING PROBLEM (a) Net cash provided by operating activities: 2005 2004 $5,852 million $5,054 million (b) The increase in cash and cash equivalents for the year ended December 31, 2005 was $436 million. (c) PepsiCo uses the indirect method of computing and presenting the net cash provided by operating activities. (d) The change in accounts and notes receivable required cash of $272 million in 2005. The change in inventories required cash of $132 million in 2005. The change in accounts payable (and other current liabilities) provided cash of $188 million in 2005. (e) The net cash used by investing activities in 2005 was $3,517 million. (f) The supplemental disclosure of cash flow information disclosed interest paid of $213 million and income taxes paid of $1,258 million in 2005. 17-49 BYP 17-2 (a) COMPARATIVE ANALYSIS PROBLEM $5,852 – $1,736 – $1,642 = $6,423 – $899 – $2,678 = PepsiCo $2,474 Coca-Cola $2,846 All amounts in millions (b) The companies are similar in their ability to generate cash. Both had a significant amount of “free cash” available after covering capital expenditures and cash dividends. 17-50 BYP 17-3 EXPLORING THE WEB (a) Crucial to the SEC’s effectiveness is its enforcement authority. Each year the SEC brings between 400–500 civil enforcement actions against individuals and companies that break the securities laws. Typical infractions include insider trading, accounting fraud, and providing false or misleading information about securities and the companies that issue them. (b) The main purposes of these laws can be reduced to two common-sense notions:
Companies publicly offering securities for investment dollars must tell the public the truth about their businesses, the securities they are selling, and the risks involved in investing.
People who sell and trade securities—brokers, dealers, and exchan- ges—must treat investors fairly and honestly, putting investors’ interests first. (c) President Franklin Delano Roosevelt appointed Joseph P. Kennedy, President John F. Kennedy’s father, to serve as the first Chairman of the SEC. 17-51 BYP 17-4 EXPLORING THE WEB Answers will vary depending on the company chosen by the student. 17-52 BYP 17-5 (a) DECISION MAKING ACROSS THE ORGANIZATION CARPINO COMPANY Statement of Cash Flows For the Year Ended January 31, 2008 Cash flows from operating activities Net loss ............................................................ Adjustments to reconcile net income to net cash provided by operating activities Depreciation expense......................... Gain from sale of investment........... Net cash provided by operating activities ............................................. Cash flows from investing activities Sale of investment........................................ Purchase of fixtures and equipment...... Purchase of investment.............................. Net cash used by investing activities ............................................. Cash flows from financing activities Sale of capital stock..................................... Purchase of treasury stock ....................... Net cash provided by financing activities ............................................. Net increase in cash ............................................. Cash at beginning of period .............................. Cash at end of period........................................... Noncash investing and financing activities Issuance of note for truck.......................... 17-53 $ (30,000)* $ 55,000 (5,000) 50,000 20,000 80,000 (330,000) (75,000) (325,000)* 420,000 (10,000) 410,000 105,000 140,000 $245,000 $ 20,000 BYP 17-5 (Continued) *Computation of net income (loss) Sales of merchandise .................................... Interest revenue............................................... Gain on sale of investment .......................... ($80,000 – $75,000) Total revenues and gains .................... Merchandise purchased ............................... Operating expenses ....................................... ($160,000 – $55,000) Depreciation...................................................... Interest expense .............................................. Total expenses ........................................ Net loss............................................................... $380,000 6,000 5,000 391,000 $258,000 105,000 55,000 3,000 421,000 $ (30,000) (b) From the information given, it appears that from an operating standpoint, Carpino Company did not have a superb first year, having suffered a $30,000 net loss. Lisa is correct; the statement of cash flows is not prepared in correct form. The sources and uses format is no longer the acceptable form. The correct format classifies cash flows from three activities—operating, investing, and financing; and it also presents significant noncash investing and financing activities in a separate schedule. Lisa is wrong, however, about the actual increase in cash not being $105,000; $105,000 is the correct increase in cash. 17-54 BYP 17-6 COMMUNICATION ACTIVITY MEMO To: Kyle Benson From: Student Re: Statement of cash flows The statement of cash flows provides information about the cash receipts and cash payments of a firm, classified as operating, investing, and financing activities. The operating activities section of the company’s statement of cash flows shows that cash increased by $172,000 as a result of transactions which affected net income. This amount is computed by adjusting net income for those items which affect net income, but do not affect cash, such as sales on account which remain uncollected at year-end. The investing activities section of the statement reports cash flows resulting from changes in investments and other long-term assets. The company had a cash outflow from investing activities due to purchases of buildings and equipment. The financing activities section of the statement reports cash flows resulting from changes in long-term liabilities and stockholders’ equity. The company had a cash inflow from financing activities due to the issuance of common stock and an outflow due to the payment of cash dividends. If you have any further questions, please do not hesitate to contact me. 17-55 BYP 17-7 ETHICS CASE (a) The stakeholders in this situation are: Willie Morton, president of Tappit Corporation. Robert Jennings, controller. The Board of Directors. The stockholders of Tappit Corporation. (b) The president’s statement, “We must get that amount above $1 million,” puts undue pressure on the controller. This statement along with his statement, “I know you won’t let me down, Robert,” encourages Robert to do something unethical. Controller Robert Jennings’ reclassification (intentional misclassification) of a cash inflow from a long-term note (financing activity) issuance to an “increase in payables” (operating activity) is inappropriate and unethical. (c) It is unlikely that any board members (other than board members who are also officers of the company) would discover the misclassification. Board members generally do not have detailed enough knowledge of their company’s transactions to detect this misstatement. It is possible that an officer of the bank that made the loan would detect the misclassification upon close reading of Tappit Corporation’s statement of cash flows. It is also possible that close scrutiny of the balance sheet showing an increase in notes payable (long-term debt) would reveal that there is no comparable financing activity item (proceeds from note payable) in the statement of cash flows. 17-56 BYP 17-8 ALL ABOUT YOU ACTIVITY (a) The article describes three factors that determine how much money you should set aside. (1) Your willingness to take risk. You need to evaluate how willing you are to experience wide swings in your financial position. (2) Your needs. Your need to carefully evaluate your situation and evaluate the possibility of various events and what the financial implications would be. This is also impacted by the number of dependents you have. (3) Your upcoming expenses. Here you need to look further out into the horizon and consider the implications of larger events such as a big trip, a wedding, or education costs. (b) They recommend having at least three months of living expenses set aside, and up to six months. (c) Responses to this question will vary. What is most important is that students begin the process of considering their cash needs and developing a plan to set aside enough money to provide a cushion in the event of a financial “hiccup.” 17-57 CHAPTER 18 Financial Statement Analysis ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises 1. Discuss the need for comparative analysis. 1, 2, 3, 5 1 2. Identify the tools of financial statement analysis. 2, 3, 5, 6 2 3. Explain and apply horizontal analysis. 3, 4, 5 2, 3, 5, 6, 7 1, 3, 4 4. Describe and apply vertical analysis. 3, 4, 5 2, 4, 8 2, 3, 4 5. Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. 5, 6, 7, 8, 9, 2, 9, 10, 11, 5, 6, 7, 8, 10, 11,12, 13, 12, 13 9, 10, 11 14, 15, 16, 17, 18, 19 1, 2, 3, 4, 5, 6, 7 6. Understand the concept of earning power, and how irregular items are presented. 20, 21, 22, 23 8, 9 7. Understand the concept of quality of earnings. 24 18-1 14, 15 Exercises 12, 13 Problems 1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1 Prepare vertical analysis and comment on profitability. Simple 20–30 2 Compute ratios from balance sheet and income statement. Simple 20–30 3 Perform ratio analysis, and evaluate financial position and operating results. Simple 20–30 4 Compute ratios, and comment on overall liquidity and profitability. Moderate 30–40 5 Compute selected ratios, and compare liquidity, profitability, and solvency for two companies. Moderate 50–60 6 Compute numerous ratios. Simple 30–40 7 Compute missing information given a set of ratios. Complex 30–40 8 Prepare income statement with discontinued operations and extraordinary loss. Moderate 30–40 9 Prepare income statement with nontypical items. Moderate 30–40 18-2 Study Objective Knowledge 1. Discuss the need for comparative analysis. Comprehension Q18-1 Q18-2 Q18-3 Q18-5 BE18-1 Q18-5 Application Analysis Synthesis Evaluation BE18-2 18-3 2. Identify the tools of financial statement analysis. Q18-6 BE18-2 Q18-2 Q18-3 3. Explain and apply horizontal analysis. BE18-2 Q18-3 Q18-5 Q18-4 BE18-2 BE18-3 BE18-5 BE18-6 BE18-7 E18-1 E18-3 E18-4 4. Describe and apply vertical analysis. BE18-2 Q18-3 Q18-5 Q18-4 BE18-2 BE18-4 BE18-8 E18-2 E18-3 E18-4 P18-1 5. Identify and compute ratios used in analyzing a firm’s liquidity, profitability, and solvency. Q18-6 Q18-8 BE18-2 Q18-5 Q18-7 Q18-9 Q18-10 Q18-11 Q18-12 Q18-13 Q18-14 Q18-15 Q18-16 Q18-17 Q18-18 Q18-19 BE18-2 BE18-9 BE18-10 E18-6 E18-7 E18-8 E18-9 E18-10 P18-2 P18-3 P18-6 BE18-11 BE18-12 BE18-13 E18-5 E18-11 P18-1 6. Understand the concept of earning power, and how irregular items are presented. Q18-20 Q18-21 Q18-22 Q18-23 BE18-14 BE18-15 E18-12 E18-13 P18-8 P18-9 7. Understand the concept of quality of earnings. Q18-24 Broadening Your Perspective Communication Decision Making Across the Organization P18-2 P18-3 P18-4 P18-5 P18-7 Financial Reporting Comp. Analysis Exploring the Web Comp. Analysis Financial Reporting Decision Making Across the Organization Ethics Case All About You BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. (a) Juan is not correct. There are three characteristics: liquidity, profitability, and solvency. (b) The three parties are not primarily interested in the same characteristics of a company. Short-term creditors are primarily interested in the liquidity of the enterprise. In contrast, long-term creditors and stockholders are primarily interested in the profitability and solvency of the company. 2. (a) 3. Horizontal analysis (also called trend analysis) measures the dollar and percentage increase or decrease of an item over a period of time. In this approach, the amount of the item on one statement is compared with the amount of that same item on one or more earlier statements. Vertical analysis expresses each item within a financial statement in terms of a percent of a base amount. 4. (a) $360,000 X 1.245 = $448,200, 2009 net income. (b) $360,000 ÷ .06 = $6,000,000, 2008 revenue. 5. A ratio expresses the mathematical relationship between one quantity and another. The relationship is expressed in terms of either a percentage (200%), a rate (2 times), or a simple proportion (2:1). Ratios can provide clues to underlying conditions that may not be apparent from individual financial statement components. The ratio is more meaningful when compared to the same ratio in earlier periods or to competitors’ ratios or to industry ratios. 6. (a) Liquidity ratios: Current ratio, acid-test ratio, receivables turnover, and inventory turnover. (b) Solvency ratios: Debt to total assets and times interest earned. 7. Cindy is correct. A single ratio by itself may not be very meaningful and is best interpreted by comparison with: (1) past ratios of the same company, (2) ratios of other companies, or (3) industry norms or predetermined standards. In addition, other ratios of the enterprise are necessary to determine overall financial well-being. 8. (a) Liquidity ratios measure the short-term ability of the enterprise to pay its maturing obligations and to meet unexpected needs for cash. (b) Profitability ratios measure the income or operating success of a company for a given period of time. (c) Solvency ratios measure the ability of the company to survive over a long period of time. Comparison of financial information can be made on an intracompany basis, an intercompany basis, and an industry average basis (or norms). (1) An intracompany basis compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years. (2) The industry averages basis compares an item or financial relationship of a company with industry averages (or norms) published by financial rating services. (3) An intercompany basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies. (b) The intracompany basis of comparison is useful in detecting changes in financial relationships and significant trends within a company. The industry averages basis provides information as to a company’s relative performance within the industry. The intercompany basis of comparison provides insight into a company’s competitive position. 18-4 Questions Chapter 18 (Continued) 9. The current ratio relates current assets to current liabilities. The acid-test ratio relates cash, short-term investments, and net receivables to current liabilities. The current ratio includes inventory and prepaid expenses while the acid-test ratio excludes these. The acid-test ratio provides additional information about short-term liquidity and is an important complement to the current ratio. 10. Donte Company does not necessarily have a problem. The receivables turnover ratio can be misleading in that some companies encourage credit and revolving charge sales and slow collections in order to earn a healthy return on the outstanding receivables in the form of high rates of interest. 11. (a) Asset turnover. (b) Inventory turnover. (c) Return on common stockholders’ equity. (d) Times interest earned. 12. The price earnings (P/E) ratio is a reflection of investors’ assessments of a company’s future earnings. In this question, investors favor Microsoft because it has the higher P/E ratio. The investors feel that Microsoft will be able to generate even higher future earnings and so the investors are willing to pay more for the stock. 13. The payout ratio is cash dividends paid divided by net income. In a growth company, the payout ratio is often low because the company is reinvesting earnings in the business. 14. (a) The increase in profit margin is good news because it means that a greater percentage of net sales is going towards income. (b) The decrease in inventory turnover signals bad news because it is taking the company longer to sell the inventory and consequently there is a greater chance of inventory obsolescence. (c) An increase in the current ratio signals good news because the company improved its ability to meet maturing short-term obligations. (d) The earnings per share ratio is a deceptive ratio. The decrease might be bad news to the company because it could mean a decrease in net income. If there is an increase in stockholders’ investment (as a result of issuing additional shares) and a decrease in EPS, then this means that the additional investment is earning a lower return (as compared to the return on common equity before the additional investment). Generally, this is undesirable. (e) The increase in the price-earnings ratio is generally good news because it means that the market price per share of stock has increased and investors are willing to pay that higher price for the stock. An increase in the P/E ratio is good news for investors who own the stock and don’t want to buy any more. It is bad news for investors who want to buy (or buy more of) the stock. (f) The increase in the debt to total assets ratio is bad news because it means that the company has increased its obligations to creditors and has lowered its equity “buffer.” (g) The decrease in the times interest earned ratio is bad news because it means that the company’s ability to meet interest payments as they come due has weakened. 18-5 Questions Chapter 18 (Continued) Net Income Return on assets = Average Assets (7.6%) 15. Net Income – Preferred Dividends Return on common stockholders’ equity = Average Common Stockholde rs' Equity (12.8%) The difference between the two rates can be explained by looking at the denominator value and by remembering the basic accounting equation, A = L + SE. The asset value will clearly be the larger of the two denominator values; therefore, it will also give the smaller return. 16. (a) 17. Earnings per share means earnings per share of common stock. Preferred stock dividends are subtracted from net income in computing EPS in order to obtain income available to common stockholders. 18. (a) Trading on the equity means that the company has borrowed money at a lower rate of interest than it is able to earn by using the borrowed money. Simply stated, it is using money supplied by nonowners to increase the return to the owners. (b) A comparison of the return on total assets with the rate of interest paid for borrowed money indicates the profitability of trading on the equity. 19. The times interest earned ratio, which is an indication of the company’s ability to meet interest payments, and the debt to total assets ratio, which indicates the company’s ability to withstand losses without impairing the interests of creditors. (b) The current ratio and the acid-test ratio, which indicate a company’s liquidity and short-term debt-paying ability. (c) The earnings per share and the return on stockholders’ equity, both of which indicate the earning power of the investment. Net income – Preferred dividends = Earnings per share Weighted average common shares outstandin g $160,000 – $40,000 50,000 = $2.40 EPS of $2.40 is high relative to what? Is it high relative to last year’s EPS? The president may be comparing the EPS of $2.40 to the market price of the company’s stock. 20. Discontinued operations refers to the disposal of a significant component of the business such as the stopping of an entire activity or eliminating a major class of customers. It is important to report discontinued operations separately from continuing operations because the discontinued component will not affect future income statements. 21. EPS on income before extraordinary items usually is more relevant to an investment decision than EPS on net income. Income before extraordinary items represents the results of continuing and ordinary business activity. It is therefore a better basis for predicting future operating results than an EPS figure which includes the effect of extraordinary items that are not expected to recur again in the foreseeable future. 18-6 Questions Chapter 18 (Continued) 22. Extraordinary items are events and transactions that are unusual in nature and infrequent in occurrence. Therefore, an extraordinary item is a one-time item which is not typical of the company’s operations. When comparing EPS trends, extraordinary items should be omitted since they are not reflective of normal operations. In this example, the trend is unfavorable because EPS, exclusive of extraordinary items, has decreased from $3.20 to $2.99 23. Items (a), (d), and (g) are extraordinary items. 24. (1) Use of alternative accounting methods. Variations among companies in the application of generally accepted accounting principles may hamper comparability. (2) Use of pro forma income measures that do not follow GAAP. Pro forma income is calculated by excluding items that the company believes are unusual or nonrecurring. It is often difficult to determine what was included and excluded. (3) Improper revenue and expense recognition. Many high-profile cases of inappropriate accounting involve recording items in the wrong period. 18-7 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 18-1 Dear Uncle Frank, It was so good to hear from you! I hope you and Aunt Irene are still enjoying your new house. You asked some interesting questions. They relate very well to the material that we are studying now in my financial accounting class. You said you heard that different users of financial statements are interested in different characteristics of companies. This is true. A short-term creditor, such as a bank, is interested in the company’s liquidity, or ability to pay obligations as they become due. The liquidity of a borrower is extremely important in evaluating the safety of a loan. A long-term creditor, such as a bondholder, would be interested in solvency, the company’s ability to survive over a long period of time. A long-term creditor would also be interested in profitability. They are interested in the likelihood that the company will survive over the life of the debt and be able to meet interest payments. Stockholders are also interested in profitability, and in the solvency of the company. They want to assess the likelihood of dividends and the growth potential of the stock. It is important to compare different financial statement elements to other items. The amount of a financial statement element such as cash does not have much meaning unless it is compared to something else. Comparisons can be done on an intracompany basis. This basis compares an item or financial relationship within a company for the current year to one or more previous years. Intracompany comparisons are useful in detecting changes in financial relationships and significant trends. Comparisons can also be done with industry averages. This basis compares an item or financial relationship with industry averages or norms. Comparisons with industry averages provide information as to a company’s relative performance within the industry. Finally, comparisons can be done on an intercompany basis. This basis compares an item or financial relationship with the same item or relationship in one or more competing companies. Intercompany comparisons are useful in determining a company’s competitive position. I hope this answers your questions. If it does not, or you have more questions, please write me again or call. We could even meet for lunch sometime; it would be great to see you! Love, Your niece (or nephew) 18-8 BRIEF EXERCISE 18-2 (a) The three tools of financial statement analysis are horizontal analysis, vertical analysis, and ratio analysis. Horizontal analysis evaluates a series of financial statement data over a period of time. Vertical analysis evaluates financial statement data by expressing each item in a financial statement as a percent of a base amount. Ratio analysis expresses the relationship among selected items of financial statement data. (b) Horizontal Analysis Current assets 2007 100% 2008 115% 2009 120% (115 = $230,000/$200,000; 120 = $240,000/$200,000) Vertical Analysis Current assets* 2007 40% 2008 38% 2009 39% *as a percentage of total assets (40% = $200,000/$500,000; 38% = $230,000/$600,000; 39% = $240,000/$620,000) Ratio Analysis Current ratio 2007 1.25 2008 1.37 2009 1.30 (1.25 = $200,000/$160,000; 1.37 = $230,000/$168,000; 1.30 = $240,000/$184,000) BRIEF EXERCISE 18-3 Horizontal analysis: Increase or (Decrease) Dec. 31, 2009 Dec. 31, 2008 Accounts receivable Inventory Total assets 120,000 = .30 400,000 $ 520,000 $ 840,000 $3,000,000 $ 400,000 $ 600,000 $2,500,000 Amount Percentage $120,000 $240,000 $500,000 30% 40% 20% 500,000 = .20 2,500,000 240,000 = .40 600,000 18-9 BRIEF EXERCISE 18-4 Vertical analysis: Dec. 31, 2009 Amount Percentage* Accounts receivable Inventory Total assets 17.3% 28.0% 100% $ 520,000 $ 840,000 $3,000,000 * 520,000 = .173 3,000,000 ** 400,000 = .16 2,500,000 * 840,000 = .28 3,000,000 ** 600,000 = .24 2,500,000 Dec. 31, 2008 Amount Percentage** $ 400,000 $ 600,000 $2,500,000 BRIEF EXERCISE 18-5 Net income 2009 2008 2007 $522,000 $450,000 $500,000 Increase or (Decrease) (a) 2007–2008 (b) 2008–2009 Amount Percentage (50,000) (72,000) (10%) (16%) 50,000 = .10 500,000 72,000 = .16 450,000 BRIEF EXERCISE 18-6 Net income X .30 = 2009 2008 Increase $585,000 X 30% 585,000 – X X .30X = 585,000 – X 18-10 16.0% 24.0% 100% BRIEF EXERCISE 18-6 (Continued) 1.30X = 585,000 X = 450,000 2008 Net income = $450,000 BRIEF EXERCISE 18-7 Comparing the percentages presented results in the following conclusions: The net income for Epstein increased in 2008 because of the combination of an increase in sales and a decrease in both cost of goods sold and expenses. However, the reverse was true in 2009 as sales decreased while both cost of goods sold and expenses increased. This resulted in a decrease in net income. BRIEF EXERCISE 18-8 Sales Cost of goods sold Expenses Net income 2009 2008 2007 100.0 59.2 25.0 15.8 100.0 62.4 25.6 12.0 100.0 64.5 27.5 8.0 Net income as a percent of sales for Charles increased over the three-year period because cost of goods sold and expenses both decreased as a percent of sales every year. BRIEF EXERCISE 18-9 (a) Working capital = Current assets – Current liabilities Current assets Current liabilities Working capital $45,918,000 40,644,000 $ 5,274,000 18-11 BRIEF EXERCISE 18-9 (Continued) (b) Current ratio: Current assets $45,918,000 = Current liabilities $40,644,000 = 1.13:1 (c) Acid-test ratio: Cash + Short-term investments + Rec ceivables (net) $8,041,000 + $4,947,000 + $12,545,000 = Current liabilities $40,644,000 0 = $25,533,000 $40,644,000 = .63:1 BRIEF EXERCISE 18-10 (a) Asset turnover = = Net sales Average assets $80,000,000 $14,000,000 + $18,000,000 2 = 5 times (b) Profit margin = Net income Net sales = $11,440,000 $80,000,000 = 14.3% 18-12 BRIEF EXERCISE 18-11 (a) Receivables turnover = Net credit sales Average net receivables 2009 2008 (1) $3,960,000 = 7.4 times $535,000* *($520,000 + $550,000) ÷ 2 (2) Average collection period $3,100,000 = 6.2 times $500,000** **($480,000 + $520,000) ÷ 2 365 = 49.3 days 7.4 365 = 58.9 days 6.2 (b) Marino Company should be pleased with the effectiveness of its credit and collection policies. The company has decreased the average collection period by 9.6 days and the collection period of approximately 49 days is well within the 60 days allowed in the credit terms. BRIEF EXERCISE 18-12 (a) Inventory turnover = (1) Cost of goods sold Average inventory 2009 2008 $4,300,000 = 4.3 times  $980,000 + $1,020,000    2 $4,541,000 = 4.9 times  $860,000 + $980,000    2 Beginning inventory Purchases Goods available for sale Ending inventory Cost of goods sold $ 980,000 4,340,000 5,320,000 1,020,000 $4,300,000 (2) Days in inventory 365 = 84.9 days 4.3 365 = 74.5 days 4.9 18-13 $ 860,000 4,661,000 5,521,000 980,000 $4,541,000 BRIEF EXERCISE 18-12 (Continued) (b) Management should be concerned with the fact that inventory is moving slower in 2009 than it did in 2008. The decrease in the turnover could be because of poor pricing decisions or because the company is stuck with obsolete inventory. BRIEF EXERCISE 18-13 Payout ratio = Cash dividends Net income .20 = X $66,000 X = $66,000 (.20) = $13,200 Cash dividends = $13,200 Return on assets= Net income Average assets .15 = $66,000 X .15X = $66,000 X= $66,000 .15 X = $440,000 Average assets = $440,000 18-14 BRIEF EXERCISE 18-14 MING CORPORATION Partial Income Statement Income before income taxes........................................................... Income tax expense ($400,000 X 30%)......................................... Income before extraordinary item................................................. Extraordinary loss from flood, net of $21,000 tax savings ($70,000 X 30%)................................................... Net income ............................................................................................ $400,000 120,000 280,000 49,000 $231,000 BRIEF EXERCISE 18-15 REEVES CORPORATION Partial Income Statement Loss from operations of Mexico facility, net of $90,000 tax saving ($300,000 X 30%).............. $210,000 Loss on disposal of Mexico facility, net of $36,000 tax saving ($120,000 X 30%)................... 84,000 $294,000 18-15 SOLUTIONS TO EXERCISES EXERCISE 18-1 BLEVINS INC. Condensed Balance Sheets December 31 Increase or (Decrease) Assets Current assets Plant assets (net) Total assets 2009 2008 Amount Percentage $125,000 396,000 $521,000 $100,000 330,000 $430,000 ($25,000 ( 66,000 91,000 (25.0%) (20.0%) (21.2%) $ 91,000 133,000 224,000 $ 70,000 95,000 165,000 ($21,000) ( 38,000) ( 59,000) (30.0%) (40.0%) (35.8%) 161,000 136,000 115,000 150,000 ( 46,000 (14,000) (40.0%) (9.3%) 297,000 265,000 ( 32,000) ( 12.1%) $521,000 $430,000 ($91,000) 21.2% Liabilities Current liabilities Long-term liabilities Total liabilities Stockholders’ Equity Common stock, $1 par Retained earnings Total stockholders’ equity Total liabilities and stockholders’ equity 18-16 EXERCISE 18-2 GALLUP CORPORATION Condensed Income Statements For the Years Ended December 31 2009 Amount Percent Sales Cost of goods sold Gross profit Selling expenses Administrative expenses Total operating expenses Income before income taxes Income tax expense Net income $750,000 465,000 285,000 120,000 60,000 180,000 105,000 33,000 $ 72,000 2008 Amount Percent 100.0% 62.0% 38.0% 16.0% 8.0% 24.0% 14.0% 4.4% 9.6% $600,000 390,000 210,000 72,000 54,000 126,000 84,000 24,000 $ 60,000 100.0% 65.0% 35.0% 12.0% 9.0% 21.0% 14.0% 4.0% 10.0% EXERCISE 18-3 (a) CONARD CORPORATION Condensed Balance Sheets December 31 Assets Current assets Property, plant & equipment (net) Intangibles Total assets Percentage Change from 2008 2009 2008 Increase (Decrease) $ 74,000 $ 80,000 $ (6,000) (7.5%) 90,000 99,000 40,000 27,000 $200,000 $210,000 ( 9,000) (13,000) $(10,000) (10.0%) (32.5%) (4.8%) 18-17 EXERCISE 18-3 (Continued) CONARD CORPORATION Condensed Balance Sheets (Continued) December 31 2009 2008 Liabilities and stockholders’ equity Current liabilities $ 42,000 $ 48,000 Long-term liabilities 143,000 150,000 Stockholders’ 12,000 15,000 equity Total liabilities and stockholders’ $200,000 $210,000 equity (b) Percentage Increase Change (Decrease) from 2008 $ (6,000) (12.5%) (7,000) (4.7%) 3,000) (25.0%) $(10,000) (4.8%) CONARD CORPORATION Condensed Balance Sheet December 31, 2009 Amount Percent Assets Current assets Property, plant, and equipment (net) Intangibles Total assets $ 74,000 99,000 27,000 $200,000 37.0% 49.5% 13.5% 100.0% Liabilities and stockholders’ equity Current liabilities Long-term liabilities Stockholders’ equity Total liabilities and stockholders’ equity $ 42,000 143,000 15,000 $200,000 21.0% 71.5% 7.5% 100.0% 18-18 EXERCISE 18-4 (a) HENDI CORPORATION Condensed Income Statements For the Years Ended December 31 Increase or (Decrease) During 2008 Net sales Cost of goods sold Gross profit Operating expenses Net income (b) 2009 2008 Amount $600,000 483,000 117,000 57,200 $ 59,800 $500,000 420,000 80,000 44,000 $ 36,000 $100,000 63,000 37,000 13,200 $ 23,800 Percentage 20.0% 15.0% 46.3% 30.0% 66.1% HENDI CORPORATION Condensed Income Statements For the Years Ended December 31 2009 Net sales Cost of goods sold Gross profit Operating expenses Net income Amount Percent 2008 Amount Percent $600,000 483,000 117,000 57,200 $ 59,800 100.0% 80.5% 19.5% 9.5% 10.0% $500,000 420,000 80,000 44,000 $ 36,000 EXERCISE 18-5 (a) Current ratio = 1.9:1 ($2,572 ÷ $1,341) Acid-test ratio = .75:1 ($1,007 ÷ $1,341) Receivables turnover = 10.9 times ($7,131 ÷ $656.5)* Inventory turnover = 5.0 times ($4,559 ÷ $909.5)** *($646 + $667) ÷ 2 **(917 + 902) ÷ 2 18-19 100.0% 84.0% 16.0% 8.8% 7.2% EXERCISE 18-5 (Continued) (b) Ratio Current Acid-test Receivables turnover Inventory turnover Nordstrom J.C. Penney Industry 1.9:1 .75:1 10.9 5.0 5.7:1 1.2:1 69.0 3.6 1.3:1 .3:1 10.8 6.7 Nordstrom is below J.C. Penney for the current and acid-test ratios and the receivables turnover. Nordstrom is better than J.C. Penney for inventory turnover. Nordstrom is better than the industry average for the current and acid test ratios and the receivables turnover, but below the industry average for the inventory turnover ratio. EXERCISE 18-6 (a) Current ratio as of February 1, 2008 = 2.6:1 ($130,000 ÷ $50,000). Feb. 3 7 11 14 18 2.6:1 2.0:1 2.0:1 2.4:1 2.1:1 No change in total current assets or liabilities. ($102,000 ÷ $50,000). No change in total current assets or liabilities. ($90,000 ÷ $38,000). ($90,000 ÷ $43,000). (b) Acid-test ratio as of February 1, 2008 = 2.3:1 ($113,000* ÷ $50,000). *$130,000 – $15,000 – $2,000 Feb. 3 7 11 14 18 2.3:1 1.7:1 1.6:1 1.8:1 1.6:1 No change in total quick assets or current liabilities. ($85,000 ÷ $50,000). ($82,000 ÷ $50,000). ($70,000 ÷ $38,000). ($70,000 ÷ $43,000). 18-20 EXERCISE 18-7 (a) $145,000 = 2.9:1. $50,000 (b) $85,000 = 1.7:1. $50,000 (c) $390,000 = 6.0 times. $65,000 (1) (d) $198,000 = 3.6 times. $55,000 (2) (1) $70,000 + $60,000 2 (2) $60,000 + $50,000 2 EXERCISE 18-8 $50,000 = 6.6%. $760,000 (a) Profit margin $760,000 = 1.4 times.  $500,000 + $580,000    2   (b) Asset turnover $50,000 = 9.3%. $540,000 (c) Return on assets (d) Return on common stockholders’ equity 18-21 $50,000 = 13.2%.  $325,000 + $430,000    2   EXERCISE 18-9 (a) $65,000 – $5,000 = $2.00. 30,000 shares (b) $13.00 = 6.5 times. $2.00 (c) $26,000 = 40%. $65,000 (d) $65,000 + $16,000 + $24,000 $105,000 = = 6.6 times. $16,000 $16,000 EXERCISE 18-10 (a) Inventory turnover = 3.5 = Cost of goods sold  $200,000 + $180,000    2   3.5 X $190,000 = Cost of goods sold Cost of goods sold = $665,000. (b) Receivables turnover = 8.8 = Net sales (credit)  $72,500 + $126,000    2   8.8 X $99,250 = Net sales (credit) = $873,400. (c) Return on common stockholders’ equity = 24% = Net income  $400,000 + $113,500 + $400,000 + $101,000 0   2   .24 X $507,250 = Net income = $121,740. 18-22 EXERCISE 18-10 (Continued) (d) Return on assets = 20% = Average assets = $121,740 [see (c) above] Average assets $121,740 = $608,700 .20 Total assets (Dec. 31, 2009) + $605,000 = $608,700 2 Total assets (Dec. 31, 2009) = ($608,700 X 2) – $605,000 = $612,400. EXERCISE 18-11 (a) ($4,300 + $21,200+ $10,000)/$12,370 = 2.87 (b) ($4,300 + $21,200)/$12,370 = 2.06 (c) $100,000/[($21,200 + $23,400)/2] = 4.48 (d) $60,000/[($10,000 + $7,000)/2] = 7.06 (e) $15,000/$100,000 = 15% (f) $100,000/[($110,500 + $120,100)/2] = .87 (g) $15,000/[($110,500 + $120,100)/2] = 13% (h) $15,000/[($98,130 + $89,000)/2] = 16% (i) $12,370/$110,500 = 11.2% EXERCISE 18-12 (a) MOLINI CORPORATION Partial Income Statement For the Year Ended October 31, 2008 Income before income taxes............................................................ Income tax expense ($540,000 X 30%).......................................... Income before extraordinary item.................................................. Extraordinary loss from flood, net of $45,000 tax savings ($150,000 X 30%) ................................................. Net income ............................................................................................. 18-23 $540,000 162,000 378,000 105,000 $273,000 EXERCISE 18-12 (Continued) (b) To: Chief Accountant From: Your name, Independent Auditor After reviewing your income statement for the year ended 10/31/08, we believe it is misleading for the following reasons: The amount reported for income before extraordinary items is overstated by $45,000. The income tax expense should be 30% of $540,000, or $162,000, not $117,000. Also, the effect of the extraordinary loss on net income is only $105,000, not $150,000. An income tax savings of $45,000 should be netted against the extraordinary loss. EXERCISE 18-13 (a) YADIER CORPORATION Partial Income Statement For the Year Ended December 31, 2008 Income from continuing operations .............................................. Discontinued operations Gain on discontinued division, net of $9,000 income taxes .......................................................................... Income before extraordinary item .................................................. Extraordinary item Extraordinary loss, net of $24,000 income tax saving ......... Net income.............................................................................................. $290,000 21,000 311,000 56,000 $255,000 (b) The correction of an error in last year’s financial statements is a prior period adjustment. The correction is reported in the 2008 retained earnings statement as an adjustment that increases the reported beginning balance of retained earnings by $14,000, or [$20,000 – ($20,000 X 30%)]. 18-24 SOLUTIONS TO PROBLEMS PROBLEM 18-1 (a) Condensed Income Statement For the Year Ended December 31, 2009 Douglas Company Dollars Percent Net sales Cost of goods sold Gross profit Operating expenses Income from operations Other expenses and losses Interest expense Income before income taxes Income tax expense Net income Maulder Company Dollars Percent $1,549,035 100.0% 69.8% 1,080,490 468,545 30.2% 302,275 19.5% 166,270 10.7% $339,038 241,000 98,038 79,000 19,038 100.0% 71.1% 28.9% 23.3% 5.6% 8,980 157,290 54,500 $ 102,790 2,252 16,786 6,650 $ 10,136 .7% 4.9% 1.9% 3.0% .6% 10.1% 3.5% 6.6% (b) Douglas Company appears to be more profitable. It has higher relative gross profit, income from operations, income before taxes, and net income.  $102, 790  a Douglas’s return on assets of 12.4%  is higher than Maulder’s  $829, 848   $10,136  b . Also, Douglas’s return on common return on assets of 4.7%   $214,172   $102, 790  c is higher than Maulder’s return stockholders’ equity of 15.6%   $660, 028   $10,136  d . on stockholders’ equity of 6.6%   $154,047  18-25 PROBLEM 18-1 (Continued) a $102,790 is Douglas’s 2009 net income. $829,848 is Douglas’s 2009 average assets: Current assets Plant assets Total assets 2009 2008 $312,410 $325,975 521,310 500,000 $847,285 + $812,410 = $1,659,695 2 b $10,136 is Maulder’s 2009 net income. $214,172 is Maulder’s 2009 average assets: Current assets Plant assets Total assets 2009 2008 $ 83,336 $ 79,467 139,728 125,812 $223,064 + $205,279 = $428,343 2 c $102,790 is Douglas’s 2009 net income. $660,028 is Douglas’s 2009 average stockholders’ equity: 2009 2008 Common stock $500,000 $500,000 Retained earnings 173,460 146,595 Stockholders’ equity $673,460 + $646,595 = $1, 320, 055 2 d $10,136 is Maulder’s 2009 net income. $154,047 is Maulder’s 2009 average stockholders’ equity: 2009 2008 Common stock $120,000 $120,000 Retained earnings 38,096 29,998 Stockholders’ equity $158,096 + $149,998 = 18-26 $308,094 2 PROBLEM 18-2 (a) Earnings per share = $192,000 = $3.37. 57,000 (b) Return on common stockholders’ equity = = $192,000  $465,400 + $566,700    2   $192,000 $516,050 = 37.2%. (c) Return on assets = (d) Current ratio = $369,900 = 1.82:1 $203,500 (e) Acid-test ratio = (f) $192,000 $192,000 = = 21.1%. $911,500  $852,800 + $970,200    2   $246,900 = 1.21:1 $203,500 Receivables turnover = = $1,818,500  ($102,800 + $117,800 )    2   $1,818,500 $110,300 = 16.5 times. 18-27 PROBLEM 18-2 (Continued) (g) Inventory turnover = $1,011,500 $1,011,500 = = 8.5 times. $119,250  $115,500 + $123,000    2   (h) Times interest earned = (i) Asset turnover = $291,000 = 16.2 times. $18,000 $1,818,500 = 2.0 times. $911,500* *($852,800 + $970,200) ÷ 2 (j) Debt to total assets = $403,500 = 41.6%. $970,200 18-28 PROBLEM 18-3 (a) 2008 2009 (1) Profit margin. $30,000 $650,000 $45,000 = 4.6% $700,000 = 6.4% (2) Asset turnover. $650,000  $533,000 + $600,000    2   = 1.1 times $700,000  $600,000 + $640,000    2   = 1.1 times (3) Earnings per share. $30,000 = $.97 31,000 $45,000 = $1.41 32,000 (4) Price-earnings ratio. $5.00 = 5.2 times $.97 $8.00 = 5.7 times $1.41 (5) Payout ratio. $18,000* = 60.0% $30,000 $25,000** = 55.6% $45,000 *($113,000 + $30,000 – $125,000) **($125,000 + $45,000 – $145,000) (6) Debt to total assets. $165,000 = 27.5% $600,000 $155,000 = 24.2% $640,000 18-29 PROBLEM 18-3 (Continued) (b) The underlying profitability of the corporation appears to have improved. For example, profit margin and earnings per share have both increased. In addition, the corporation’s price-earnings ratio has increased, which suggests that investors may be looking more favorably at the corporation. Also, the corporation appears to be involved in attempting to reduce its debt burden as its debt to total assets ratio has decreased. Similarly, its payout ratio has decreased, which should help its overall solvency. 18-30 PROBLEM 18-4 (a) LIQUIDITY 2008 2009 Change Current $343,000 = 1.9:1 $182,000 $374,000 =1.9:1 $198,000 No change Acid-test $185,000 = 1.0:1 $182,000 $220,000 = 1.1:1 $198,000 Increase Receivables turnover $790,000 = 9.4 times $84,000* $850,000 = 9.6 times $89,000** Increase *($88,000 + $80,000) ÷ 2 Inventory turnover **($80,000 + $98,000) ÷ 2 $575,000 = 4.5 $126,500* times $620,000 = 4.8 $130,000** times *($118,000 + $135,000) ÷ 2 Increase **($135,000 + $125,000) ÷ 2 An overall increase in short-term liquidity has occurred. PROFITABILITY Profit margin $42,000 = 5.3% $790,000 $43,000 = 5.1% $850,000 Decrease Asset turnover $790,000 = 1.2 times $639,000 $850,000 = 1.3 times $666,000 Increase Return on assets $42,000 = 6.6% $639,000 $43,000 = 6.5% $666,000 Decrease Earnings per share $42,000 = $2.10 20,000 $43,000 = $2.15 20,000 Increase Profitability has remained relatively the same. 18-31 PROBLEM 18-4 (Continued) (b) 2009 2010 Change 1. Return on common stockholders’ equity $43,000 = 13.2% $326,000 (a) $50,000 = 11.1% $451,000 (b) Decrease 2. Debt to total assets $348,000 = 50.9% $684,000 $248,000 = 35.4% $700,000 Decrease Price-earnings ratio $9.00 = 4.2 times $2.15 $12.80 = 5.1 times $2.50 (c) Increase 3. (a) ($200,000 + $136,000 + $200,000 + $116,000) ÷ 2. (b) ($380,000 + $186,000 + $200,000 + $136,000) ÷ 2. (c) $50,000 ÷ 20,000. 18-32 PROBLEM 18-5 (a) Ratio Target Wal-Mart (All Dollars Are in Millions) (1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) Current Receivables turnover Average collection period Inventory turnover Days in inventory Profit margin Asset turnover Return on assets Return on common stockholders’ equity Debt to total assets Times interest earned 1.7:1 9.4 38.8 6.3 57.9 7.0% 1.4 10.0% ($13,922 ÷ $8,220) ($45,682 ÷ $4,845) (365 ÷ 9.4) ($31,445 ÷ $4,958) (365 ÷ 6.3) ($3,198 ÷ $45,682) ($45,682 ÷ $31,854.5a) ($3,198 ÷ $31,854.5a) 26.5% ($3,198 ÷ $12,080.5b) 59.7% ($19,264 ÷ $32,293) 8.6 ($4,914 ÷ $570) a c b d ($32,293 + $31,416) ÷ 2 ($13,029 + $11,132) ÷ 2 .9:1 192.1 1.9 7.8 46.8 3.6% 2.5 9.1% ($38,491 ÷ $42,888) ($285,222 ÷ $1,485) (365 ÷ 192.1) ($219,793 ÷ $28,030) (365 ÷ 7.8) ($10,267 ÷ $285,222) ($285,222 ÷ $112,814c) ($10,267 ÷ $112,814c) 22.1% ($10,267 ÷ $46,509.5d) 58.9% ($70,827 ÷ $120,223) 17.1 ($16,842 ÷ $986) ($120,223 + $105,405) ÷ 2 ($49,396 + $43,623) ÷ 2 (b) The comparison of the two companies shows the following: Liquidity—Target’s current ratio of 1.7:1 is significantly better than Wal-Mart’s .9:1. However, Wal-Mart has a better inventory turnover ratio than Target and its receivables turnover is substantially better than Target’s. Solvency—Wal-Mart betters Target in both of the solvency ratios. Thus, it is more solvent than Target. Profitability—With the exception of asset turnovers, Target betters Wal-Mart in all of the profitability ratios. Thus, it is more profitable than Wal-Mart. 18-33 PROBLEM 18-6 (a) Current ratio = $215,000 = 1.5:1. $145,000 (b) Acid-test ratio = $21,000 + $18,000 + $86,000 = 0.86:1. $145,000 $600,000  ($86,000 + $74,000)    2   = 7.5 times. (c) Receivables turnover = (d) Inventory turnover = (e) Profit margin ratio = (f) Asset turnover = $415,000 = 5.2 times.  $90,000 + $70,000    2   $38,400 = 6.4%. $600,000 $600,000 = 1.0 times.  $638,000 + $560,000    2   (g) Return on assets = $38,400 = 6.4%.  $638,000 + $560,000    2   $38,400  $373,000 + $350,000    2   = 10.6%. (h) Return on common stockholders’ equity = 18-34 PROBLEM 18-6 (Continued) (i) Earnings per share = $38,400 = $1.28. 30,000 (1) (1) $150,000 ÷ $5.00 (j) Price-earnings ratio = (k) Payout ratio = $19.50 = 15.2 times. $1.28 $15,400 (2) = 40.1%. $38,400 (2) $200,000 + $38,400 – $223,000 (l) Debt to total assets = $265,000 = 41.5%. $638,000 (m) Times interest earned = $64,200 (3) = 8.2 times. $7,800 (3) $38,400 + $18,000 + $7,800 18-35 PROBLEM 18-7 Receivables turnover = 10 = Average receivables = $11,000,000 Average receivables $11,000,000 = $1,100,000 10 Net receivables 12/31/09 + $950,000 = $1,100,000 2 Net receivables 12/31/09 + $950,000 = $2,200,000 Net receivables 12/31/09 = $1,250,000 Profit margin = 14.5% = .145 = Net income $11,000,000 Net income = $11,000,000 X .145 = $1,595,000 Income before income taxes = $1,595,000 + $560,000 = $2,155,000 Return on assets = 22% = .22 = $1,595,000 Average assets Average assets = $1,595,000 ÷ .22 = $7,250,000 Assets (12/31/09) + $7,000,000 = $7,250,000 2 Assets (12/31/09) = $7,500,000 Total current assets = $7,500,000 – $4,620,000 = $2,880,000 Inventory = $2,880,000 – $1,250,000 – $450,000 = $1,180,000 Total liabilities and stockholders’ equity = $7,500,000 Total liabilities = $7,500,000 – $3,400,000 = $4,100,000 18-36 PROBLEM 18-7 (Continued) Current ratio = 3.0 = $2,880,000 Current liabilities Current liabilities = $2,880,000 ÷ 3.0 = $960,000 Long-term notes payable = $4,100,000 – $960,000 = $3,140,000 Inventory turnover = 4.8 = Cost of goods sold  $1,720,000 + $1,180,000    2   Cost of goods sold = $1,450,000 X 4.8 = $6,960,000 Gross profit = $11,000,000 – $6,960,000 = $4,040,000 Income from operations = $4,040,000 – $1,665,000 = $2,375,000 Interest expense = $2,375,000 – $2,155,000 = $220,000 18-37 PROBLEM 18-8 CHEANEY CORPORATION Condensed Income Statement For the Year Ended December 31, 2008 Operating revenues ($12,850,000 – $2,000,000) ............................. Operating expenses ($8,700,000 – $2,400,000) ............................... Income from operations...................................... Other revenues and gains .................................. Income before income taxes ............................. Income tax expense ($4,650,000 X 30%) ....... Income from continuing operations ............... Discontinued operations Loss from operations of hotel chain*, net of $120,000 income tax savings................................................. Gain on sale of hotels, net of $60,000 income taxes ............................. Income before extraordinary item ................... Extraordinary item Extraordinary loss, net of $240,000 income tax saving ................................... Net income............................................................... *$2,000,000 – $2,400,000 = ($400,000) 18-38 $10,850,000 6,300,000 4,550,000 100,000 4,650,000 1,395,000 3,255,000 $280,000 140,000 140,000 3,115,000 560,000 $ 2,555,000 PROBLEM 18-9 LARUSSA CORPORATION Income Statement For the Year Ended December 31, 2008 Net sales ........................................................................ Cost of goods sold..................................................... Gross profit................................................................... Selling and administrative expenses ................... Income from operations ........................................... Other revenues and gains........................................ Other expenses and losses..................................... Income before income taxes................................... Income tax expense ($322,000 X 30%)................. Income from continuing operations..................... Discontinued operations Income from operations of discontinued division, net of $6,000 income taxes .......... Loss on sale of discontinued division, net of $27,000 income tax saving ............ Income before extraordinary item ........................ Extraordinary item Gain from expropriation, net of $36,000 income taxes................................................... Net income .................................................................... 18-39 $1,700,000 1,100,000 600,000 270,000 330,000 $20,000 28,000 8,000 322,000 96,600 225,400 14,000 63,000 49,000 176,400 84,000 $ 260,400 BYP 18-1 FINANCIAL REPORTING PROBLEM (a) PEPSICO, INC. Trend Analysis of Net Sales and Net Income For the Five Years Ended 2005 Base Period 2001—(in millions) (1) Net sales Trend (2) Net income Trend 2005 2004 2003 2002 2001 $32,562 138% $29,261 124% $26,971 115% $25,112 107% $23,512 100% 4,078 170% 4,212 176% 3,568 149% 3,000 125% 2,400 100% Between 2001 and 2003 PepsiCo’s net sales increased by 15%. Its net sales increased 20% from 2003 to 2005. PepsiCo’s net income increased by 70% between 2001 and 2005 or about 18% per annum. (b) (dollar amounts in millions) (1) Profit Margin 2005: 2004: $4,078 ÷ $32,562 = 12.5% $4,212 ÷ $29,261 = 14.4% (2) Asset Turnover 2005: 2004: $35,562 ÷ [($31,727 + $27,987) ÷ 2] = 1.19 times $29,261 ÷ [($27,987 + $25,327) ÷ 2] = 1.10 times (3) Return on Assets 2005: 2004: $4,078 ÷ [($31,727 + $27,987) ÷ 2] = 13.7% $4,212 ÷ [($27,987 + $25,327) ÷ 2] = 15.8% 18-40 BYP 18-1 (Continued) (4) Return on Common Stockholders’ Equity 2005: 2004: $4,078 ÷ [($14,320 + $13,572) ÷ 2] = 29.2% $4,212 ÷ [($13,572 + $11,896) ÷ 2] = 33.1% In general, PepsiCo’s profitability has decreased from 2004 to 2005. (c) (dollar amounts in millions) (1) Debt to Total Assets 2005: 2004: $17,476 ÷ $31,727 = 55.1% $14,464 ÷ $27,987 = 51.7% (2) Times Interest Earned 2005: 2004: ($6,382 + $256) ÷ $256 = 25.9 times ($5,546 + $167) ÷ $167 = 34.2 times Although creditors are providing more than 55% of PepsiCo’s total assets, its long-term solvency is not in jeopardy. PepsiCo has the ability to pay the interest on its debt as indicated by the times interest earned ratio of about 26 in 2005. (d) Substantial amounts of important information about a company are not in its financial statements. Events involving such things as industry changes, management changes, competitors’ actions, technological developments, governmental actions, and union activities are often critical to the successful operation of a company. Financial reports in the media and publications of financial service firms (Standard & Poors, Dun & Bradstreet) will provide relevant information not usually found in the annual report. 18-41 BYP 18-2 COMPARATIVE ANALYSIS PROBLEM (a) PepsiCo (1) (i) Percentage increase in net sales (ii) Percentage increase (decrease) in net income (2) (i) Percentage increase (decrease) in total assets (ii) Percentage increase (decrease) in total stockholders’ equity (3) Basic earnings per share Price-earnings ratio Coca-Cola Company $32,562 − $29,261 = 11.3% $29,261 $23,104 − $21,742 = 6.3% $21,742 $4,078 − $4,212 $4,212 $4,872 − $4,847 $4,847 = (3.2%) = .5% $31,727 − $27,987 = 13.4% $27,987 $29,427 − $31,441 = (6.4%) $31,441 $14,320 − $13,572 = 5.5% $13,572 $16,355 − $15,935 = 2.6% $15,935 $2.43* $2.04* $59.08 = 24.3 times $2.43 $43.60 = 21.4 times $2.04 *Given on income statement (b) PepsiCo’s net sales increased 11.3% while Coca-Cola’s increased 6.3%. PepsiCo’s net income decreased 3.2% while Coca-Cola’s net income increased .5% from 2004 to 2005. PepsiCo’s total assets increased 13.4% while Coca-Cola decreased its assets 6.4%. PepsiCo increased stockholders’ equity by 5.5% while Coca-Cola’s stockholders’ equity increased 2.6%. The absolute amounts of earnings per share, $2.43 for PepsiCo and $2.04 for Coca-Cola, are not comparable in a qualitative way since these amounts are dependent on the number of shares outstanding. PepsiCo’s net income decreased, even though their net sales increased more than Coca-Cola’s net sales. 18-42 BYP 18-3 EXPLORING THE WEB (a) Optional elements include:





Financial highlights Letter to stockholders Corporate message Report of management Board of directors and management Stockholder information (b) SEC-required elements include:



Auditors’ report Management discussion Financial statements and notes Selected financial data (c) Management discussion. This series of short, detailed reports discusses and analyzes the company’s performance. It covers results of operations, and the adequacy of liquid and capital resources to fund operations. (d) Auditors’ report. This summary of the findings of an independent firm of certified public accountants shows whether the financial statements are complete, reasonable, and prepared consistent with generally accepted accounting principles (GAAP) at a set time. (e) Selected financial data. This information summarizes a company’s financial condition and performance over five years or longer. Data for making comparisons over time may include revenue (sales), gross profit, net earnings (net income), earnings per share, dividends per share, financial ratios such as return on equity, number of shares outstanding, and the market price per share. 18-43 BYP 18-4 DECISION MAKING ACROSS THE ORGANIZATION The current ratio increase is a favorable indication as to liquidity, but alone tells little about the going-concern prospects of the client. From this ratio change alone, it is impossible to know the amount and direction of the changes in individual accounts, total current assets, and total current liabilities. Also unknown are the reasons for the changes. The acid-test ratio decrease is an unfavorable indication as to liquidity, especially when the current-ratio increase is also considered. This decline is also unfavorable as to the going-concern prospects of the client because it reflects a declining cash position and raises questions as to reasons for the increases in other current assets, such as inventories. The change in asset turnover cannot alone tell anything about either solvency or going-concern prospects. There is no way to know the amount and direction of the changes in sales and assets. An increase in sales would be favorable for going-concern prospects, while a decrease in assets could represent a number of possible scenarios and would need to be investigated further. The increase in net income is a favorable indicator for both solvency and going-concern prospects, although much depends on the quality of receivables generated from sales and how quickly they can be converted into cash. If there has been a decline in sales, a significant factor is that management has been able to reduce costs to produce an increase in earnings. Indirectly, the improved income picture may have a favorable impact on solvency and going-concern potential by enabling the client to borrow currently (if it needs to do so) to meet cash requirements. The 32-percent increase in earnings per share, which is identical to the percentage increase in net income, is an indication that there has probably been no change in the number of shares of common stock outstanding. This, in turn, indicates that financing was not obtained through the issuance of common stock. It is not possible to reach conclusions about solvency and going-concern prospects without additional information about the nature and extent of financing. 18-44 BYP 18-4 (Continued) The increase in the book value per share is a favorable indicator for both solvency and the going-concern potential of the company. The collective implications of these data alone are that the client entity is about as solvent and as viable a going concern at the end of the current year as it was at the beginning although there may be a need for short-term operating cash. 18-45 BYP 18-5 (a) DECISION MAKING ACROSS THE ORGANIZATION GENERAL DYNAMICS CORPORATION Income Statement For the Year Ended December 31, 2008 Net sales........................................................................... Cost of goods sold........................................................ Gross profit ..................................................................... Selling and administrative expenses...................... Income from operations.............................................. Other revenues and gains Interest revenue................................................... Other expenses and losses Interest expense.................................................. Income before income taxes ..................................... Income tax expense...................................................... Income from continuing operations........................ Discontinued operations Earnings from operation of Quincy Division, net of $12.5 income taxes ......... Loss from disposal of Quincy Division, net of $4.3 income tax saving .................... Net income....................................................................... Earnings per share of common stock Income from continuing operations ............. Gain from discontinued operations.............. Net income ............................................................ (In Millions of Dollars) $8,163.8 6,958.8 1,205.0 537.0 668.0 $ 3.6 13.6 654.4 282.9 371.5 17.2 15.8 5.0 10.8 $ 382.3 $ $ 8.78 .26 9.04 (b) (1) In the preceding year, Quincy had net earnings from discontinued operations of $28.8 million ($51.6 – $22.8). Therefore, the average number of common shares outstanding during the year is 47.2 million shares. This amount is found by dividing the income from discontinued operations, $28.8 million, by its earning per share amount $0.61. (2) In the preceding year, Quincy had income from continuing operations of $352.6 million (47.2 million shares X $7.47/share). 18-46 BYP 18-6 COMMUNICATION ACTIVITY To: Beth Harlan From: Accounting Major Subject: Financial Statement Analysis There are two fundamental considerations in financial statement analysis: (1) the bases of comparison and (2) the factors affecting quality of earnings. Each of these considerations is explained below. 1. 2. Bases of comparison. The bases of comparison are: a. Intracompany—This basis compares an item or financial relationship within a company in the current year with the same item or relationship in one or more prior years. b. Industry averages—This basis compares an item or financial relationship of a company with industry averages (or norms). c. Intercompany—This basis compares an item or financial relationship of one company with the same item or relationship in one or more competing companies. Factors affecting quality of earnings are: a. Alternative accounting methods—Variations among companies in the application of generally accepted accounting principles may hamper comparability and reduce quality of earnings. b. Pro forma income—This income figure usually excludes items that the company thinks are unusual or nonrecurring. c. Improper recognition—Because some managers have felt pressure from investors to continually increase earnings, they have manipulated the earnings numbers to meet these expectations. 18-47 BYP 18-7 ETHICS CASE (a) The stakeholders in this case are:





Jack McClintock, president of McClintock Industries. Jeremy Phelps, public relations director. You, as controller of McClintock Industries. Stockholders of McClintock Industries. Potential investors in McClintock Industries. Any readers of the press release. (b) The president’s press release is deceptive and incomplete and to that extent his actions are unethical. (c) As controller you should at least inform Jeremy, the public relations director, about the biased content of the release. He should be aware that the information he is about to release, while factually accurate, is deceptive and incomplete. Both the controller and the public relations director (if he agrees) have the responsibility to inform the president of the bias of the about to be released information. 18-48 BYP 18-8 ALL ABOUT YOU ACTIVITY Student responses will vary. We suggest that in class you ask for a few students to share their responses in order to increase students understanding of the various reasons why different people will choose different investment vehicles. 18-49 CHAPTER 19 Managerial Accounting ASSIGNMENT CLASSIFICATION TABLE Study Objectives Questions Brief Exercises Exercises A Problems B Problems *1. Explain the distinguishing features of managerial accounting. 1, 2, 3 1 1 *2. Identify the three broad functions of management. 4, 5, 6, 7 2, 3 *3. Define the three classes of manufacturing costs. 10, 11 4, 5, 7 2, 3, 4, 5, 6 1A, 2A 1B, 2B *4. Distinguish between product and period costs. 12 6 3, 4, 5, 7, 13 1A, 2A 1B, 2B *5. Explain the difference between a merchandising and a manufacturing income statement. 8, 13 8, 12, 13, 14, 15, 17 3A, 4A, 5A 3B, 4B, 5B *6. Indicate how cost of goods manufactured is determined. 14, 15, 16, 17 8, 10, 11 8, 9, 10, 11, 12, 13, 14, 15, 16, 17 3A, 4A, 5A 3B, 4B, 5B *7. Explain the difference between a merchandising and a manufacturing balance sheet. 9, 18 9 14, 15, 16, 17 3A, 4A 3B, 4B *8. Identify trends in managerial accounting. 19, 20, 21, 22 18 19-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Classify manufacturing costs into different categories and compute the unit cost. Simple 20–30 2A Classify manufacturing costs into different categories and compute the unit cost. Simple 20–30 3A Indicate the missing amount of different cost items, and prepare a condensed cost of goods manufactured schedule, an income statement, and a partial balance sheet. Moderate 30–40 4A Prepare a cost of goods manufactured schedule, a partial income statement, and a partial balance sheet. Moderate 30–40 5A Prepare a cost of goods manufactured schedule and a correct income statement. Moderate 30–40 1B Classify manufacturing costs into different categories and compute the unit cost. Simple 20–30 2B Classify manufacturing costs into different categories and compute the unit cost. Simple 20–30 3B Indicate the missing amount of different cost items, and prepare a condensed cost of goods manufactured schedule, an income statement, and a partial balance sheet. Moderate 30–40 4B Prepare a cost of goods manufactured schedule, a partial income statement, and a partial balance sheet. Moderate 30–40 5B Prepare a cost of goods manufactured schedule and a correct income statement. Moderate 30–40 19-2 Study Objective Knowledge Comprehension Application Analysis Explain the distinguishing features of managerial accounting. Q19-1 Q19-2 Q19-3 BE19-1 E19-1 *2. Identify the three broad functions of management. Q19-4 Q19-5 Q19-6 Q19-7 BE19-2 BE19-3 *3. Define the three classes of manufacturing costs. Q19-11 BE19-4 BE19-5 BE19-7 E19-4 E19-2 E19-5 E19-3 E19-6 P19-1A P19-2A P19-1B P19-2B *4. Distinguish between product and period costs. Q19-12 BE19-6 E19-3 E19-4 E19-5 E19-7 E19-13 P19-1A P19-2A P19-1B P19-2B *5. Explain the difference between a merchandising and a manufacturing income statement. Q19-8 Q19-13 E19-15 E19-8 E19-12 E19-13 E19-14 E19-17 P19-4A P19-4B P19-3A P19-5A P19-3B P19-5B *6. Indicate how cost of goods manufactured is determined. Q19-14 E19-15 Q19-15 Q19-16 Q19-17 BE19-8 BE19-10 BE19-11 E19-8 E19-9 E19-10 E19-11 E19-12 E19-13 E19-14 E19-8 E19-16 E19-10 E19-17 E19-11 P19-4A P19-3A P19-4B P19-5A P19-3B P19-5B *7. Q19-18 Explain the difference between a merchandising and a manufacturing balance sheet. Q19-9 E19-15 BE19-9 E19-14 E19-16 *8. Identify trends in managerial accounting. Q19-19 Q19-20 Q19-21 19-3 *1. Broadening Your Perspective Q19-10 Synthesis Evaluation E19-17 P19-3A P19-4A P19-3B P19-4B Q19-22 E19-18 Real-World Focus Decision Making Across the Organization Communication Managerial Analysis Exploring the Web Ethics Case All About You BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. (a) Disagree. Managerial accounting is a field of accounting that provides economic and financial information for managers and other internal users. (b) Mary is incorrect. Managerial accounting applies to all types of businesses—service, merchandising, and manufacturing. 2. (a) (b) (c) 3. Financial accounting is concerned primarily with external users such as stockholders, creditors, and regulators. In contrast, managerial accounting is concerned primarily with internal users such as officers and managers. Classified financial statements are the end product of financial accounting. The statements are prepared quarterly and annually. In managerial accounting, internal reports may be prepared daily, weekly, monthly, quarterly, annually, or as needed. The purpose of financial accounting is to provide general-purpose information for all users. The purpose of managerial accounting is to provide special-purpose information for a particular user for a specific decision. Differences in the content of the reports are as follows: Financial Managerial • Pertains to business as a whole and is highly aggregated. • Limited to double-entry accounting and cost data. • Generally accepted accounting principles. • Pertains to subunits of the business and may be very detailed. • May extend beyond double-entry accounting system to any relevant data. • Standard is relevance to decisions. In financial accounting, financial statements are verified annually through an independent audit by certified public accountants. There are no independent audits of internal reports issued by managerial accountants. 4. Budgets are prepared by companies to provide future direction. Because the budget is also used as an evaluation tool, some managers try to game the budgeting process by underestimating their division’s predicted performance so that it will be easier to meet their performance targets. On the other hand, if the budget is set at unattainable levels, managers sometimes take unethical actions to meet targets to receive higher compensation or in some cases to keep their jobs. 5. Karen should know that the management of an organization performs three broad functions: (1) Planning requires management to look ahead and to establish objectives. (2) Directing involves coordinating the diverse activities and human resources of a company to produce a smooth-running operation. (3) Controlling is the process of keeping the company’s activities on track. 6. Disagree. Decision making is not a separate management function. Rather, decision making involves the exercise of good judgment in performing the three management functions explained in the answer to question five above. 7. CEOs and CFOs must now certify that financial statements give a fair presentation of the company’s operating results and its financial condition and that the company maintains an adequate system of internal controls. In addition, the composition of the board of directors and audit committees receives more scrutiny, and penalties for misconduct have increased. 19-4 Questions Chapter 19 (Continued) 8. 9. The differences between income statements are in the computation of the cost of goods sold as follows: Manufacturing company: Beginning finished goods inventory plus cost of goods manufactured minus ending finished goods inventory = cost of goods sold. Merchandising company: Beginning merchandise inventory plus cost of goods purchased minus ending merchandise inventory = cost of goods sold. The difference in balance sheets pertains to the presentation of inventories in the current asset section. In a merchandising company, only merchandise inventory is shown. In a manufacturing company, three inventory accounts are shown: finished goods, work in process, and raw materials. 10. Manufacturing costs are classified as either direct materials, direct labor, or manufacturing overhead. 11. No, Matt is not correct. The distinction between direct and indirect materials is based on two criteria: (1) physical association and (2) the convenience of making the physical association. Materials which can not be easily associated with the finished product are considered indirect materials. 12. Product costs, or inventoriable costs, are costs that are a necessary and integral part of producing the finished product. Period costs are costs that are identified with a specific time period rather than with a salable product. These costs relate to nonmanufacturing costs and therefore are not inventoriable costs. 13. A merchandising company has beginning merchandise inventory, cost of goods purchased, and ending merchandise inventory. A manufacturing company has beginning finished goods inventory, cost of goods manufactured, and ending finished goods inventory. 14. (a) (b) 15. Raw materials inventory, beginning ..................................................................................... Raw materials purchases ....................................................................................................... Total raw materials available for use ................................................................................... Raw materials inventory, ending........................................................................................... Direct materials used ................................................................................................... $ 12,000 170,000 182,000 15,000 $167,000 16. Direct materials used............................................................................................................... Direct labor used ...................................................................................................................... Total manufacturing overhead............................................................................................... Total manufacturing costs ........................................................................................... $240,000 200,000 180,000 $620,000 17. (a) (b) $646,000 $614,000 18. The order of listing is finished goods inventory, work in process inventory, and raw materials inventory. 19. The value chain refers to all activities associated with providing a product or service. For a manufacturer, this includes research and development, product design, acquisition of raw materials, production, sales and marketing, delivery, customer relations, and subsequent service. x = total cost of work in process. x = cost of goods manufactured. Total cost of work in process ($26,000 + $620,000).............................................. Cost of goods manufactured ($646,000 – $32,000) .............................................. 19-5 Questions Chapter 19 (Continued) 20. In a just-in-time inventory system the company has no extra inventory stored. Consequently, if some units that are produced are defective, the company will not have enough units to deliver to customers. 21. The balanced scorecard is called “balanced” because it strives to not over emphasize any one performance measure, but rather uses both financial and non-financial measures to evaluate all aspects of a company’s operations in an integrated fashion. 22. Activity-based costing is an approach used to allocate overhead based on each product’s relative use of activities in making the product. Activity-based costing is beneficial because it results in more accurate product costing and in more careful scrutiny of all activities in the value chain. 19-6 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 19-1 Financial Accounting Managerial Accounting Primary users External users Internal users Types of reports Financial statements Internal reports Frequency of reports Quarterly and annually As frequently as needed Purpose of reports General-purpose Special-purpose information for a particular user for a specific decision Content of reports Generally accepted accounting principles Relevance to decisions Verification Annual audit by certified public accountant No independent audits BRIEF EXERCISE 19-2 One implication of SOX was to clarify top management’s responsibility for the company’s financial statements. CEOs and CFOs must now certify that financial statements give a fair presentation of the company’s operating results and its financial condition. In addition, top management must certify that the company maintains an adequate system of internal controls to safeguard the company’s assets and ensure accurate financial reports. Also, more attention is now paid to the composition of the company’s board of directors. In particular, the audit committee of the board of directors must be comprised entirely of independent members (that is, non-employees) and must contain at least one financial expert. Finally, to increase the likelihood of compliance with these and other new rules, the penalties for misconduct were substantially increased. 19-7 BRIEF EXERCISE 19-3 (a) (1) Planning. (b) (2) Directing. (c) (3) Controlling. BRIEF EXERCISE 19-4 (a) (b) (c) (d) DM DL MO MO Frames and tires used in manufacturing bicycles. Wages paid to production workers. Insurance on factory equipment and machinery. Depreciation on factory equipment. BRIEF EXERCISE 19-5 (a) (b) (c) (d) (e) (f) (g) (h) Direct materials. Direct materials. Direct labor. Manufacturing overhead. Manufacturing overhead. Direct materials. Direct materials. Manufacturing overhead. BRIEF EXERCISE 19-6 (a) (b) (c) (d) (e) (f) Product. Period. Period. Period. Product. Product. 19-8 BRIEF EXERCISE 19-7 Product Costs Direct Materials (a) (b) (c) (d) Direct Labor Factory Overhead X X X X BRIEF EXERCISE 19-8 (a) Direct materials used....................................................................... Direct labor ......................................................................................... Total manufacturing overhead ..................................................... Total manufacturing costs.................................................... $180,000 229,000 208,000 $617,000 (b) Beginning work in process ........................................................... Total manufacturing costs............................................................. Total cost of work in process .............................................. $ 25,000 617,000 $642,000 BRIEF EXERCISE 19-9 DIEKER COMPANY Balance Sheet December 31, 2008 Current assets Cash ............................................................................... Accounts receivable ................................................. Inventories Finished goods.................................................. Work in process ................................................ Raw materials..................................................... Prepaid expenses ...................................................... Total current assets ................................ 19-9 $ 62,000 200,000 $71,000 87,000 73,000 231,000 38,000 $531,000 BRIEF EXERCISE 19-10 Direct Materials Used (1) (2) (3) Direct Labor Used Factory Overhead Total Manufacturing Costs $136,000 $81,000 $144,000 BRIEF EXERCISE 19-11 Total Manufacturing Costs (1) (2) (3) Work in Process (January 1) Work in Process (December 31) $136,000 Cost of Goods Manufactured $174,000 $123,000 $58,000 19-10 SOLUTIONS TO EXERCISES EXERCISE 19-1 1. False. Financial accounting focuses on providing information to external users. 2. True. 3. False. Preparation of budgets is part of managerial accounting. 4. False. Managerial accounting applies to service, merchandising and manufacturing companies. 5. True. 6. False. Managerial accounting reports are prepared as frequently as needed. 7. True. 8. True. 9. False. Financial accounting reports must comply with Generally Accepted Accounting Principles. 10. False. Managerial accountants are expected to behave ethically, and there is a code of ethical standards for managerial accountants. EXERCISE 19-2 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. (b) (c) (c) (c) (a) (b) (c) (c) (c) (a) Direct labor.* Manufacturing overhead. Manufacturing overhead. Manufacturing overhead. Direct materials. Direct labor. Manufacturing overhead. Manufacturing overhead. Manufacturing overhead. Direct materials. *or sometimes (c), depending on the circumstances 19-11 EXERCISE 19-3 (a) Materials used in product........ DM Advertising expense .................Period Depreciation on plant............. MOH Property taxes on plant............... MOH Property taxes on store......Period Delivery expense ........................Period Labor costs of assembly Sales commissions....................Period line workers ................................ DL Salaries paid to sales clerks......Period Factory supplies used ........... MOH (b) Product costs are recorded as a part of the cost of inventory, because they are an integral part of the cost of producing the product. Product costs are not expensed until the goods are sold. Period costs are recognized as an expense when incurred. EXERCISE 19-4 (a) Factory utilities .................................................................................... Depreciation on factory equipment .............................................. Indirect factory labor ......................................................................... Indirect materials ................................................................................ Factory manager’s salary................................................................. Property taxes on factory building ............................................... Factory repairs..................................................................................... Manufacturing overhead................................................................... $ 11,500 12,650 48,900 80,800 8,000 2,500 2,000 $166,350 (b) Direct materials................................................................................... Direct labor........................................................................................... Manufacturing overhead.................................................................. Product costs ...................................................................................... $137,600 69,100 166,350 $373,050 (c) Depreciation on delivery trucks .................................................... Sales salaries ...................................................................................... Repairs to office equipment ........................................................... Advertising ........................................................................................... Office supplies used ......................................................................... Period costs ......................................................................................... $ 19-12 3,800 46,400 1,300 18,000 2,640 $ 72,140 EXERCISE 19-5 1. 2. * (c) (c) 3. 4. (a) (c) 5. 6. (b)* (d) 7. 8. (a) (b) 9. 10. or sometimes (c), depending on the circumstances. EXERCISE 19-6 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. (b) (c) (a) (c) (c) (c) (c) (c) (c) (c) EXERCISE 19-7 (a) (b) Delivery service (product) costs: Indirect materials Depreciation on delivery equipment Dispatcher’s salary Gas and oil for delivery trucks Drivers’ salaries Delivery equipment repairs Total $ 5,400 11,200 5,000 2,200 11,000 300 $35,100 Period costs: Property taxes on office building CEO’s salary Advertising Office supplies Office utilities Repairs on office equipment Total $ 870 12,000 1,600 650 990 180 $16,290 19-13 (c) (c) EXERCISE 19-8 (a) Work-in-process, 1/1..................................... Direct materials used.................................... Direct labor....................................................... Manufacturing overhead Depreciation on plant ........................... Factory supplies used.......................... Property taxes on plant ....................... Total manufacturing overhead .................. Total manufacturing costs.......................... Total cost of work-in-process.................... Less: ending work-in-process ................... Cost of goods manufactured ..................... $ 12,000 $100,000 110,000 $60,000 23,000 14,000 97,000 (b) Finished goods, 1/1 ....................................... Cost of goods manufactured .................... Cost of goods available for sale ............... Finished goods, 12/31 .................................. Cost of goods sold ........................................ 307,000 319,000 15,500 $303,500 $ 60,000 303,500 363,500 55,600 $307,900 EXERCISE 19-9 Total raw materials available for use: Direct materials used.................................................................. Add: Raw materials inventory (12/31)................................. Total raw materials available for use..................................... $190,000 12,500 $202,500 Raw materials inventory (1/1): Direct materials used.................................................................. Add: Raw materials inventory (12/31) ................................... Less: Raw materials purchases .............................................. Raw materials inventory (1/1)................................................... $190,000 12,500 (158,000) $ 44,500 Total cost of work in process: Cost of goods manufactured ................................................... Add: Work in process (12/31) .................................................. Total cost of work in process................................................... $510,000 81,000 $591,000 19-14 EXERCISE 19-9 (Continued) Total manufacturing costs: Total cost of work in process ....................................................... Less: Work in process (1/1)........................................................... Total manufacturing costs............................................................. $591,000 (210,000) $381,000 Direct labor: Total manufacturing costs............................................................. Less: Total overhead ....................................................................... Direct materials used .......................................................... Direct labor ......................................................................................... $381,000 (122,000) (190,000) $ 69,000 EXERCISE 19-10 A + $57,000 + $46,500 = $185,650 A = $82,150 $242,500 – $11,000 = F F = $231,500 $185,650 + B = $221,500 B = $35,850 $130,000 + G + $102,000 = $253,700 G = $21,700 $221,500 – C = $185,275 C = $36,225 $253,700 + H = $337,000 H = $83,300 $58,400 + $86,000 + $81,600 = D D = $226,000 $337,000 – $70,000 = I I = $267,000 $226,000 + $16,500 = E E = $242,500 Additional explanation to EXERCISE 19-10 solution: Case A (a) Total manufacturing costs............................................................. Less: Manufacturing overhead .................................................... Direct labor ............................................................................. Direct materials used....................................................................... 19-15 $185,650 (46,500) (57,000) $ 82,150 EXERCISE 19-10 (Continued) (b) Total cost of work in process........................................................ Less: Total manufacturing costs ................................................. Work in process (1/1/08) ................................................................. $221,500 185,650 $ 35,850 (c) Total cost of work in process........................................................ Less: Cost of goods manufactured ............................................ Work in process (12/31/08)............................................................. $221,500 185,275 $ 36,225 Case B (d) Direct materials used....................................................................... Direct labor.......................................................................................... Manufacturing overhead................................................................. Total manufacturing costs ............................................................. $ 58,400 86,000 81,600 $226,000 (e) Total manufacturing costs ............................................................. Work in process (1/1/08) ................................................................. Total cost of work in process........................................................ $226,000 16,500 $242,500 (f) $242,500 11,000 $231,500 Total cost of work in process........................................................ Less: Work in process (12/31/08)................................................. Cost of goods manufactured ........................................................ Case C (g) Total manufacturing costs ............................................................. Less: Manufacturing overhead..................................................... Direct materials used.......................................................... Direct labor........................................................................................... $253,700 (102,000) (130,000) $ 21,700 (h) Total cost of work in process........................................................ Less: Total manufacturing costs ................................................. Work in process (1/1/08) ................................................................. $337,000 253,700 $ 83,300 (i) $337,000 70,000 $267,000 Total cost of work in process........................................................ Less: Work in process (12/31/08)................................................. Cost of goods manufactured ........................................................ 19-16 EXERCISE 19-11 (a) (a) $127,000 + $140,000 + $77,000 = $344,000 (b) $344,000 + $33,000 – $360,000 = $17,000 (c) $450,000 – ($200,000 + $132,000) = $118,000 (d) $40,000 + $470,000 – $450,000 = $60,000 (e) $245,000 – ($80,000 + $100,000) = $65,000 (f) $245,000 + $60,000 – $80,000 = $225,000 (g) $288,000 – ($70,000 + $75,000) = $143,000 (h) $288,000 + $45,000 – $270,000 = $63,000 (b) IKERD COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2008 Work in process, January 1...................................... Direct materials ............................................................ Direct labor .................................................................... Manufacturing overhead ........................................... Total manufacturing costs............................... Total cost of work in process .................................. Less: Work in process inventory, December 31................................................ Cost of goods manufactured ................................... 19-17 $ 33,000 $127,000 140,000 77,000 344,000 377,000 17,000 $360,000 EXERCISE 19-12 (a) AIKMAN CORPORATION Cost of Goods Manufactured Schedule For the Month Ended June 30, 2008 Work in process, June 1 .................................. Direct materials used........................................ Direct labor........................................................... Manufacturing overhead Indirect labor............................................... Factory manager’s salary....................... Indirect materials....................................... Maintenance, factory equipment.......... Depreciation, factory equipment.......... Factory utilities .......................................... Total manufacturing overhead....... Total manufacturing costs .............................. Total cost of work in process......................... Less: Work in process, June 30................... Cost of goods manufactured ......................... (b) $ 3,000 $20,000 30,000 $4,500 3,000 2,200 1,800 1,400 400 13,300 63,300 66,300 3,800 $62,500 AIKMAN CORPORATION Income Statement (Partial) For the Month Ended June 30, 2008 Net sales............................................................................ Cost of goods sold Finished goods inventory, June 1 ................... Cost of goods manufactured [from (a)]............ Cost of goods available for sale....................... Finished goods inventory, June 30................. Cost of goods sold ...................................... Gross profit ...................................................................... 19-18 $87,100 $ 5,000 62,500 67,500 7,500 60,000 $27,100 EXERCISE 19-13 (a) DANNER, CHENEY, AND HOWE Schedule of Cost of Contract Services Provided For the Month Ended August 31,2008 Supplies used (direct materials) .......................................... $ 1,200 Salaries of professionals (direct labor) ............................. 12,600 Service overhead: Utilities for contract operations ..................................... $1,400 Contract equipment depreciation.................................. 900 Insurance on contract operations ................................. 800 Janitorial services for professional offices................ 400 Total overhead .............................................................. 3,500 Cost of contract services provided............................... $17,300 (b) The costs not included in the cost of contract services provided would all be classified as period costs. As such, they would be reported on the income statement under administrative expenses. EXERCISE 19-14 (a) Work-in-process, 1/1.................................... Direct materials Materials inventory, 1/1 ...................... $ 21,000 Materials purchased ............................ 150,000 Materials available for use ................ 171,000 Less: Materials inventory, 12/31 ..... 30,000 Direct materials used .................................. Direct labor ..................................................... Manufacturing overhead ............................ Total manufacturing costs ........................ Total cost of work-in-process................... Less: Work-in-process, 12/31................... Cost of goods manufactured.................... (b) Sales ................................................................. Cost of goods sold Finished goods, 1/1 ............................. Cost of goods manufactured .......... Cost of goods available for sale ..... Finished goods, 12/31 ........................ Cost of goods sold ....................... Gross profit..................................................... 19-19 $ 13,500 $141,000 200,000 180,000 521,000 534,500 17,200 $517,300 $900,000 $ 27,000 517,300 544,300 21,000 523,300 $376,700 EXERCISE 19-14 (Continued) (c) Current assets Inventories Finished goods........................................................ Work in process ..................................................... Raw materials .......................................................... $21,000 17,200 30,000 $68,200 (d) In a merchandising company’s income statement, the only difference would be in the computation of cost of goods sold. Beginning and ending finished goods would be replaced by beginning and ending merchandise inventory, and cost of goods manufactured would be replaced by purchases. In a merchandising company’s balance sheet, there would be one inventory account (merchandise inventory) instead or three. EXERCISE 19-15 1. 2. 3. 4. 5. 6. 7. 8. (a) (a) (a), (c) (b) (a) (a) (a) (b), (c) 9. 10. 11. 12. 13. 14. 15. 16. 19-20 (a) (a), (b) (b) (b) (a) (a) (a) (a) EXERCISE 19-16 (a) CHAMBERLIN MANUFACTURING Cost of Goods Manufactured Schedule For the Month Ended June 30, 2008 Work in process inventory, June 1 ..................... Direct materials Raw materials inventory, June 1 ............. Raw materials purchases........................... Total raw materials available for use......... Less: Raw materials inventory, June 30 ..... Direct materials used................................... Direct labor .............................................................. Manufacturing overhead Indirect labor .................................................. $5,500 Factory insurance......................................... 4,000 Machinery depreciation .............................. 4,000 Factory utilities.............................................. 3,100 Machinery repairs ......................................... 1,800 Miscellaneous factory costs ..................... 1,500 Total manufacturing overhead ........... Total manufacturing costs.................................. Total cost of work in process ............................ Less: Work in process inventory, June 30......... Cost of goods manufactured ............................. (b) $ 5,000 $ 9,000 54,000 63,000 13,100 49,900 57,000 19,900 126,800 131,800 7,000 $124,800 CHAMBERLIN MANUFACTURING (Partial) Balance Sheet June 30, 2008 Current assets Inventories Finished goods.................................................. Work in process ................................................ Raw materials..................................................... 19-21 $ 6,000 7,000 13,100 $ 26,100 EXERCISE 19-17 (a) Raw Materials account: (5,000 – 4,650) X $9 = $3,150 Work in Process account: (4,600 X 10%) X $9 = $4,140 Finished Goods account: (4,600 X 90% X 25%) X $9 = $9,315 Cost of Goods Sold account: (4,600 X 90% X 75%) X $9 = $27,945 Selling Expenses account: 50 X $9 = $450 Proof of cost of head lamps allocated (5,000 X $9 = $45,000) Raw materials Work in process Finished goods Cost of goods sold Selling expenses Total (b) To: $ 3,150 4,140 9,315 27,945 450 $45,000 Chief Accountant From: Student Subject: Statement Presentation of Accounts Two accounts will appear in the income statement. Cost of Goods Sold will be deducted from net sales in determining gross profit. Selling expenses will be shown under operating expenses and will be deducted from gross profit in determining net income. Sometimes, the calculation for Cost of Good Sold is shown on the income statement. In these cases, the balance in Finished Goods inventory would also be shown on the income statement. The other accounts associated with the head lamps are inventory accounts which contain end-of-period balances. Thus, they will be reported under inventories in the current assets section of the balance sheet in the following order: finished goods, work in process, and raw materials. EXERCISE 19-18 1. 2. 3. 4. (d) (c) (a) (b) Activity-based costing Just-in-time inventory Balanced scorecard Value chain 19-22 (a) Cost Item Total production costs Direct materials Direct labor Manufacturing overhead Total production cost $ 7,000 1,500 $75,000 900 $ 300 $43,000 800 1,100 5,700 400 000,000 $75,000 000,000 $43,000 $ 75,000 43,000 18,100 $136,100 Production cost per helmet = $136,100/10,000 = $13.61. 1,500 $18,100 14,000 7,000 000,000 $22,100 SOLUTIONS TO PROBLEMS (b) Period Costs PROBLEM 19-1A 19-23 Rent on factory equipment Insurance on factory building Raw materials Utility costs for factory Supplies for general office Wages for assembly line workers Depreciation on office equipment Miscellaneous materials Factory manager’s salary Property taxes on factory building Advertising for helmets Sales commissions Depreciation on factory building Direct Materials Product Costs Direct Manufacturing Labor Overhead (a) 19-24 (1) (2) (3) (4) (5) $78,000 $ 4,900 6,500 3,000 1,300 $8,500 000,000 $96,200 000,000 $78,000 600 750 $17,050 $74 X 1,300 = $96,200. $12 X 5 X 1,300 = $78,000. $5 X 1,300 = $6,500. $7,200/12 = $600. $9,000/12 = $750. (b) Total production costs Direct materials Direct labor Manufacturing overhead Total production cost Period Costs $ 96,200 78,000 17,050 $191,250 Production cost per system = $191,250/1,300 = $147.12. (rounded) 00,000 $8,500 PROBLEM 19-2A Cost Item Raw materials (1) Wages for workers (2) Rent on equipment Indirect materials (3) Factory supervisor’s salary Janitorial costs Advertising Depreciation on factory building (4) Property taxes on factory building (5) Direct Materials $96,200 Product Costs Direct Manufacturing Labor Overhead PROBLEM 19-3A (a) Case 1 A = $7,600 + $5,000 + $8,000 = $20,600 $20,600 + $1,000 – B = $17,000 B = $20,600 + $1,000 – $17,000 = $4,600 $17,000 + C = $18,000 C = $18,000 – $17,000 = $1,000 D = $18,000 – $3,400 = $14,600 E = ($24,500 – $2,500) – $14,600 = $7,400 F = $7,400 – $2,500 = $4,900 Case 2 G + $8,000 + $4,000 = $18,000 G = $18,000 – $8,000 – $4,000 = $6,000 $18,000 + H – $3,000 = $22,000 H = $22,000 + $3,000 – $18,000 = $7,000 (I – $1,400) – K = $7,000 (I – $1,400) – $22,800 = $7,000 I = $1,400 + $22,800 + $7,000 = $31,200 (Note: Item I can only be solved after item K is solved.) J = $22,000 + $3,300 = $25,300 K = $25,300 – $2,500 = $22,800 $7,000 – L = $5,000 L = $2,000 19-25 PROBLEM 19-3A (Continued) (b) CASE 1 Cost of Goods Manufactured Schedule Work in process, beginning........................................ Direct materials............................................................... Direct labor....................................................................... Manufacturing overhead.............................................. Total manufacturing costs ................................. Total cost of work in process..................................... Less: Work in process, ending................................. Cost of goods manufactured ..................................... (c) $ 1,000 $7,600 5,000 8,000 20,600 21,600 4,600 $17,000 CASE 1 Income Statement Sales ................................................................................... Less: Sales discounts ................................................. Net sales............................................................................ Cost of goods sold Finished goods inventory, beginning ............ Cost of goods manufactured............................. Cost of goods available for sale....................... Less: Finished goods inventory, ending...... Cost of goods sold ...................................... Gross profit ...................................................................... Operating expenses ...................................................... Net income........................................................................ $24,500 2,500 $22,000 1,000 17,000 18,000 3,400 14,600 7,400 2,500 $ 4,900 CASE 1 (Partial) Balance Sheet Current assets Cash........................................................................... Receivables (net)................................................... Inventories Finished goods ............................................. Work in process............................................ Raw materials ................................................ Prepaid expenses.................................................. Total current assets..................................... 19-26 $ 4,000 15,000 $3,400 4,600 600 8,600 400 $28,000 PROBLEM 19-4A (a) STELLAR MANUFACTURING COMPANY Cost of Goods Manufactured Schedule For the Year Ended June 30, 2008 Work in process, July 1, 2007................ Direct materials Raw materials inventory, July 1, 2007..................................... Raw materials purchases ............... Total raw materials available for use .............................................. Less: Raw materials inventory, June 30, 2008 .................... Direct materials used....................... Direct labor .................................................. Manufacturing overhead Plant manager’s salary ................... Factory utilities.................................. Indirect labor ...................................... Factory machinery depreciation...... Factory property taxes.................... Factory insurance............................. Factory repairs................................... Total manufacturing overhead................................. Total manufacturing costs...................... Total cost of work in process ................ Less: Work in process, June 30............ Cost of goods manufactured ................. 19-27 $ 19,800 $ 48,000 96,400 144,400 39,600 $104,800 149,250 29,000 27,600 24,460 16,000 9,600 4,600 1,400 112,660 366,710 386,510 18,600 $367,910 PROBLEM 19-4A (Continued) (b) STELLAR MANUFACTURING COMPANY (Partial) Income Statement For the Year Ended June 30, 2008 Sales revenues Sales ...................................................................... Less: Sales discounts .................................... Net sales............................................................... Cost of goods sold Finished goods inventory, July 1, 2007 ..................................................... Cost of goods manufactured......................... Cost of goods available for sale................... Less: Finished goods inventory, June 30, 2008 .................................... Cost of goods sold .................................. Gross profit ......................................................... (c) $554,000 4,200 $549,800 96,000 367,910 463,910 95,900 368,010 $181,790 STELLAR MANUFACTURING COMPANY (Partial) Balance Sheet June 30, 2008 Assets Current assets Cash....................................................................... Accounts receivable......................................... Inventories Finished goods ......................................... Work in process........................................ Raw materials ............................................ Total current assets........................ 19-28 $ 32,000 27,000 $95,900 18,600 39,600 154,100 $213,100 PROBLEM 19-5A (a) TOMBERT COMPANY Cost of Goods Manufactured Schedule For the Month Ended October 31, 2008 Work in process, October 1................ Direct materials Raw materials inventory, October 1..................................... $ 18,000 Raw materials purchases ..................................... 264,000 Total raw materials available for use ............................................ 282,000 Less: Raw materials inventory, October 31 ....................... 34,000 Direct materials used..................... Direct labor ................................................ Manufacturing overhead Factory facility rent ........................ 60,000 Depreciation on factory equipment ..................................... 31,000 Indirect labor .................................... 28,000 Factory utilities* .............................. 8,400 Factory insurance**........................ 4,800 Total manufacturing overhead............................... Total manufacturing costs.................... Total cost of work in process .............. Less: Work in process, October 31........ Cost of goods manufactured ............... **$12,000 X 70% = $8,400 **$8,000 X 60% = $4,800 19-29 $ 16,000 $248,000 190,000 132,200 570,200 586,200 14,000 $572,200 PROBLEM 19-5A (Continued) (b) TOMBERT COMPANY Income Statement For the Month Ended October 31, 2008 Sales (net).................................................................... Cost of goods sold Finished goods inventory, October 1........ Cost of goods manufactured........................ Cost of goods available for sale.................. Less: Finished goods inventory, October 31......................................... Cost of goods sold ................................. Gross profit ................................................................. Operating expenses Advertising expense ....................................... Selling and administrative salaries ............ Depreciation expense—sales equipment ...................................................... Utilities expense*.............................................. Insurance expense** ....................................... Total operating expenses ..................... Net income................................................................... **$12,000 X 30% **$8,000 X 40% 19-30 $780,000 $ 30,000 572,200 602,200 48,000 554,200 225,800 90,000 75,000 45,000 3,600 3,200 216,800 $ 9,000 (a) Cost Item (b) Total production costs Direct materials Direct labor Manufacturing overhead Total production cost $ Period Costs 600 4,000 8,000 3,000 700 6,000 3,000 $20,000 800 200 $44,000 000,000 $20,000 000,000 $44,000 2,000 $17,100 $20,000 44,000 17,100 $81,100 Production cost per motorcycle helmet = $81,100/1,000 = $81.10. 500 000,000 $11,700 PROBLEM 19-1B 19-31 Maintenance costs on factory building Factory manager’s salary Advertising for helmets Sales commissions Depreciation on factory building Rent on factory equipment Insurance on factory building Raw materials Utility costs for factory Supplies for general office Wages for assembly line workers Depreciation on office equipment Miscellaneous materials Direct Materials Product Costs Direct Manufacturing Labor Overhead (a) Cost Item 19-32 (1) (2) (3) (4) (5) $46,000 $52,000 $ 1,300 6,000 3,500 1,400 $6,000 000,000 $46,000 000,000 $52,000 700 450 $13,350 $23 X 2,000 = 46,000. $13 X 2 X 2,000 = $52,000. $3 X 2,000 = $6,000. $8,400/12 = $700. $5,400/12 = $450. (b) Total production costs Direct materials Direct labor Manufacturing overhead Total production cost Period Costs $ 46,000 52,000 13,350 $111,350 Production cost per racket = $111,350/2,000 = $55.68. (rounded) 00,000 $6,000 PROBLEM 19-2B Raw materials (1) Wages for workers (2) Rent on equipment Indirect materials (3) Factory supervisor’s salary Janitorial costs Advertising Depreciation on factory building (4) Property taxes on factory building (5) Direct Materials Product Costs Direct Manufacturing Labor Overhead PROBLEM 19-3B (a) Case 1 A = $8,300 + $3,000 + $6,000 = $17,300 $17,300 + $1,000 – B = $15,800 B = $17,300 + $1,000 – $15,800 = $2,500 $15,800 + C = $17,300 C = $17,300 – $15,800 = $1,500 D = $17,300 – $1,200 = $16,100 E = ($22,500 – $1,500) – $16,100 = $4,900 F = $4,900 – $2,700 = $2,200 Case 2 G + $4,000 + $5,000 = $18,000 G = $18,000 – $4,000 – $5,000 = $9,000 $18,000 + H – $2,000 = $20,000 H = $20,000 + $2,000 – $18,000 = $4,000 (I – $1,200) – K = $6,000 (I – $1,200) – $21,500 = $6,000 I = $1,200 + $21,500 + $6,000 = $28,700 (Note: Item I can only be solved after item K is solved.) J = $20,000 + $4,000 = $24,000 K = $24,000 – $2,500 = $21,500 $6,000 – L = $3,200 L = $2,800 19-33 PROBLEM 19-3B (Continued) (b) CASE 1 Cost of Goods Manufactured Schedule Work in process, beginning....................................... Direct materials.............................................................. Direct labor...................................................................... Manufacturing overhead............................................. Total manufacturing costs ................................ Total cost of work in process.................................... Less: Work in process, ending................................ Cost of goods manufactured .................................... (c) $ 1,000 $8,300 3,000 6,000 17,300 18,300 2,500 $15,800 CASE 1 Income Statement Sales .................................................................................. Less: Sales discounts ................................................ Net sales........................................................................... Cost of goods sold Finished goods inventory, beginning ........... Cost of goods manufactured............................ Cost of goods available for sale...................... Finished goods inventory, ending.................. Cost of goods sold ..................................... Gross profit ..................................................................... Operating expenses ..................................................... Net income....................................................................... $22,500 1,500 $21,000 $ 1,500 15,800 17,300 1,200 16,100 4,900 2,700 $ 2,200 CASE 1 (Partial) Balance Sheet Current assets Cash.......................................................................... Receivables (net).................................................. Inventories Finished goods ............................................ Work in process........................................... Raw materials ............................................... Prepaid expenses................................................. Total current assets.................................... 19-34 $ 3,000 10,000 $1,200 2,500 700 4,400 200 $17,600 PROBLEM 19-4B (a) RUIZ MANUFACTURING COMPANY Cost of Goods Manufactured Schedule For the Year Ended December 31, 2008 Work in process inventory, January 1 ....................................... Direct materials Raw materials inventory, January 1............................... Raw materials purchases ............................. Total raw materials available for use ................ Less: Raw materials inventory, December 31 ........... Direct materials used............. Direct labor ........................................ Manufacturing overhead Plant manager’s salary ......... Indirect labor ............................ Factory utilities........................ Factory machinery depreciation ......................... Factory insurance................... Factory property taxes.......... Factory repairs......................... Total manufacturing overhead....................... Total manufacturing costs............ Total cost of work in process ...... Less: Work in process, December 31.................... Cost of goods manufactured ....... 19-35 $ 9,500 $ 47,000 67,500 114,500 44,200 $ 70,300 145,100 30,000 18,100 12,900 7,700 7,400 6,100 800 83,000 298,400 307,900 8,000 $299,900 PROBLEM 19-4B (Continued) (b) RUIZ MANUFACTURING COMPANY (Partial) Income Statement For the Year Ended December 31, 2008 Sales revenues Sales ..................................................................... Less: Sales discounts ................................... Net sales.............................................................. Cost of goods sold Finished goods inventory, January 1 ........................................................ Cost of goods manufactured (see schedule) ........................................................ Cost of goods available for sale.................. Finished goods inventory, December 31.................................................. Cost of goods sold ................................. Gross profit ................................................................. (c) $475,000 2,500 $472,500 85,000 299,900 384,900 77,800 307,100 $165,400 RUIZ MANUFACTURING COMPANY (Partial) Balance Sheet December 31, 2008 Assets Current assets Cash...................................................................... Accounts receivable........................................ Inventories Finished goods ........................................ Work in process....................................... Raw materials ........................................... Total current assets....................... 19-36 $ 28,000 27,000 $77,800 8,000 44,200 130,000 $185,000 PROBLEM 19-5B (a) AGLER COMPANY Cost of Goods Manufactured Schedule For the Month Ended August 31, 2008 Work in process, August 1 ..................... Direct materials Raw materials inventory, August 1 .......................................... Raw materials purchases............... Total raw materials available for use ........................... Less: Raw materials inventory, August 31........................... Direct materials used....................... Direct labor .................................................. Manufacturing overhead Factory facility rent .......................... Depreciation on factory equipment ....................................... Indirect labor ...................................... Factory utilities* ................................ Factory insurance**.......................... Total manufacturing overhead................................. Total manufacturing costs...................... Total cost of work in process ................ Less: Work in process, August 31.................................... Cost of goods manufactured ................. *$10,000 X 60% **$5,000 X 70% 19-37 $ 25,000 $ 19,500 200,000 219,500 30,000 $189,500 160,000 $ 60,000 35,000 20,000 6,000 3,500 124,500 474,000 499,000 21,000 $478,000 PROBLEM 19-5B (Continued) (b) AGLER COMPANY Income Statement For the Month Ended August 31, 2008 Sales (net)...................................................................... Cost of goods sold Finished goods inventory, August 1 ........... Cost of goods manufactured.......................... Cost of goods available for sale.................... Less: Finished goods inventory, August 31 ............................................ Cost of goods sold ................................... Gross profit ................................................................... Operating expenses Advertising expense ......................................... Selling and administrative salaries .............. Depreciation expense—sales equipment ........................................................ Utilities expense*................................................ Insurance expense** ......................................... Total operating expenses ....................... Net income..................................................................... *$10,000 X 40% **$5,000 X 30% 19-38 $675,000 $ 40,000 478,000 518,000 64,000 454,000 221,000 75,000 70,000 50,000 4,000 1,500 200,500 $ 20,500 BYP 19-1 DECISION MAKING ACROSS THE ORGANIZATION Ending Raw Materials Inventory Beginning raw materials + Raw materials purchased = Raw materials available for use = $19,000 + $345,000 = $364,000 Raw materials available for use – Ending raw materials inventory = Direct materials used $364,000 – Ending raw materials inventory = $350,000 Ending raw materials inventory = $364,000 – $350,000 = $14,000 Ending Work in Process Inventory Direct materials + Direct labor + Manufacturing overhead = Total manufacturing costs = $350,000 + $240,000 + ($240,000 X 60%) = $734,000 Beginning work in process inventory + Total manufacturing costs = Total cost of work in process = $25,000 + $734,000 = $759,000 Cost of goods manufactured + Beginning finished goods inventory = Cost of goods available for sale Cost of goods manufactured + $38,000 = $770,000 Cost of goods manufactured = $770,000 – $38,000 = $732,000 Total cost of work in process – Ending work in process inventory = Cost of goods manufactured $759,000 – Ending work in process inventory = $732,000 Ending work in process inventory = $759,000 – $732,000 = $27,000 Ending Finished Goods Inventory Sales – Cost of goods sold = Gross profit $1,260,000 – Cost of goods sold = $1,260,000 X 40% Cost of goods sold = $1,260,000 – $504,000 = $756,000 Cost of goods available for sale – Ending finished goods inventory = Cost of goods sold $770,000 – Ending finished goods inventory = $756,000 Ending finished goods inventory = $770,000 – $756,000 = $14,000 19-39 BYP 19-2 MANAGERIAL ANALYSIS Since the questions were fairly open-ended, the following are only suggested results. The class may be able to think of others, or of more items for each one. (a) Andre Agassi Needs information on sales, perhaps by salesperson and by territory. Serena Williams Needs cost information for her department. Pete Sampras Needs all accounting information. Andy Roddick Needs product cost information. Venus Williams Needs information on component costs and costs for her department. Income statement. (b) Andre Agassi Serena Williams None. Pete Sampras All. Andy Roddick Income statement and cost of goods manufactured schedule. Venus Williams (c) Andre Agassi None. Sales by Territory—Detailed information, possibly by product line, issued daily or weekly. Serena Williams Cost of Computer Programs—Accumulated cost incurred for each major program used including maintenance and updates of program, issued monthly. Pete Sampras Cost of Preparing Reports—Detailed analysis of all reports provided, their frequency, time, and estimated cost to prepare, issued monthly. Andy Roddick Cost of Product—Detailed cost by product line, including a comparison with estimated costs for that product. Issued as each batch of production is completed. Venus Williams Cost of Product Design—Accumulated total costs of each new product, issued at end of each project. 19-40 BYP 19-3 REAL-WORLD FOCUS The factors that affect the cost of products are direct materials, direct labor, and manufacturing overhead. The percentage increase of total cost of products sold to net sales of 1.7% during the year appears to be entirely due to net increases in costs. The current year events and their possible impact on the three manufacturing cost elements are as follows: Operational problems at a major furnace. The principal effect is on manufacturing overhead due to higher maintenance costs. The problems may also have resulted in higher direct labor costs and higher direct materials because of the malfunctioning of the furnace. Higher downtime and costs and expenses associated with capital improvement projects. Higher downtime causes higher indirect labor. Costs associated with capital improvement projects impact product costs through depreciation which is part of manufacturing overhead. Increases in labor and other manufacturing costs. The increases in labor resulted in higher direct labor costs. The increases in indirect labor costs and in other manufacturing costs resulted in higher manufacturing overhead. Reduced fixed costs. Fixed costs such as insurance and rent are classified as manufacturing overhead. Thus, this factor reduced overhead costs during the year. Productivity and efficiency gains. This factor could have resulted in reductions of both direct material and direct labor costs. 19-41 BYP 19-4 EXPLORING THE WEB (a) The IMA has nearly 65,000 members. These members include business leaders, managers, and decision makers in accounting and finance. (b) Student and Associate members receive all the benefits of Regular membership at a significant savings. • Unique access to professional designations, the Certified Management Accountant (CMA) and Certified Financial Manager (CFM) • Specialized learning opportunities • Educational assistance, grants, educational competitions • Around-the-Clock Networking • Career management resources (c) The answer to this question will vary by school. 19-42 BYP 19-5 COMMUNICATION ACTIVITY Ms. Sue Tombert President Agler Company Dear Sue: As you requested, I corrected the income statement for October from the information you gave me. The corrected statement is enclosed and it shows that you actually earned net income of $9,000 for October. I also noticed that you did not have a cost of goods manufactured schedule, so I prepared one for you. The income statement your assistant accountant prepared was not correct for two primary reasons. First, product costs were not separated from selling and administrative expenses. Second, and more importantly, the reported net loss did not reflect changes in inventories. This had the effect of treating these costs as expenses rather than assets. A reconciliation of the reported net loss of $23,000 to net income of $9,000 is as follows: Net loss as reported............................................................... Increase (decrease) in inventories Raw materials ($34,000 – $18,000) ........................... $16,000 Work in process ($14,000 – $16,000)....................... (2,000) Finished goods ($48,000 – $30,000) ........................ 18,000 Total increase......................................................... Net income as corrected ...................................................... $(23,000) (32,000 $ (9,000 The changes in raw materials and work in process inventories are reported in the cost of goods manufactured schedule. You will see, for example, that the cost of direct materials used was $248,000, not $264,000 as reported by your accountant in the income statement. The difference is the change in raw materials inventories. Similarly, you will see that the $2,000 decrease in work in process inventories increases total manufacturing costs of $570,200 to produce cost of goods manufactured of $572,200. The change in finished goods inventories is reported in the income statement. Notice that the change of $18,000 is subtracted from cost of goods manufactured of $572,200 to produce cost of goods sold of $554,200. 19-43 BYP 19-5 (Continued) I have also modified the form of the income statement to recognize the distinction between product costs (cost of goods sold) and period costs (operating expenses) as required by generally accepted accounting principles. Thanks for letting me help. If I can be of further assistance, don’t hesitate to call. I hope you find a replacement for your controller soon. Sincerely, 19-44 BYP 19-6 ETHICS CASE (a) The stakeholders in this situation are: • • • • The users of Robbin Industries’ financial statements. Wayne Terrago, controller. The vice-president of finance. The president of Robbin Industries. (b) The ethical issues in this situation pertain to the adherence to sound and acceptable accounting principles. Intentional violation of generally accepted accounting principles in order to satisfy a practical short-term personal or company need and thus create misleading financial statements would be unethical. Selecting one acceptable method of accounting and reporting among other acceptable methods is not necessarily unethical. (c) Ethically, the management of Robbin Industries should be trying to report the financial condition and results of operations as fairly as possible; that is, in accordance with GAAP. Wayne should inform management what is acceptable accounting and what is not. The basic concept to be supported in this advertising cost transaction is matching costs and revenues. Normally, advertising costs are expensed in the period in which they are incurred because it is very difficult to associate them with specific revenues. 19-45 BYP 19-7 ALL ABOUT YOU ACTIVITY Student responses will vary. We have provided some basic examples that may represent common responses. (a) Individuals must often make purchase decisions which involve choosing between an item that has a more expensive initial purchase price, but is expected to either last longer, or provides some form of cost savings. The question that the individual faces is whether the cost savings or additional benefit justifies the additional initial cost. For example, more expensive dishwashers and refrigerators also tend to be more energy efficient. The labels on these appliances provide information regarding the energy savings which can be used to make a break-even evaluation. (b) In order to increase control over their financial situation and reduce the probability of financial hardship all people should prepare personal budgets. Preparation of a personal budget requires the individual to plan for the future and to prioritize expenditures. (c) Companies employ the balanced scorecard as a mechanism to ensure that their financial goals are consistent with their efforts. Use of the balanced scorecard requires clear articulation of goals, priorities and strategies. By employing these same techniques in their everyday life individuals can be better assured that they will expend effort on those things that really matter to them, rather than wasting efforts on less important distractions. (d) Capital budgeting involves financial evaluation of long-term assets. Companies routinely make capital budgeting decisions, but so do individuals. The purchase of a home or car is a decision that has implications for your finances for many subsequent years. Buying a house or car is a very personal decision, influenced by many personal, nonfinancial, preferences. However, these decisions should also be subjected to a financial evaluation using capital budgeting techniques to ensure that the choice makes good economic sense. 19-46 CHAPTER 20 Job Order Cost Accounting ASSIGNMENT CLASSIFICATION TABLE Brief Exercises Exercises A Problems B Problems 5, 6, 7, 8,11, 12 1, 2, 3, 4 1, 2, 3, 4, 6, 7, 8, 9,11 1A, 2A, 3A, 5A 1B, 2B, 3B, 5B Explain the nature and importance of a job cost sheet. 9, 10, 11, 12 5 1, 2, 3, 6, 7, 8, 10, 12 1A, 2A, 3A, 5A 1B, 2B, 3B, 5B 4. Indicate how the predetermined overhead rate is determined and used. 13, 14, 15 6, 7 2, 3, 5, 6, 7, 8, 11,12, 13 1A, 2A, 3A, 4A, 5A 1B, 2B, 3B, 4B, 5B 5. Prepare entries for jobs completed and sold. 16 8 2, 3, 4, 6, 7, 8, 9, 10, 11 1A, 2A, 3A, 5A 1B, 2B, 3B, 5B 6. Distinguish between under- and overapplied manufacturing overhead. 17, 18 9 5, 12, 13 1A, 2A, 4A, 5A 1B, 2B, 4B, 5B Study Objectives Questions 1. Explain the characteristics and purposes of cost accounting. 1, 2, 3, 4 2. Describe the flow of costs in a job order cost accounting system. 3. 20-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) Simple 30−40 1A Prepare entries in a job cost system and job cost sheets. 2A Prepare entries in a job cost system and partial income statement. Moderate 30−40 3A Prepare entries in a job cost system and cost of goods manufactured schedule. Simple 30−40 4A Compute predetermined overhead rates, apply overhead, and calculate under- or overapplied overhead. Simple 20−30 5A Analyze manufacturing accounts and determine missing amounts. Complex 30−40 1B Prepare entries in a job cost system and job cost sheets. Simple 30−40 2B Prepare entries in a job cost system and partial income statement. Moderate 30−40 3B Prepare entries in a job cost system and cost of goods manufactured schedule. Simple 30−40 4B Compute predetermined overhead rates, apply overhead, and calculate under- or overapplied overhead. Simple 20−30 5B Analyze manufacturing accounts and determine missing amounts. Complex 30−40 20-2 Study Objective Knowledge Comprehension Analysis 20-3 1. Explain the characteristics and purposes of cost accounting. 2. Describe the flow of costs in a job order cost accounting system. Q20-5 Q20-7 Q20-8 Q20-12 Q20-6 BE20-1 BE20-2 BE20-3 BE20-4 E20-1 E20-2 E20-3 E20-6 E20-7 E20-8 E20-9 E20-11 P20-1A P20-3A P20-1B P20-3B 3. Explain the nature and importance of a job cost sheet. Q20-11 Q20-12 Q20-9 Q20-10 BE20-5 E20-1 E20-2 E20-3 E20-6 E20-7 E20-8 E20-10 E20-12 E20-1A E20-3A P20-2A P20-1B P20-5A P20-3B P20-2B P20-5B 4. Indicate how the predetermined overhead rate is determined and used. Q20-15 Q20-13 Q20-14 BE20-6 BE20-7 E20-2 E20-3 E20-6 E20-7 E20-8 E20-11 E20-12 E20-13 P20-1A P20-3A P20-4A P20-1B P20-3B P20-4B 5. Prepare entries for jobs completed and sold. Q20-16 BE20-8 E20-2 E20-3 E20-6 E20-7 E20-8 E20-9 E20-10 E20-11 P20-1A P20-3A E20-4 P20-1B P20-2A P20-3B P20-5A P20-2B P20-5B 6. Distinguish between under- and overapplied manufacturing overhead. Q20-17 Q20-18 BE20-9 E20-12 E20-13 P20-1A P20-1B E20-5 P20-4A P20-2A P20-4B P20-5A P20-2B P20-5B Broadening Your Perspective Q20-1 Q20-2 Application Synthesis Evaluation Q20-3 Q20-4 Communication Real-World Focus Exploring the Web E20-4 P20-2A P20-5A P20-2B P20-5B E20-5 P20-2A P20-5A P20-2B P20-5B Managerial Analysis All About You Decision Making Across the Organization Ethics Case BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. (a) Cost accounting involves the measuring, recording, and reporting of product costs. A cost accounting system consists of manufacturing cost accounts that are fully integrated into the general ledger of a company. (b) An important feature of a cost accounting system is the use of a perpetual inventory system that provides immediate, up-to-date information on the cost of a product. 2. (a) The two principal types of cost accounting systems are: (1) job order costing and (2) process costing. Under a job order cost system, costs are assigned to each job or batch of goods; at all times each job or batch of goods can be separately identified. A job order cost system measures costs for each completed job, rather than for set time periods. Under a process cost system, product-related costs are accumulated by or assigned to departments or processes for a set period of time. Job order costing lends itself to specific, special-order manufacturing or servicing while process costing is better suited to similar, large-volume products and continuous process manufacturing. (b) A company may use both types of systems. For example, General Motors uses process costing for standard model cars and job order costing for custom-made vehicles. 3. A job order cost system is most likely to be used by a company that receives special orders, or custom builds, or produces heterogeneous, nontransferable items or products; that is, the product manufactured or the service rendered is tailored to the customer or client’s requests, needs, or situation. Examples of industries that use job order systems are custom home builders, commercial printing companies, motion picture companies, construction contractors, repair shops, accounting and law firms, hospitals, shipbuilders, and architects. 4. A process cost system is most likely to be used by manufacturing firms with continuous production flows usually found in mass production, assembly line, large-volume, uniform, or relatively similar product industries. Companies producing appliances, chemicals, pharmaceuticals, rubber and tires, plastics, cement, petroleum, and automobiles utilize process cost systems. 5. The major steps in the flow of costs in a job order cost accounting system are: (1) accumulating the manufacturing costs incurred and (2) assigning the accumulated costs to work done. 6. The three inventory control accounts and their subsidiary ledgers are: Raw materials inventory—materials inventory records (stores ledger cards). Work in process inventory—job cost sheets. Finished goods inventory—finished goods records. 7. The source documents used in accumulating direct labor costs are time tickets and time cards. 8. Disagree. Entries to Manufacturing Overhead are also made at the end of an accounting period. For example, there will be adjusting entries for factory depreciation, property taxes, and insurance. 9. The source document for materials is the materials requisition slip and the source document for labor is the time ticket. The entries are: Materials Work in Process Inventory Manufacturing Overhead Raw Materials Inventory Labor XX XX XX 20-4 Work in Process Inventory Manufacturing Overhead Factory Labor XX XX XX Questions Chapter 20 (Continued) 10. The purpose of a job cost sheet is to record the costs chargeable to a specific job and to determine the total and unit costs of the completed job. 11. The source documents for charging costs to specific jobs are materials requisition slips for direct materials, time tickets for direct labor, and the predetermined overhead rate for manufacturing overhead. 12. A materials inventory record, also called the stores ledger card, is used in a perpetual inventory system as a record of individual parts, units, assemblies, or other materials (direct as well as indirect). The materials inventory record is the basic inventory record in the subsidiary ledger. The materials requisition slip is a business document used as an authorization to issue materials from inventory to production. It is approved and signed by authorized personnel so that materials may be removed from inventory and charged to production, to specific jobs, departments, or processes. The materials requisition slip is the basis for posting to the materials inventory records and to the job cost sheet. 13. Disagree. Actual manufacturing overhead cannot be determined until the end of a period of time. Consequently, there could be a significant delay in assigning overhead and in determining the total cost of the completed job. 14. The relationships for computing the predetermined overhead rate are the estimated annual overhead costs and an expected activity base such as direct labor hours. The rate is computed by dividing the estimated annual overhead costs by the expected annual operating activity. 15. At any point in time, the balance in Work in Process Inventory should equal the sum of the costs shown on the job cost sheets of unfinished jobs. Alternatively, posting to Work in Process Inventory may be compared with the sum of the postings to the job cost sheets for each of the manufacturing cost elements. 16. Tina is incorrect. There is a difference in computing total manufacturing costs. In job order costing, manufacturing overhead applied is used, whereas in Chapter 19, actual manufacturing overhead is used. 17. Underapplied overhead means that the overhead assigned to work in process is less than the overhead incurred. Overapplied overhead means that the overhead assigned to work in process is greater than the overhead incurred. Manufacturing Overhead will have a debit balance when overhead is underapplied and a credit balance when overhead is overapplied. 18. Under- or overapplied overhead is not closed to Income Summary. The balance in Manufacturing Overhead is eliminated through an adjusting entry. Under- or overapplied overhead generally is considered to be an adjustment of Cost of Goods Sold. 20-5 Factory Labor (2) Factory labor (5) Factory labor incurred used Finished Goods Inventory (7) Cost of com(8) Cost of goods pleted jobs sold Cost of Goods Sold (8) Cost of goods sold 20-6 Key to Entries: Accumulation 1. Purchase raw materials 2. Incur factory labor 3. Incur manufacturing overhead Manufacturing Overhead (6) Overhead (3) Depreciation applied Insurance Repairs (4) Indirect materials used (5) Indirect labor used Assignment 4. 5. 6. 7. 8. Raw materials are used Factory labor is used Overhead is applied Completed goods are recognized Cost of goods sold is recognized SOLUTIONS TO BRIEF EXERCISES Work in Process Inventory (4) Direct (7) Cost of commaterials used pleted jobs (5) Direct labor used (6) Overhead applied BRIEF EXERCISE 20-1 Raw Materials Inventory (1) Purchases (4) Materials used BRIEF EXERCISE 20-2 Jan. 31 31 31 Raw Materials Inventory.............................................. Accounts Payable................................................. 4,000 Factory Labor ................................................................. Factory Wages Payable...................................... Employer Payroll Taxes Payable..................... 5,000 Manufacturing Overhead ............................................ Utilities Payable .................................................... 2,000 4,000 4,200 800 2,000 BRIEF EXERCISE 20-3 Jan. 31 Work in Process Inventory......................................... Manufacturing Overhead ............................................ Raw Materials Inventory..................................... 2,800 600 3,400 BRIEF EXERCISE 20-4 Jan. 31 Work in Process Inventory......................................... Manufacturing Overhead ............................................ Factory Labor......................................................... 4,200 800 5,000 BRIEF EXERCISE 20-5 Date 1/31 1/31 Job 1 Direct Materials 900 Direct Labor Date 1/31 1/31 1,200 Date 1/31 1/31 Job 3 Direct Materials 700 Direct Labor 1,400 20-7 Job 2 Direct Materials 1,200 Direct Labor 1,600 BRIEF EXERCISE 20-6 Overhead rate per direct labor cost is 160%, or ($800,000 ÷ $500,000). Overhead rate per direct labor hour is $16, or ($800,000 ÷ 50,000). Overhead rate per machine hour is $8, or ($800,000 ÷ 100,000). BRIEF EXERCISE 20-7 Jan. 31 Feb. 28 Mar. 31 Work in Process Inventory ................................... Manufacturing Overhead.............................. ($40,000 X 90%) 36,000 Work in Process Inventory ................................... Manufacturing Overhead.............................. ($30,000 X 90%) 27,000 Work in Process Inventory ................................... Manufacturing Overhead.............................. ($50,000 X 90%) 45,000 36,000 27,000 45,000 BRIEF EXERCISE 20-8 Mar. 31 31 31 Finished Goods Inventory .................................... Work in Process Inventory .......................... 55,000 Cash ............................................................................. Sales.................................................................... 35,000 Cost of Goods Sold................................................. Finished Goods Inventory............................ 25,000 55,000 35,000 25,000 BRIEF EXERCISE 20-9 Dec. 31 Dec. 31 Lott Company Cost of Goods Sold................................................. Manufacturing Overhead.............................. 1,500 Perez Company Manufacturing Overhead....................................... Cost of Goods Sold ........................................ 900 20-8 1,500 900 SOLUTIONS TO EXERCISES EXERCISE 20-1 (a) Factory Labor..................................................................... Factory Wages Payable ......................................... Employer Payroll Taxes Payable........................ Employer Fringe Benefits Payable..................... 72,000 (b) Work in Process Inventory ($72,000 X 85%)............ Manufacturing Overhead................................................ Factory Labor............................................................ 61,200 10,800 60,000 8,000 4,000 72,000 EXERCISE 20-2 (a) May 31 31 31 31 Work in Process Inventory ........................ Manufacturing Overhead............................ Raw Materials Inventory .................... 10,400 800 Work in Process Inventory ........................ Manufacturing Overhead............................ Factory Labor ........................................ 12,500 1,200 Work in Process Inventory......................... ($12,500 X 80%) Manufacturing Overhead ................... 10,000 Finished Goods Inventory.......................... Work in Process Inventory................ 7,920 11,200 13,700 10,000 7,920 ($2,000 + $2,500 + $1,900 + $1,520)* *$1,900 X 80% (b) May 1 Balance 31 31 31 May 31 Balance Work in Process Inventory 3,200 May 31 10,400 12,500 10,000 28,180 20-9 7,920 EXERCISE 20-2 (Continued) Job Cost Sheets Job No. Beginning Work in Process Direct Material Direct Labor Manufacturing* Overhead Total 430 431 $1,200 0 $1,200 $3,500 4,400 $7,900 $ 3,000 7,600 $10,600 $2,400 6,080 $8,480 $10,100 18,080 $28,180 * Direct labor X .80 EXERCISE 20-3 (a) 1. $15,500, or ($5,000 + $6,000 + $4,500). 2. Last year 75%, or ($4,500 ÷ $6,000); this year 80% (either $6,400 ÷ $8,000 or $3,200 ÷ $4,000). (b) Jan. 31 31 31 31 Work in Process Inventory ........................... Raw Materials Inventory ....................... 8,000 Work in Process Inventory ........................... Factory Labor ........................................... 12,000 Work in Process Inventory ........................... Manufacturing Overhead...................... 9,600 Finished Goods Inventory............................. Work in Process Inventory .................. 45,100 EXERCISE 20-4 (a) + $50,000 + $42,500 = $155,650 (a) = $63,150 $155,650 + (b) = $201,500 (b) = $45,850 $201,500 – (c) = $192,300 (c) = $9,200 20-10 8,000 12,000 9,600 45,100 EXERCISE 20-4 (Continued) [Note: The instructions indicate that manufacturing overhead is applied on the basis of direct labor cost, and the rate is the same in all cases. From Case A, a student should note the overhead rate to be 85%, or ($42,500 ÷ $50,000).] (d) = .85 X $120,000 (d) = $102,000 $83,000 + $120,000 + $102,000 = (e) (e) = $305,000 $305,000 + $15,500 = (f) (f) = $320,500 $320,500 – $11,800 = (g) (g) = $308,700 [Note: (h) and (i) are solved together.] (i) = .85(h) $63,150 + (h) + .85(h) = $213,000 1.85(h) = $149,850 (h) = $81,000 (i) = $68,850 (j) = $213,000 + $18,000 (j) = $231,000 $231,000 – (k) = $222,000 (k) = $9,000 EXERCISE 20-5 (a) $2.44 per machine hour ($305,000 ÷ 125,000). (b) ($322,000) – ($2.44 x 130,000 Machine Hours) $322,000 – $317,200 = $4,800 underapplied (c) Cost of Goods Sold............................................................. Manufacturing Overhead.......................................... 20-11 4,800 4,800 EXERCISE 20-6 (a) (1) The source documents are: Direct materials—Materials requisition slips. Direct labor—Time tickets. Manufacturing overhead—Predetermined overhead rate. (2) The predetermined overhead rate is 125% of direct labor cost. For example, on July 15, the computation is $550 ÷ $440 = 125%. The same result is obtained on July 22 and 31. (3) The total cost is: Direct materials....................................................................... Direct labor............................................................................... Manufacturing overhead...................................................... $4,825 1,360 1,700 $7,885 The unit cost is $3.94 ($7,885 ÷ 2,000). (b) July 31 Finished Goods Inventory.................................. Work in Process Inventory........................ 7,885 7,885 EXERCISE 20-7 1. 2. 3. 4. Raw Materials Inventory ......................................................... Accounts Payable ............................................................ 46,300 Work in Process Inventory..................................................... Manufacturing Overhead ........................................................ Raw Materials Inventory ................................................ 29,200 6,800 Factory Labor ............................................................................. Factory Wages Payable.................................................. Employer Payroll Taxes Payable ................................ 53,900 Work in Process Inventory..................................................... Manufacturing Overhead ........................................................ Factory Labor .................................................................... 48,000 5,900 20-12 46,300 36,000 49,000 4,900 53,900 EXERCISE 20-7 (Continued) 5. 6. 7. 8. Manufacturing Overhead............................................... Accounts Payable................................................... 80,500 Work in Process Inventory ($48,000 X 150%)......... Manufacturing Overhead...................................... 72,000 Finished Goods Inventory ............................................ Work in Process Inventory .................................. 88,000 Accounts Receivable...................................................... Sales............................................................................ 103,000 Cost of Goods Sold......................................................... Finished Goods Inventory ................................... 75,000 80,500 72,000 88,000 103,000 75,000 EXERCISE 20-8 1. 2. 3. 4. Raw Materials Inventory ................................................ Accounts Payable................................................... 192,000 Factory Labor.................................................................... Factory Wages Payable ........................................ 87,300 Work in Process Inventory ........................................... Manufacturing Overhead............................................... Raw Materials Inventory ....................................... 153,530 4,470 Work in Process Inventory ........................................... Manufacturing Overhead............................................... Factory Labor........................................................... 80,000 7,300 Manufacturing Overhead............................................... Accounts Payable................................................... 39,500 Manufacturing Overhead............................................... Accumulated Depreciation—Machinery and Equipment .................................................... 14,550 20-13 192,000 87,300 158,000 87,300 39,500 14,550 EXERCISE 20-8 (Continued) 5. 6. Work in Process Inventory............................................ Manufacturing Overhead ...................................... (80% X $80,000) 64,000 Finished Goods Inventory............................................. Work in Process Inventory................................... 234,430 64,000 234,430 Computation of cost of jobs finished: Job A20 A21 A23 Direct Materials $35,240 42,920 39,270 Direct Labor $18,000 22,000 25,000 Manufacturing Overhead $14,400 17,600 20,000 Total $ 67,640 82,520 84,270 $234,430 EXERCISE 20-9 (a) HANNIFAN MANUFACTURING COMPANY Cost of Goods Manufactured Schedule For the Month Ended May 31, 2008 Work in process, May 1................................................ Direct materials used.................................................... Direct labor....................................................................... Manufacturing overhead applied .............................. Total manufacturing costs ................................. Total cost of work in process..................................... Less: Work in process, May 31 ................................ Cost of goods manufactured ..................................... 20-14 $ 14,700 $62,400 32,000 40,000 134,400 149,100 17,900 $131,200 EXERCISE 20-9 (Continued) (b) HANNIFAN MANUFACTURING COMPANY (Partial) Income Statement For the Month Ended May 31, 2008 Sales................................................................................ Cost of goods sold Finished goods, May 1 ..................................... Cost of goods manufactured ......................... Cost of goods available for sale ................... Finished goods, May 31................................... Cost of goods sold ................................... Gross profit................................................................... $200,000 $ 12,600 131,200 143,800 9,500 134,300 $ 65,700 (c) In the May 31 balance sheet, the manufacturing inventories will be reported in current assets as follows: Finished goods $9,500, Work in Process $17,900, and Raw Materials $7,100. EXERCISE 20-10 (a) Work in Process Inventory April 30 May 31 June 30 $9,300 $17,600 $8,500 (#10, $5,200 + #11, $4,100) (#11, $8,000 + #13, $4,700 + #14, $4,900) (#14, $4,900 + $3,600) (b) Finished Goods Inventory April 30 May 31 June 30 $1,200 $9,600 $20,200 (#12) (#10) (#11, $11,000 + #13, $9,200) (c) Gross Profit Month May June July Job Number 12 10 11/13 Sales Cost of Goods Sold Gross Profit $ 1,500 12,000 25,250 $ 1,200 9,600 20,200 $ 300 2,400 5,050 20-15 EXERCISE 20-11 (a) Transaction Accounts Titles Number 1 Supplies Accounts Payable 2 Work in Process Operating Overhead Supplies 3 4 5 6 (b) 2. 3. 5. Debit 1,500 Credit 1,500 720 480 1,200 Work in Process Operating Overhead Salaries Payable 40,000 10,000 Operating Overhead Cash 40,000 Work in Process ($40,000 X 90%) Operating Overhead 36,000 Cost of Completed Work Work in Process 70,000 50,000 40,000 Work in Process 720 70,000 40,000 36,000 6,720 20-16 36,000 70,000 (6) EXERCISE 20-12 (a) Direct materials Auditor labor costs Applied overhead Total cost Gonzalez $ 600 5,400 3,960 $9,960 Navarro $ 400 6,600 4,840 $11,840 Rojas $ 200 3,375 2,475 $6,050 (b) The Gonzalez job is the only incomplete job, therefore, $9,960. (c) Actual overhead Applied overhead Balance $12,000 (DR) 11,275 (CR) $ 725 (DR) EXERCISE 20-13 (a) Predetermined overhead rate = Budgeted overhead ÷ Budgeted decorator hours = $960,000 ÷ 40,000 decorator hours = $24 per decorator hour (b) Applied overhead Work in Process (40,500 hrs X $24) Operating Overhead (c) Actual overhead Applied overhead Balance 972,000 $982,800 972,000 $ 10,800 underapplied 20-17 972,000 SOLUTIONS TO PROBLEMS PROBLEM 20-1A (a) $1,050,000 ÷ $700,000 direct labor costs = 150% of direct labor costs (b) See solution to part (e) for job cost sheets (c) Raw Materials Inventory .................................................... Accounts Payable ....................................................... 90,000 Factory Labor ........................................................................ Employer Payroll Taxes Payable ........................... Factory Wages Payable............................................. 65,000 Manufacturing Overhead ................................................... Raw Materials Inventory ........................................... Factory Labor ............................................................... Accumulated Depreciation....................................... Accounts Payable ....................................................... 71,000 (d) Work in Process Inventory................................................ Raw Materials Inventory............................................ ($10,000 + $39,000 + $30,000) 79,000 Work in Process Inventory................................................ Factory Labor ............................................................... ($5,000 + $25,000 + $20,000) 50,000 Work in Process Inventory................................................ Manufacturing Overhead .......................................... ($50,000 X 150% of direct labor costs) 75,000 90,000 16,000 49,000 17,000 15,000 19,000 20,000 79,000 50,000 See solution to part (e) for postings to job cost sheets. 20-18 75,000 PROBLEM 20-1A (Continued) (e) Job Cost Sheets Job No. 50 Date Direct Materials Beg. Jan. $20,000 10,000 $30,000 Direct Labor Manufacturing Overhead $12,000 5,000 $17,000 *$16,000* * 7,500* *$23,500* Cost of completed job Direct materials......................................................................... Direct labor ................................................................................. Manufacturing overhead........................................................ Total cost ............................................................................................. $30,000 17,000 23,500 $70,500 *$5,000 X 150% Job No. 51 Date Jan. Direct Materials $39,000 $39,000 Direct Labor $25,000 $25,000 Manufacturing Overhead **$37,500** **$37,500** Cost of completed job Direct materials.......................................................................... $ 39,000 Direct labor .................................................................................. 25,000 Manufacturing overhead......................................................... 37,500 Total cost .............................................................................................. $101,500 **$25,000 X 150% Job No. 52 Date Direct Materials Jan. $30,000 Direct Labor Manufacturing Overhead $20,000 ***$30,000*** ***$20,000 X 150% 20-19 PROBLEM 20-1A (Continued) (f) Finished Goods Inventory.............................................. Work in Process Inventory.................................... ($70,500 + $101,500) 172,000 Cost of Goods Sold .......................................................... Finished Goods Inventory..................................... ($90,000 + $70,500) 160,500 Accounts Receivable ....................................................... Sales ............................................................................. ($122,000 + $158,000) 280,000 (g) Beginning balance Cost of completed jobs 50 and 51 Ending balance Finished Goods Inventory 90,000 160,500 172,000 101,500 172,000 160,500 280,000 Cost of jobs 49 and 50 sold The balance in this account consists of the cost of completed Job No. 51 which has not yet been sold. (h) Manufacturing Overhead Actual Applied 71,000 75,000 4,000 The balance in the Manufacturing Overhead account is overapplied. 20-20 PROBLEM 20-2A (a) 1/1 12/31 Work in Process Inventory Balance (1) 128,400 Completed work (5) (c) Direct materials (2) 121,000 Direct labor (3) 139,000 Manufacturing overhead (4) 166,800 Balance 169,000 386,200 (1) Job 7640 Job 7641 $ 77,800 50,600 $128,400 (3) Job 7640 Job 7641 Job 7642 $ 36,000 48,000 55,000 $139,000 (2) Job 7640 Job 7641 Job 7642 $ 30,000 43,000 48,000 $121,000 (4) Job 7640 Job 7641 Job 7642 $ 43,200 57,600 66,000 $166,800 (5) (a) Job 7640 Beginning balance.......................................................... Direct materials ............................................................... Direct labor........................................................................ Manufacturing overhead .............................................. (b) Job 7641 Beginning balance.......................................................... Direct materials ............................................................... Direct labor........................................................................ Manufacturing overhead .............................................. (c) Total cost of completed work Job 7640............................................................................ Job 7641............................................................................ 20-21 $ 77,800 30,000 36,000 43,200 $187,000 $ 50,600 43,000 48,000 57,600 $199,200 $187,000 199,200 $386,200 PROBLEM 20-2A (Continued) Work in process balance ...................................................... $169,000 Unfinished job No. 7642........................................................ $169,000 (a) (a) Current year’s cost Direct materials...................................... Direct labor .............................................. Manufacturing overhead..................... $ 48,000 55,000 66,000 $169,000 (b) Actual overhead costs Incurred on account ...................................................... Indirect materials............................................................ Indirect labor.................................................................... Depreciation..................................................................... Applied overhead costs Job 7640 ............................................................................ Job 7641 ............................................................................ Job 7642 ............................................................................ Actual overhead....................................................................... Applied overhead .................................................................... Overapplied overhead ........................................................... Manufacturing Overhead ...................................................... 4,800 Cost of Goods Sold ....................................................... (c) Sales (given) ................................................................ Cost of goods sold Add: Job 7638 ............................................................ Job 7639 ............................................................ Job 7641 ............................................................ Less: Overapplied overhead ................................. Gross profit .................................................................. 20-22 $120,000 14,000 20,000 8,000 $162,000 $ 43,200 57,600 66,000 $166,800 $162,000 166,800 $ 4,800 4,800 $530,000 $ 87,000 92,000 199,200 378,200 4,800 373,400 $156,600 PROBLEM 20-3A (a) (i) Raw Materials Inventory .................................................... Accounts Payable....................................................... 3,900 3,900 Factory Labor........................................................................ Cash ................................................................................ 4,800 Manufacturing Overhead................................................... Accumulated Depreciation—Equipment............. Accounts Payable....................................................... 1,100 (ii) Work in Process Inventory ............................................... Manufacturing Overhead................................................... Raw Materials Inventory ........................................... 4,900 1,500 Work in Process Inventory ............................................... Manufacturing Overhead................................................... Factory Labor............................................................... 3,600 1,200 Work in Process Inventory ($3,600 X 1.25) ................. Manufacturing Overhead.......................................... 4,500 (iii) Finished Goods Inventory ................................................ Work in Process Inventory ...................................... 14,740 Job Fowler Haines Krantz Direct Materials Direct Labor Manufacturing Overhead* Total Costs $1,700 1,300 2,200 $1,160 900 2,180 $1,450 1,125 2,725 $ 4,310 3,325 7,105 $14,740 4,800 700 400 6,400 4,800 4,500 14,740 *125% X direct labor amount Cash ......................................................................................... Sales................................................................................ 18,900 Cost of Goods Sold............................................................. Finished Goods Inventory ....................................... 14,740 20-23 18,900 14,740 PROBLEM 20-3A (Continued) (b) 6/1 6/30 Work in Process Inventory Balance 5,540 June Completed work Direct materials 4,900 Direct labor 3,600 Overhead applied 4,500 Balance 3,800 14,740 (c) Work in Process Inventory................................................................... $3,800 Job: Elgin (Direct materials $2,000 + Direct labor $800 + Manufacturing overhead $1,000) ....................................... $3,800 (d) ENOS INC. Cost of Goods Manufactured Schedule For the Month Ended June 30, 2008 Work in process, June 1 .................................................. Direct materials used........................................................ Direct labor........................................................................... Manufacturing overhead applied .................................. Total manufacturing costs ..................................... Total cost of work in process......................................... Less: Work in process, June 30................................... Cost of goods manufactured ......................................... 20-24 $ 5,540 $4,900 3,600 4,500 13,000 18,540 3,800 $14,740 PROBLEM 20-4A (a) Department D: Department E: Department K: $1,050,000 ÷ $1,500,000 = 70% of direct labor cost. $1,500,000 ÷ 125,000 = $12.00 per direct labor hour. $840,000 ÷ 120,000 = $7.00 per machine hour. (b) Manufacturing Costs Direct materials Direct labor Overhead applied Total D Department E $140,000 120,000 84,000 * $344,000 $126,000 110,000 132,000 ** $368,000 K $ 78,000 37,500 72,800 *** $188,300 *$120,000 X 70% **11,000 X $12.00 ***10,400 X $7.00 (c) Department Manufacturing Overhead Incurred Applied Under (over) applied D $89,000 84,000 $ 5,000 20-25 E $124,000 132,000 $ (8,000) K $74,000 72,800 $ 1,200 PROBLEM 20-5A (a) $7,600 ($18,850 + $7,975 – $19,225). (b) $36,750 [$9,750 + $15,000 + (80% X $15,000)]. (Given in other data). (c) $16,950 ($18,850 – $1,900). (d) $7,040 ($8,800 X 80%). (e) $12,440 [Given in other data—$3,800 + $4,800 + (80% + $4,800)]. (f) ($36,750 + $16,950 + $8,800 + $7,040 – $12,440). $57,100 (g) $5,000 (Given in other data). (h) $57,100 (See (f) above). (i) $58,100 ($5,000 + $57,100 – $4,000). (j) $4,000 (Given in other data). (k) $12,465 (Equal to factory labor incurred). (l) ($12,465 – $8,800). $3,665 (m) $7,040 ($6,810* + $230) or (Same as (d)). *$1,900 + $3,665 + $1,245 20-26 PROBLEM 20-1B (a) $440,000 ÷ 20,000 direct labor hours = $22 per direct labor hour (b) See solution to part (e) for job cost sheets (c) Raw Materials Inventory .................................................... Accounts Payable....................................................... 45,000 Factory Labor........................................................................ Employer Payroll Taxes Payable........................... Factory Wages Payable ............................................ 31,500 Manufacturing Overhead................................................... Raw Materials Inventory ........................................... Factory Labor............................................................... Accumulated Depreciation ...................................... Accounts Payable....................................................... 37,500 (d) Work in Process Inventory ............................................... Raw Materials Inventory ........................................... ($5,000 + $20,000 + $15,000) 40,000 Work in Process Inventory ............................................... Factory Labor............................................................... ($3,000 + $12,000 + $9,000) 24,000 Work in Process Inventory ............................................... Manufacturing Overhead.......................................... (200 + 800 + 600) X $22 per hour 35,200 45,000 7,500 24,000 10,000 7,500 12,000 8,000 40,000 24,000 See solution to part (e) for postings to job cost sheets. 20-27 35,200 PROBLEM 20-1B (Continued) (e) Job Cost Sheets Job No. 25 Date Direct Materials Beg. Jan. Direct Labor Manufacturing Overhead $6,000 3,000 $9,000 *$ 9,000* * 4,400* *$13,400* $10,000 5,000 $15,000 Cost of completed job Direct materials......................................................................... Direct labor................................................................................. Manufacturing overhead........................................................ Total cost ............................................................................................. $15,000 9,000 13,400 $37,400 *$22 X 200 direct labor hours Job No. 26 Date Jan. Direct Materials $20,000 $20,000 Direct Labor $12,000 $12,000 Manufacturing Overhead **$17,600** **$17,600** Cost of completed job Direct materials......................................................................... Direct labor................................................................................. Manufacturing overhead........................................................ Total cost ............................................................................................. $20,000 12,000 17,600 $49,600 **$22 X 800 direct labor hours Job No. 27 Date Direct Materials Jan. Direct Labor Manufacturing Overhead $9,000 ***$13,200*** $15,000 ***$22 X 600 direct labor hours 20-28 PROBLEM 20-1B (Continued) (f) Finished Goods Inventory ........................................... Work in Process Inventory ................................. ($37,400 + $49,600) 87,000 Cost of Goods Sold........................................................ Finished Goods Inventory .................................. ($45,000 + $37,400) 82,400 Accounts Receivable..................................................... Sales........................................................................... ($67,000 + $74,000) 141,000 (g) Beginning balance Direct materials Direct labor Manufacturing overhead Ending balance Work in Process 25,000 87,000 40,000 24,000 35,200 37,200 87,000 82,400 141,000 Cost of completed jobs 25 and 26 The balance in this account consists of the current costs assigned to Job No. 27: Direct Materials............................................................................ Direct Labor .................................................................................. Manufacturing Overhead.......................................................... Total costs assigned......................................................... $15,000 9,000 13,200 $37,200 (h) Manufacturing Overhead Actual Applied 37,500 35,200 2,300 The balance in the Manufacturing Overhead account is underapplied. 20-29 PROBLEM 20-2B (a) 1/1 12/31 Work in Process Inventory Balance (1) 115,500 Completed work (5) (c) Direct materials (2) 100,000 Direct labor (3) 138,000 Manufacturing overhead (4) 172,500 Balance 193,000 333,000 (1) Job 7650 Job 7651 $ 63,000 52,500 $115,500 (3) Job 7650 Job 7651 Job 7652 $ 30,000 40,000 68,000 $138,000 (2) Job 7650 Job 7651 Job 7652 $ 32,000 28,000 40,000 $100,000 (4) Job 7650 Job 7651 Job 7652 $ 37,500 50,000 85,000 $172,500 (5) (a) Job 7650 Beginning balance .......................................................... Direct materials................................................................ Direct labor ........................................................................ Manufacturing overhead............................................... (b) Job 7651 Beginning balance .......................................................... Direct materials................................................................ Direct labor ........................................................................ Manufacturing overhead............................................... (c) Total cost of completed work Job 7650 ............................................................................. Job 7651 ............................................................................. 20-30 $ 63,000 32,000 30,000 37,500 $162,500 $ 52,500 28,000 40,000 50,000 $170,500 $162,500 170,500 $333,000 PROBLEM 20-2B (Continued) Work in process balance.......................................................... $193,000 Unfinished job No. 7652 ........................................................... $193,000 (a) (a) Current year’s cost Direct materials ................................ Direct labor ........................................ Manufacturing overhead ............... $ 40,000 68,000 85,000 $193,000 (b) Actual overhead costs Incurred on account........................................................ Indirect materials ............................................................. Indirect labor ..................................................................... Depreciation ...................................................................... Applied overhead costs Job 7650.............................................................................. Job 7651.............................................................................. Job 7652.............................................................................. Actual overhead ........................................................................ Applied overhead...................................................................... Underapplied overhead .......................................................... Cost of Goods Sold................................................................. 3,000 Manufacturing Overhead.............................................. (c) Sales (given)............................................................... Cost of goods sold Add: Job 7648 ........................................................... Job 7649 ........................................................... Job 7650 ........................................................... Add: Underapplied overhead............................... Gross profit................................................................. 20-31 $126,000 12,000 18,000 19,500 $175,500 $ 37,500 50,000 85,000 $172,500 $175,500 172,500 $ 3,000 3,000 $490,000 $ 98,000 62,000 162,500 322,500 3,000 325,500 $164,500 PROBLEM 20-3B (a) (i) Raw Materials Inventory ................................................... Accounts Payable ...................................................... 5,000 5,000 Factory Labor ....................................................................... Cash................................................................................ 7,600 Manufacturing Overhead .................................................. Cash................................................................................ 1,400 (ii) Work in Process Inventory............................................... Manufacturing Overhead .................................................. Raw Materials Inventory .......................................... 5,800 1,500 Work in Process Inventory............................................... Manufacturing Overhead .................................................. Factory Labor .............................................................. 5,600 2,000 Work in Process Inventory............................................... ($5,600 X .75) Manufacturing Overhead ......................................... 4,200 (iii) Finished Goods Inventory................................................ Work in Process Inventory...................................... 20,525 Job Direct Materials Direct Labor Manufacturing Overhead* Total Costs Looper Carpenter Ingle $3,000 2,600 3,200 $2,400 2,200 2,100 $1,800 1,650 1,575 $ 7,200 6,450 6,875 $20,525 7,600 1,400 7,300 7,600 4,200 20,525 *75% of direct labor amount Cash......................................................................................... Sales (3 X $12,500)..................................................... 37,500 Cost of Goods Sold ............................................................ Finished Goods Inventory....................................... 20,525 20-32 37,500 20,525 PROBLEM 20-3B (Continued) (b) 5/1 5/31 Work in Process Inventory Balance 12,400 5/31 Completed work Direct materials 5,800 Direct labor 5,600 Overhead applied 4,200 Balance 7,475 20,525 (c) Work in Process Inventory .................................................................. $7,475 Job: Bennett (Direct materials $2,400 + Direct labor $2,900 + Manufacturing overhead $2,175)........................................ $7,475 (d) CHRIS DUNCAN COMPANY Cost of Goods Manufactured Schedule For the Month Ended May 31, 2008 Work in process, May 1 ................................................... Direct materials used........................................................ Direct labor .......................................................................... Manufacturing overhead applied.................................. Total manufacturing costs..................................... Total cost of work in process ........................................ Less: Work in process, May 31.................................... Cost of goods manufactured ......................................... 20-33 $12,400 $5,800 5,600 4,200 15,600 28,000 7,475 $20,525 PROBLEM 20-4B (a) Department A: Department B: Department C: $900,000 ÷ $600,000 = 150% of direct labor cost. $800,000 ÷ 40,000 = $20.00 per direct labor hour. $750,000 ÷ 125,000 = $6.00 per machine hour. (b) Department Manufacturing Costs Direct materials Direct labor Overhead applied Total A $ 92,000 48,000 72,000 * $212,000 B $ 86,000 35,000 70,000 ** $191,000 C $ 64,000 50,400 75,600 *** $190,000 *$48,000 X 150% **3,500 X $20 ***12,600 X $6.00 (c) Department Manufacturing Overhead Incurred Applied Under (over) applied A B $76,000 72,000 $ 4,000 $75,000 70,000 $ 5,000 20-34 C $72,100 75,600 $ (3,500) PROBLEM 20-5B (a) $78,900 ($70,000 + $8,900). (b) $30,500 [($19,000 + $90,400) – $78,900 (See (a))]. (c) $27,200 (Given in other data—$19,000 + $8,200). (d) $80,000 ($104,000 manufacturing overhead applied ÷ 130%). (e) $104,000 (Manufacturing overhead applied). (f) [$27,200 + $70,000 + $80,000 + $104,000 – $5,450 (See (g))]. $275,750 (g) $5,450 [$2,000 + $1,500 + ($1,500 X 130%)]. (h) $135,000 (Given in other data). (i) $275,750 (Same as (f)). (j) $267,750 [$135,000 + $275,750 – $143,000 (Given in other data)]. (k) $143,000 (Given in other data). (l) [$80,000 (See (d)) + $16,000]. $96,000 (m) $96,000 (Same as (l)). (n) $82,100 [$104,000 + $3,000 (Given in other data) – $8,900 – $16,000]. 20-35 BYP 20-1 DECISION MAKING ACROSS THE ORGANIZATION (a) The manufacturing cost element that is responsible for the fluctuating unit costs is manufacturing overhead. Manufacturing overhead is being included as incurred rather than being applied on a predetermined basis. Direct materials and direct labor are not the cause as they have the same unit cost per batch in each quarter. (b) The solution is to apply overhead using a predetermined overhead rate based on a relevant basis of production activity. Based on actual overhead incurred and using batches of product TC-1 as the activity base, the overhead rate is $15,000 per batch [($105,000 + $123,000 + $97,000 + $125,000) ÷ 30]. Another approach would be to use direct labor cost as the relevant basis to apply overhead on a predetermined basis. For example, a rate of 125% of direct labor cost ($450,000 ÷ $360,000) could be used. Either approach will provide the same result. (c) The quarterly results using a predetermined overhead rate based on batches produced are as follows: Quarter Costs Direct materials Direct labor Manufacturing overhead Applied ($15,000 X batches) Total Production in batches Unit cost (per batch) 1 2 3 4 $100,000 60,000 $220,000 132,000 $ 80,000 48,000 $200,000 120,000 75,000 $235,000 165,000 $517,000 60,000 $188,000 150,000 $470,000 5 11 4 10 $ 47,000 $ 47,000 $ 47,000 $ 47,000 (Note: The unit cost of a batch remains the same in each quarter. Both sales and production should be pleased with this solution to fluctuating unit costs.) 20-36 BYP 20-2 1. MANAGERIAL ANALYSIS (a) Work in Process Inventory .................................. Raw Materials Inventory .............................. 25,000 25,000 (b) If not corrected, the balance sheet is affected. Cash is understated and Raw Materials Inventory is overstated. 2. (a) Sales Bonus Expense ........................................... Cash ................................................................... 12,000 12,000 (b) Both the income statement and the balance sheet are affected. In the income statement, Sales Bonus Expense is understated, Income Tax Expense is overstated, and net income is overstated. The error causes the underapplied overhead to be overstated or the overapplied overhead to be understated. This affects Cost of Goods Sold, since the over- or underapplied balance is closed out to Cost of Goods Sold. The error in Cost of Goods Sold also has an effect on Retained Earnings. Also, Retained Earnings is overstated because of the overstatement of net income, and Income Taxes Payable is overstated. 3. (a) Factory Labor........................................................... Factory Wages Payable ............................... Employer Payroll Taxes Payable.............. 120,000 105,000 15,000 (b) If not corrected, both the income statement and the balance sheet are affected. On the income statement, Cost of Goods Sold is understated and Wages Expense is overstated. On the balance sheet, Cash, Factory Wages Payable, and Employer Payroll Taxes Payable are understated. 20-37 BYP 20-2 (Continued) 4. (a) Manufacturing Overhead ....................................... Raw Materials Inventory ............................... 3,000 3,000 (b) Both the income statement and balance sheet are affected. If units that were in process during the month have been sold, then in the income statement Cost of Goods Sold is overstated, Income Tax Expense is understated, and net income is understated. This causes the Retained Earnings and Income Taxes Payable in the balance sheet to be understated. Also the error causes underapplied overhead to be understated or overapplied overhead to be overstated. This affects Cost of Goods Sold, since the over- or underapplied balance is closed out to Cost of Goods Sold. The error in Cost of Good Sold also has an affect on Retained Earnings. 20-38 BYP 20-3 REAL-WORLD FOCUS (a) The advantages of job order costing include the following: 1. Accurate costing results because actual costs of direct materials and direct labor are assigned to each job. 2. A comparison of actual costs with costs estimated in the company’s bid provides a basis for controlling job costs and improving operating efficiency. 3. Cost data on specific jobs may be useful to management in bidding on similar jobs in the future. 4. Accurate costs are assigned to work in process and finished goods inventories. 5. Job costing enables management to assess the relationship of the cost of goods sold for each job to the sales price of each job. The reciprocal of this relationship is the gross profit on each job. Improving these relationships is an important factor in increasing net income. (b) Products in job order costing are usually custom-made to customer specifications so that a sale is assured prior to the start of the manufacturing process. Specific products include cruise ships, presidential limousines, buildings, homes, wedding invitations, and graduation and birth announcements. Products in process costing are relatively homogeneous such as boxes of cereal, bottles and cans of soda, jars of peanut butter, quarts of motor oil, and automobiles. The manufacture of the product is continuous to ensure that adequate inventories of finished products are available at all times. 20-39 BYP 20-4 EXPLORING THE WEB (a) Candidates for the CMA or CFM Certificate must complete two continuous years of professional experience in management accounting or financial management. This requirement may be completed prior to or within seven years of passing the examination. (b) CMAs, CFMs, and candidates who have successfully completed all parts of a certification program must maintain their professional competence through a regular program of continuing professional education. To remain in good standing with the Institute of Certified Management Accountants, 30 hours of continuing education must be completed each year subsequent to passing the exam. Reporting of continuing education is done in conjunction with renewal of IMA membership. Credit will be given for subjects relevant to the CMA’s or CFM’s career development and related to employer needs. Such qualifying subjects include: management accounting, financial management, corporate taxation, computer science, systems analysis, statistics, management skills, insurance, marketing, and business law. 20-40 BYP 20-5 COMMUNICATION ACTIVITY Newberry Manufacturing Date Donna Werly 123 Cedar Lane Altoona, Kansas 66651 Dear Ms. Werly: Thank you for your prompt payment! I am very glad that you found the cost information helpful. Thank you also for your questions about our overhead costs. We do try to provide our customers with as much information as possible, but we cannot give detailed information on overhead costs. The cost of providing such information is prohibitive. You asked why we do not use actual overhead costs when we bill our customers. We estimate overhead costs, rather than use actual costs, for several reasons. One of the most important for you is that we could not prepare bills in a timely manner if we had to use actual overhead. We would have to wait until we were billed for such things as electricity and telephone service. A second reason is that some costs we include in overhead are only payable once or twice a year, such as insurance and taxes. When we use an estimated rate, we are able to allow for those costs. A third reason is that some costs are fixed, which means that they stay the same in dollar amount from month to month. This category includes items such as rent. If we billed you based on our actual costs, you would be billed a higher amount if your work was done during a slow time (because we would have fewer jobs to spread the costs over). An estimated overhead rate allows us to level out these costs. 20-41 BYP 20-5 (Continued) I hope this answers some of your questions. I’m glad you are interested in our company and that you took the time to write. I am sending a copy of our annual report under separate cover. It contains some details on the information you asked about. Thanks again for your letter and for having Newberry make your new cabinets! Sincerely, Student 20-42 BYP 20-6 ETHICS CASE (a) The stakeholders in this situation are:



Betty Keiser, controller for SEK Printing. The president of SEK Printing. The customers of SEK Printing. The competitors of SEK Printing. (b) Padding cost-plus contracts is both unethical and illegal. Betty is faced with an ethical dilemma. She will be in trouble with the president if she doesn’t follow his directive, and she will be committing an unethical act if she does follow his instructions. (c) Betty should continue to accurately account for cost-plus contracts and, if challenged by the president, she should say that she is doing her very best to charge each and every legitimate cost to the cost-plus contracts. Let the president perform the unethical act if he continues to persist in padding costs. 20-43 BYP 20-7 (a) ALL ABOUT YOU ACTIVITY Your chances of success in small business are increased if you have the following characteristics: You are a self-starter, you get along with many different kinds of people, you are good at making decisions, you have physical and emotional stamina, you are well organized, you have a strong desire to succeed and you will receive family support during the start up phase. (b) The top ten reason why businesses fail as sited in article from the books Small Business Management by Michael Ames, and The Do it Yourself Business Book by Gustav Berle are: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. Lack of experience Insufficient capital (money) Poor location Poor inventory management Over-investment in fixed assets Poor credit arrangements Personal use of business funds Unexpected growth Competition Low sales 20-44 CHAPTER 21 Process Cost Accounting ASSIGNMENT CLASSIFICATION TABLE Brief Exercises A Problems B Problems 3A 3B 2, 4 3A 3B 5, 10 3, 5, 6, 7, 8, 9, 10, 11, 13 1A, 2A, 4A, 5A, 6A 1B, 2B, 4B, 5B, 6B 4, 6, 7, 8, 9 3, 5, 6, 7, 8, 9, 10, 11, 13 1A, 2A, 4A, 5A 1B, 2B, 4B, 5B 7, 12, 13 1A, 2A, 4A, 5A, 6A 1B, 2B, 4B, 5B, 6B 14, 15 7A Study Objectives Questions * 1. Understand who uses process cost systems. 1, 2 1 * 2. Explain the similarities and differences between job order cost and process cost systems. 2, 3, 4, 5 1 * 3. Explain the flow of costs in a process cost system. 6 * 4. Make the journal entries to assign manufacturing costs in a process cost system. 6, 7 1, 2, 3 * 5. Compute equivalent units. 10, 11, 12, 13 * 6. Explain the four steps necessary to prepare a production cost report. 8, 9, 14, 15, 18 * 7. Prepare a production cost report. 16, 17, 19, 20 * 8. Explain just-in-time (JIT) processing. 21 * 9. Explain activity-based costing (ABC). 22, 23 *10. Apply activity-based costing to specific company data. 24 11 Exercises *Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix*to the chapter. 21-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Complete four steps necessary to prepare a production cost report. Simple 30–40 2A Complete four steps necessary to prepare a production cost report. Simple 30–40 3A Journalize transactions. Moderate 20–30 4A Assign costs and prepare production cost report. Moderate 20–30 5A Determine equivalent units and unit costs and assign costs. Moderate 20–30 6A Compute equivalent units and complete production cost report. Moderate 15–25 Assign overhead to products using ABC. Moderate 40–50 *7A* 1B Complete four steps necessary to prepare a production cost report. Simple 30–40 2B Complete four steps necessary to prepare a production cost report. Simple 30–40 3B Journalize transactions. Moderate 20–30 4B Assign costs and prepare production cost report. Moderate 20–30 5B Determine equivalent units and unit costs and assign costs. Moderate 20–30 6B Compute equivalent units and complete production cost report. Moderate 15–25 21-2 Study Objective * 1. Understand who uses process cost systems. Knowledge Comprehension Q21-2 E21-1 * 2. Explain the similarities and differences Q21-2 Q21-3 between job order cost and process cost systems. Q21-4 Q21-5 E21-1 Application Analysis 21-3 Q21-6 P21-3A P21-3B * 4. Make the journal entries to assign manufacturing costs in a process cost system. Q21-6 Q21-7 BE21-1 BE21-2 BE21-3 E21-2 E21-4 P21-3A P21-3A P21-3B P21-3B * 5. Compute equivalent units. Q21-10 Q21-11 Q21-12 Q21-13 BE21-5 BE21-10 E21-3 E21-5 E21-6 E21-7 E21-8 E21-9 E21-10 E21-11 E21-13 P21-1A P21-2A P21-4A P21-5A P21-6A P21-1B P21-2B P21-4B P21-5B P21-6B P21-1A P21-2A P21-1B P21-2B * 6. Explain the four steps necessary to prepare a production cost report. Q21-8 Q21-9 Q21-14 Q21-15 Q21-18 BE21-4 BE21-6 BE21-7 BE21-8 BE21-9 E21-3 E21-5 E21-6 E21-7 E21-8 E21-9 E21-10 E21-11 E21-13 P21-1A P21-2A P21-4A P21-5A P21-1B P21-2B P21-4B P21-5B P21-1A P21-2A P21-1B P21-2B * 7. Prepare a production cost report. Q21-16 Q21-17 Q21-19 Q21-16 Q21-20 E21-7 E21-12 E21-13 P21-1A P21-2A P21-4A P21-5A P21-6A P21-1B P21-2B P21-4B P21-5B P21-6B Broadening Your Perspective P21-3A P21-3B Q21-21 * 9. Explain activity-based costing (ABC). *10. Apply activity-based costing to specific company data. Evaluation Q21-1 * 3. Explain the flow of costs in a process cost system. * 8. Explain just-in-time (JIT) processing. Synthesis Q21-22 Q21-23 BE21-11 E21-14 Q21-24 Real-World Focus Exploring the Web E21-15 P21-7A Managerial Analysis Decision Making Across the Decision Making Organization Across the Real-World Focus Organization Communication Ethics Case All About You BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. (a) (b) (c) (d) Process cost. Process cost. Job order. Job order. 2. The primary focus of job order cost accounting is on the individual job. In process cost accounting, the primary focus is on the processes involved in producing homogeneous products. 3. The similarities are: (1) all three manufacturing cost elements—direct materials, direct labor, and overhead—are the same; (2) the accumulation of the costs of materials, labor, and overhead is the same; and (3) the flow of costs is the same. 4. The features of process cost accounting are: (1) separate work in process accounts for each process, (2) production cost reports, (3) product costs computed for each accounting period, and (4) unit costs computed based on total manufacturing costs. 5. Mel is correct. The flow of costs is the same in process cost accounting as in job order cost accounting. The method of assigning costs, however, is significantly different. 6. (a) (1) Materials are charged to production on the basis of materials requisition slips. (2) Labor is usually charged to production on the basis of the payroll register or departmental payroll summaries. (b) The criterion used in assigning overhead to processes is to identify the activity that “drives” or causes the cost. In many companies this activity is machine time, not direct labor. 7. The entry to assign overhead to production is: July 31 Work in Process—Machining ............................................................... Work in Process—Assembly ................................................................ Manufacturing Overhead.............................................................. 15,000 12,000 27,000 8. To prepare a production cost report, four steps are followed: (a) compute the physical unit flow, (b) compute equivalent units of production, (c) compute unit costs of production, and (d) prepare a cost reconciliation schedule. 9. Physical units to be accounted for consist of units in process at the beginning of the period plus units started (or transferred) into production during the period. Units accounted for consist of units completed and transferred out during the period plus units in process at the end of the period. 10. Equivalent units of production measure the work done during the period, expressed in fully completed units. 11. Equivalent units are the sum of: (1) units completed and transferred out and (2) equivalent units of ending work in process. 12. Units started into production were 9,600, or (9,000 + 600). 21-4 Questions Chapter 21 (Continued) 13. Equivalent Units Materials Conversion Cost 12,000 12,000 Units transferred out Work in process 800 X 100% 800 X 20% Total equivalent units 14. 800 12,800 Units transferred out were 3,300 Units to be accounted for Work in process (beginning) Started into production Total units 160 12,160 500 3,000 3,500 Units accounted for Completed and transferred out Work in process (ending) Total units 3,300 200 3,500 15. (a) (b) The cost of the units transferred out is $126,000, or (14,000 X $9). The cost of the units in ending inventory is $9,000, or [(2,000 X $3) + (500 X $6)]. 16. (a) (b) Eve is incorrect. The report is an internal report for management. There are four sections in a production cost report: (1) number of physical units, (2) equivalent units determination, (3) unit costs, and (4) cost reconciliation schedule. 17. The production cost report provides the basis for evaluating: (1) the productivity of a department, (2) whether unit and total costs are reasonable, and (3) whether management’s predetermined production and cost goals are being met. 18. The per unit conversion cost is $8.75. [Conversion costs = $6,000 – $3,200 = $2,800. Equivalent units for conversion costs are 320 (800 X 40%); $2,800 ÷ 320 = $8.75.] 19. Operations costing is similar to process costing in that standardized methods are used to manufacture the product. At the same time, the product may have some individual features that require the use of a job order cost system. 20. In deciding which system to use, a cost-benefit tradeoff occurs. In a job order system, detailed information related to the cost of the product is involved. The cost of implementing this system is often expensive. In a process cost system, an average cost of the product will suffice and therefore the cost to implement is less. In summary, the cost of implementing the system must be balanced against the benefits provided from the additional information. 21. (a) (b) Just-in-time processing has a “just-in-time” philosophy and a “pull” approach. There are three important elements in JIT processing: (1) A company must have dependable suppliers who are willing to deliver on short notice exact quantities of raw materials according to precise quality specifications. (2) A multiskilled workforce must be developed. (3) A total quality control system must be established. 21-5 Questions Chapter 21 (Continued) 22. (a) The principal differences are: (1) Primary focus (2) Bases of allocation (3) Total product costs (b) 23. Traditional Costing Units of production Single unit-level bases Direct materials plus direct labor plus manufacturing overhead There are two assumptions that must be met in using ABC: (1) All overhead costs related to the activity must be driven by the cost driver used to assign costs to products. (2) All overhead costs related to the activity should respond proportionally to changes in the activity level of the cost driver. An appropriate cost driver for each activity is: Activity Materials handling Machine setups Factory machine maintenance Factory supervision Quality control *24. Activity-Based Costing Activities performed in making products Multiple cost drivers Sum of costs of activities performed in making product Cost Driver Number of requisitions Number of setups Machine hours used Number of employees Number of inspections (a) ABC involves the following steps: (1) Identify the major activities that pertain to the manufacture of specific products. (2) Accumulate manufacturing overhead costs by activities. (3) Identify the cost driver(s) that accurately measure(s) each activity’s contribution to the finished product. (4) Assign manufacturing overhead costs for each activity to products using the cost driver(s). (b) The principal advantages of ABC are: (1) More accurate product costing is achieved. (2) Control over overhead costs is enhanced. (3) Better management decisions can be made in: (a) setting selling prices, (b) deciding whether to discontinue or expand a product line, and (c) deciding whether to make or buy a product component. 21-6 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 21-1 Mar. 31 31 Raw Materials Inventory........................................ Accounts Payable........................................... 45,000 Factory Labor ........................................................... Wages Payable ................................................ 50,000 45,000 50,000 BRIEF EXERCISE 21-2 Mar. 31 31 Work in Process—Assembly Department....... Work in Process—Finishing Department........ Raw Materials Inventory............................... 24,000 21,000 Work in Process—Assembly Department....... Work in Process—Finishing Department........ Factory Labor................................................... 30,000 20,000 45,000 50,000 BRIEF EXERCISE 21-3 Mar. 31 Work in Process—Assembly Department........ ($30,000 X 200%) Work in Process—Finishing Department......... ($20,000 X 200%) Manufacturing Overhead .............................. 60,000 40,000 100,000 BRIEF EXERCISE 21-4 Beginning work in process Started into production Total units Transferred out Ending work in process Total units 21-7 January 0 40,000 40,000 March 0 48,000 48,000 July 0 56,000 56,000 30,000 10,000 40,000 40,000 8,000 48,000 40,000 16,000 56,000 BRIEF EXERCISE 21-5 January March July Materials Conversion Costs 40,000 (30,000 + 10,000) 48,000 (40,000 + 8,000) 56,000 (40,000 + 16,000) 34,000 (30,000 + 4,000) 46,000 (40,000 + 6,000) 44,000 (40,000 + 4,000) BRIEF EXERCISE 21-6 Total materials costs $32,000 Total conversion costs $54,000 Unit materials cost $3.20 ÷ Equivalent units of materials 10,000 ÷ Equivalent units of conversion costs 12,000 + Unit conversion cost $4.50 = Unit materials cost $3.20 = Unit conversion cost $4.50 = Total manufacturing cost per unit $7.70 BRIEF EXERCISE 21-7 Assignment of Costs Transferred out Transferred out Work in process, 4/30 Materials Conversion costs Total costs Equivalent Units Unit Cost 40,000 $13.00 5,000 2,000 $ 4.00 $ 9.00 $520,000 $20,000 18,000 38,000 $558,000 BRIEF EXERCISE 21-8 Total materials costs $15,000 ÷ Equivalent units of materials 20,000 21-8 = Unit materials cost $.75 BRIEF EXERCISE 21-8 (Continued) Total conversion *costs* $47,500 ÷ Equivalent units of conversion costs 19,000 = Unit conversion cost $2.50 *$29,500 + $18,000 BRIEF EXERCISE 21-9 Costs accounted for Transferred out Work in process Materials Conversion costs Total costs $58,500 (18,000 X $3.25) (2,000 X $.75) (1,200 X $2.50) $1,500 3,000 4,500 $63,000 BRIEF EXERCISE 21-10 Units transferred out Work in process, November 30 Materials (5,000 X 100%) Conversion costs (5,000 X 40%) Total equivalent units Materials Conversion Costs 8,000 8,000 5,000 13,000 *BRIEF EXERCISE 21-11 Machine setups Machining Inspections $120,000 ÷ 1,000 = $120 per setup $300,000 ÷ 25,000 = $12 per machine hour $70,000 ÷ 2,000 = $35 per inspection 21-9 2,000 10,000 SOLUTIONS TO EXERCISES EXERCISE 21-1 1. 2. 3. True. True. False. Companies that produce soft drinks, oil, and computer chips would all use process cost accounting. 4. False. In a job order cost system, costs are tracked by individual jobs. 5. False. Job order costing and process costing track the same three manufacturing cost elements. 6. True. 7. True. 8. False. In a process cost system, multiple work in process accounts are used. 9. False. In a process cost system, costs are summarized in a production cost report for each department. 10. True. EXERCISE 21-2 (a) April 30 30 30 30 Work in Process—Cooking .......................... Work in Process—Canning .......................... Raw Materials Inventory ....................... 21,000 6,000 Work in Process—Cooking .......................... Work in Process—Canning .......................... Factory Labor........................................... 8,500 7,000 Work in Process—Cooking........................... Work in Process—Canning........................... Manufacturing Overhead ...................... 29,500 25,800 Work in Process—Canning........................... Work in Process—Cooking.................. 53,000 21-10 27,000 15,500 55,300 53,000 EXERCISE 21-3 (a) Work in process, May 1 Started into production Total units to be accounted for Less: Transferred out Work in process, May 31 400 1,100 1,500 1,200 300 (b) Equivalent Units Materials Conversion Costs Units transferred out Work in process, May 31 300 X 100% 300 X 40% 1,200 1,200 300 Work in process, May 1 Costs added Total materials cost 1,500 120 1,320 Direct Materials Conversion Costs $2,040 5,160 $7,200 $1,550 4,390 $5,940 $7,200 ÷ 1,500 = $4.80 (c) $5,940 ÷ 1,320 = $4.50 (d) Transferred out (1,200 X $9.30) $11,160 (e) Work in process Materials (300 X $4.80) Conversion costs (120 X $4.50) 21-11 $1,440 540 $1,980 EXERCISE 21-4 1. 2. 3. 4. 5. 6. 7. 8. 9. Raw Materials Inventory ................................................. Accounts Payable .................................................... 62,500 Factory Labor ..................................................................... Wages Payable.......................................................... 56,000 Manufacturing Overhead ................................................ Cash.............................................................................. Accounts Payable .................................................... 70,000 Work in Process—Cutting.............................................. Work in Process—Assembly......................................... Raw Materials Inventory ........................................ 15,700 8,900 Work in Process—Cutting.............................................. Work in Process—Assembly......................................... Factory Labor ............................................................ 29,000 27,000 Work in Process—Cutting (1,680 x $15) .................... Work in Process—Assembly (1,720 x $15)............... Manufacturing Overhead ....................................... 25,200 25,800 Work in Process—Assembly......................................... Work in Process—Cutting..................................... 67,600 Finished Goods Inventory.............................................. Work in Process—Assembly................................ 134,900 Cost of Goods Sold .......................................................... Finished Goods Inventory..................................... 150,000 Accounts Receivable ....................................................... Sales ............................................................................. 200,000 21-12 62,500 56,000 40,000 30,000 24,600 56,000 51,000 67,600 134,900 150,000 200,000 EXERCISE 21-5 (a) January May Units to be accounted for Beginning work in process Started into production Total units 0 9,000 9,000 0 21,000 21,000 Units accounted for Transferred out Ending work in process Total units 7,000 2,000 9,000 16,000 5,000 21,000 (b) (1) January March May July Materials (2) Conversion Costs 8,200 (7,000 + 1,200) 12,900 (12,000 + 900) 20,000 (16,000 + 4,000) 10,600 (10,000 + 600) 9,000 (7,000 + 2,000) 15,000 (12,000 + 3,000) 21,000 (16,000 + 5,000) 11,500 (10,000 + 1,500) EXERCISE 21-6 (a) Materials Conversion Costs 9,000 9,000 Units transferred out Work in process, July 31 3,000 X 100% 3,000 X 60% Total equivalent units 3,000 12,000 1,800 10,800 (b) Materials: $45,000 ÷ 12,000 = $3.75 Conversion costs: ($16,200 + $18,900) ÷ 10,800 = $3.25 Costs accounted for Transferred out (9,000 X $7.00) Work in process, July 31 Materials (3,000 X $3.75) Conversion costs (1,800 X $3.25) Total costs 21-13 $63,000 $11,250 5,850 17,100 $80,100 EXERCISE 21-7 ORTIZ FURNITURE COMPANY Sanding Department Production Cost Report For the Month Ended March 31, 2008 Quantities Physical Units Units to be accounted for Work in process, March 1 Started into production Total units 0 15,000 15,000 Units accounted for Transferred out Work in process, March 31 Total units 12,000 3,000 15,000 Equivalent Units Conversion Materials Costs 12,000 3,000 15,000 12,000 600 12,600 Costs Materials Conversion Costs Unit costs Costs in March Equivalent units Unit costs (a) ÷ (b) $33,000 15,000 $2.20 $63,000 12,600 $5.00 Costs to be accounted for Work in process, March 1 Started into production Total costs (3,000 X 20%) Total $96,000 $7.20 $ 0 96,000 $96,000 Cost Reconciliation Schedule Costs accounted for Transferred out (12,000 X $7.20) Work in process, March 31 Materials (3,000 X $2.20) Conversion costs (600 X $5.00) Total costs $86,400 $6,600 3,000 21-14 9,600 $96,000 EXERCISE 21-8 (a) Units transferred out Work in process, April 30 1,000 X 100% 1,000 X 40% Materials Conversion Costs 14,000 14,000 1,000 15,000 (b) Costs in April Equivalent units Unit costs (1) $100,000 + $800,000 (2) $ 70,000 + $362,000 400 14,400 Materials Conversion Costs $900,000(1) 15,000 $60.00 $432,000(2) 14,400 $30.00 (c) Transferred out (14,000 X $90.00) Work in process Materials (1,000 X $60) Conversion costs (400 X $30) Total costs $60,000 12,000 (a) Materials: 30,000 + 6,000 = 36,000 Conversion costs: 30,000 + (6,000 X 40%) = 32,400 (b) Materials: $72,000/36,000 = $2.00 Conversion costs: ($81,000 + $97,200)/32,400 = $5.50 (c) Units transferred out: 30,000 X $7.50 = $225,000 6,000 X $2.00 2,400 X $5.50 = = $12,000 13,200 $25,200 21-15 $1,332,000 $90.00 $1,260,000 EXERCISE 21-9 Units in ending work in process: Total 72,000 $1,332,000 EXERCISE 21-10 (a) Materials: 68,000(1) + 24,000 = 92,000 Conversion costs: 68,000 + (24,000 X 60%) = 82,400 (1) 20,000 + 72,000 – 24,000 (b) Materials: $101,200/92,000 = $1.10 Conversion costs: ($164,800 + $123,600)/82,400 = $3.50 (c) Units transferred out: 68,000 X $4.60 = $312,800 Units in ending work in process: 24,000 X $1.10 14,400 X $3.50 = = $26,400 50,400 $76,800 EXERCISE 21-11 (a) Physical Units Work in process, September 1 Units started into production 1,600 18,400 20,000 Units transferred out Work in process, September 30 15,000 5,000 20,000 Equivalent Units Materials Conversion Costs 15,000 15,000 Units transferred out Work in process 5,000 X 100% 5,000 X 10% 5,000 20,000 21-16 500 15,500 EXERCISE 21-11 (Continued) (b) Materials Work in process, September 1 Direct materials $ 20,000 Costs added to production during September Total materials cost 177,200 $197,200 $197,200 ÷ 20,000 = $9.86 (Materials cost per unit) Conversion Costs Work in process, September 1 Conversion costs $ 43,180 Costs added to production during September Conversion costs Total conversion costs 359,820 $403,000 $403,000 ÷ 15,500 = $26.00 (c) Costs accounted for Transferred out (15,000 X $35.86) Work in process, September 30 Materials (5,000 X $9.86) Conversion costs (500 X $26.00) Total costs 21-17 $537,900 $49,300 13,000 62,300 $600,200 EXERCISE 21-12 To: Stan Maley From: Student Re: Ending inventory The reason for any confusion related to your department’s ending inventory quantity stems from the fact that the quantity can be measured in two different ways, depending on what the information is used for. The ending inventory quantity can be measured in physical units or equivalent units. Physical units are actual units present without regard to the stage of completion. Your department’s ending inventory in physical units is at least double the amount reported as equivalent units. Equivalent units measure the work done on the physical units, expressed in terms of fully completed units. Therefore, if your ending inventory contains 4,000 units which are 50% complete, that is equivalent to having 2,000 completed units at month end. Therefore, the ending inventory could be expressed as containing 4,000 physical units or 2,000 equivalent units. I hope this clears up any misunderstandings. Please contact me if you have any further questions. 21-18 EXERCISE 21-13 BATISTA MANUFACTURING COMPANY Welding Department Production Cost Report For the Month Ended February 28, 2008 Quantities Physical Units Equivalent Units Conversion Materials Costs (Step 1) (Step 2) Units to be accounted for Work in process, February 1 Started into production Total units 15,000 60,000 75,000 Units accounted for Transferred out Work in process, February 28 Total units 49,000 26,000 75,000 Costs 49,000 26,000 75,000 Materials Unit costs (Step 3) Costs in February Equivalent units Unit costs (a) ÷ (b) (a) $198,000(1) 75,000 (b) $2.64 49,000 5,200 54,200 Conversion Costs $108,400(2) 54,200 $2.00 Costs to be accounted for Work in process, February 1 Started into production Total costs Total $306,400 $4.64 $ 32,175 274,225 $306,400 Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (49,000 X $4.64) Work in process, February 28 Materials (26,000 X $2.64) Conversion costs (5,200 X $2.00) Total costs (1) (2) $227,360 $68,640 10,400 $18,000 + $180,000 $14,175 + $32,780 + $61,445 21-19 79,040 $306,400 *EXERCISE 21-14 (a) The overhead rates are: Activity Total Cost Total Driver Volume Materials handling Machine setups Quality inspections $30,000 27,000 24,000 1,000 450 600 Overhead Rate $30 60 40 (b) The assignment of the overhead costs to products is as follows: Instruments Cost Requisitions ($30) Setups ($60) Inspections ($40) Total costs (a) Number Cost 400 150 200 $12,000 9,000 8,000 $29,000 Cost per unit (a) ÷ (b) Number 600 300 400 Cost $18,000 18,000 16,000 $52,000 50 300 $580 $173.33 Total units (b) (c) Gauges Total Cost $30,000 27,000 24,000 $81,000 MEMO To: President, Carmeli Instrument From: Student Re: Benefits of activity-based costing (ABC) ABC focuses on the activities performed in producing a product. Overhead costs are assigned to products based on cost drivers that measure the activities performed on the product. The primary benefit of ABC is more accurate and meaningful product costing. This improved cost data can lead to reduced costs as managers become more aware of the underlying causes of cost incurrence. Thus, control over costs is enhanced. The improved cost data should also lead to better management decisions. More accurate product costing should contribute to setting selling prices which will achieve desired profitability levels. In addition, it should be helpful in deciding whether to discontinue or expand a product line or in deciding whether to make or buy a product component. 21-20 *EXERCISE 21-15 (a) Direct materials (1,000 X $35)...................................... Direct labor (1,000 X $15).............................................. Overhead ($15,000 X 225%*)........................................ Total ....................................................................... $35,000 15,000 33,750 $83,750 *($450,000/$200,000) (b) Direct materials (1,000 X $35)...................................... Direct labor (1,000 X $15).............................................. Overhead Materials handling (2,500 X $2*) ......................... Machining (500 X $10**)......................................... Factory supervision (1,000 X $12.50***) ........... Total........................................................................ *$100,000 ÷ 50,000 **$200,000 ÷ 20,000 ***$150,000 ÷ 12,000 21-21 $35,000 15,000 $ 5,000 5,000 12,500 22,500 $72,500 SOLUTIONS TO PROBLEMS PROBLEM 21-1A (a) Physical units Units to be accounted for Work in process, June 1 Started into production Total units 0 20,000 20,000 Units accounted for Transferred out Work in process, June 30 Total units 18,000 2,000 20,000 (b) Equivalent units Materials Units transferred out Work in process, June 30 2,000 X 100% 2,000 X 60% Total equivalent units (c) Conversion Costs 18,000 18,000 2,000 1,200 19,200 20,000 Unit Costs Materials Conversion costs Total unit cost $9.90 ($198,000 ÷ 20,000) $8.50 ($163,200 ÷ 19,200) $18.40 ($9.90 + $8.50) (d) Costs accounted for Transferred out (18,000 X $18.40) Work in process, June 30 Materials (2,000 X $9.90) Conversion costs (1,200 X $8.50) Total costs 21-22 $331,200 $19,800 10,200 30,000 $361,200 PROBLEM 21-1A (Continued) (e) KASTEN COMPANY Molding Department Production Cost Report For the Month Ended June 30, 2008 Quantities Physical Units Equivalent Units Conversion Materials Costs (Step 1) (Step 2) Units to be accounted for Work in process, June 1 Started into production Total units 0 20,000 20,000 Units accounted for Transferred out Work in process, June 30 Total units 18,000 2,000 20,000 Costs 18,000 2,000 20,000 Materials Unit costs (Step 3) Costs in June Equivalent units Unit costs (a) ÷ (b) (a) $198,000 20,000 (b) $9.90 18,000 1,200 19,200 Conversion Costs $163,200 19,200 $8.50 Costs to be accounted for Work in process, June 1 Started into production Total costs (2,000 X 60%) Total $361,200 $18.40 $ 0 361,200 $361,200 Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (18,000 X $18.40) Work in process, June 30 Materials (2,000 X $9.90) Conversion costs (1,200 X $8.50) Total costs $331,200 $19,800 10,200 21-23 30,000 $361,200 PROBLEM 21-2A (a) (1) Physical units T12 Tables C10 Chairs Units to be accounted for Work in process, July 1 Started into production Total units 0 20,000 20,000 0 16,000 16,000 Units accounted for Transferred out Work in process, July 31 Total units 17,000 3,000 20,000 15,500 500 16,000 (2) Equivalent units T12 Tables Conversion Materials Costs Units transferred out Work in process, July 31 (3,000 X 100%) (3,000 X 60%) Total equivalent units 17,000 17,000 3,000 20,000 1,800 18,800 C10 Chairs Conversion Materials Costs Units transferred out Work in process, July 31 (500 X 100%) (500 X 80%) Total equivalent units 15,500 15,500 500 16,000 21-24 400 15,900 PROBLEM 21-2A (Continued) (3) Unit costs Materials ($380,000 ÷ 20,000) ($288,000 ÷ 16,000) Conversion costs ($338,400 ÷ 18,800) ($222,600 ÷ 15,900) Total (4) T12 Tables $19 C10 Chairs $18 18 $37 14 $32 T12 Tables Costs accounted for Transferred out (17,000 X $37) Work in process Materials (3,000 X $19) Conversion costs (1,800 X $18) Total costs $629,000 $57,000 32,400 89,400 $718,400 C10 Chairs Costs accounted for Transferred out (15,500 X $32) Work in process Materials (500 X $18) Conversion costs (400 X $14) Total costs 21-25 $496,000 $9,000 5,600 14,600 $510,600 PROBLEM 21-2A (Continued) (b) ORTEGA INDUSTRIES INC. Cutting Department—Plant 1 Production Cost Report For the Month Ended July 31, 2008 Quantities Physical Units Equivalent Units Conversion Materials Costs (Step 1) (Step 2) Units to be accounted for Work in process, July 1 Started into production Total units 0 20,000 20,000 Units accounted for Transferred out Work in process, July 31 Total units 17,000 3,000 20,000 17,000 3,000 20,000 Costs Unit costs (Step 3) Costs in July Equivalent units Unit costs (a) ÷ (b) (a) (b) 17,000 1,800 (3,000 X 60%) 18,800 Materials Conversion Costs $380,000 20,000 $19 $338,400 18,800 $18 Costs to be accounted for Work in process, July 1 Started into production Total costs Total $718,400 $37 $ 0 718,400 $718,400 Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (17,000 X $37) Work in process, July 31 Materials (3,000 X $19) Conversion costs (1,800 X $18) Total costs $629,000 $57,000 32,400 21-26 89,400 $718,400 PROBLEM 21-3A 1. 2. 3. 4. 5. 6. 7. 8. 9. Raw Materials Inventory ......................................... Accounts Payable............................................ 300,000 Work in Process—Mixing....................................... Work in Process—Packaging ............................... Raw Materials Inventory ................................ 210,000 45,000 Factory Labor............................................................. Wages Payable ................................................. 248,900 Work in Process—Mixing....................................... Work in Process—Packaging ............................... Factory Labor.................................................... 182,500 66,400 Manufacturing Overhead........................................ Accounts Payable............................................ 790,000 Work in Process—Mixing (28,000 X $22) .......... Work in Process—Packaging ............................... (6,000 X $22) Manufacturing Overhead............................... 616,000 132,000 Work in Process—Packaging ............................... Work in Process—Mixing.............................. 979,000 Finished Goods Inventory ..................................... Work in Process—Packaging ...................... 1,315,000 Accounts Receivable............................................... Sales..................................................................... 2,500,000 Cost of Goods Sold.................................................. Finished Goods Inventory ............................ 1,640,000 21-27 300,000 255,000 248,900 248,900 790,000 748,000 979,000 1,315,000 2,500,000 1,640,000 PROBLEM 21-4A (a) Physical Units Units to be accounted for Work in process, November 1 Started into production Total units 35,000 700,000 735,000 Units accounted for Transferred out Work in process, November 30 Total units 710,000 25,000 735,000 Materials cost Beginning work in process Added during month Total Equivalent units Cost per unit $ 69,000 1,548,000 $1,617,000 735,000 $2.20 Conversion costs Beginning work in process Added during month Total Equivalent units Cost per unit Equivalent Units Conversion Materials Costs 710,000 25,000 735,000 710,000 10,000 720,000 $ 48,150 563,850 ($225,920 + $337,930) $612,000 720,000 $ .85 (b) Costs accounted for Transferred out (710,000 X $3.05) Work in process, November 30 Materials (25,000 X $2.20) Conversion costs (10,000 X $.85) Total costs 21-28 $2,165,500 $55,000 8,500 63,500 $2,229,000 PROBLEM 21-4A (Continued) (c) CAVALIER COMPANY Assembly Department Production Cost Report For the Month Ended November 30, 2008 Quantities Physical Units Equivalent Units Conversion Materials Costs (Step 1) (Step 2) Units to be accounted for Work in process, November 1 Started into production Total units 35,000 700,000 735,000 Units accounted for Transferred out Work in process, November 30 Total units 710,000 25,000 735,000 710,000 25,000 735,000 Costs Unit costs (Step 3) Costs in November Equivalent units Unit costs (a) ÷ (b) Materials (a) $1,617,000 735,000 (b) $2.20 710,000 10,000 (25,000 X 40%) 720,000 Conversion Costs $612,000 720,000 $.85 Costs to be accounted for Work in process, November 1 Started into production Total costs Total $2,229,000 $3.05 $ 117,150 2,111,850 $2,229,000 Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (710,000 X $3.05) Work in process, November 30 Materials (25,000 X $2.20) Conversion costs (10,000 X $.85) Total costs $2,165,500 $55,000 8,500 21-29 63,500 $2,229,000 PROBLEM 21-5A (a) (1) Physical Units (2) Units to be accounted for Work in process, July 1 Started into production Total units 500 1,000 1,500 Units accounted for Transferred out Work in process, July 31 Total units 900 600 1,500 Materials cost Beginning work in process Added during month Total $ 750 2,400 $3,150 Equivalent Units Conversion Materials Costs 900 600 1,500 Conversion costs Beginning work in process Added during month Total $ 600 2,640 $3,240 Equivalent units 1,500 Equivalent units 1,080 Cost per unit $2.10 Cost per unit $3.00 900 180 1,080 ($1,580 + $1,060) (3) Costs accounted for Transferred out (900 X $5.10) Work in process, July 31 Materials (600 X $2.10) Conversion costs (180 X $3.00) Total costs 21-30 $4,590 $1,260 540 1,800 $6,390 PROBLEM 21-5A (Continued) (b) CHEN COMPANY Basketball Department Production Cost Report For the Month Ended July 31, 2008 Quantities Physical Units Equivalent Units Conversion Materials Costs (Step 1) (Step 2) Units to be accounted for Work in process, July 1 Started into production Total units 500 1,000 1,500 Units accounted for Transferred out Work in process, July 31 Total units 900 600 1,500 Costs Unit costs (Step 3) Costs in July Equivalent units Unit costs (a) ÷ (b) (a) (b) 900 600 1,500 900 180 1,080 Materials Conversion Costs $3,150 1,500 $2.10 $3,240 1,080 $3.00 Costs to be accounted for Work in process, July 1 Started into production Total costs Total $6,390 $1,350 5,040 $6,390 Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (900 X $5.10) Work in process, July 31 Materials (600 X $2.10) Conversion costs (180 X $3.00) Total costs $4,590 $1,260 540 21-31 1,800 $6,390 PROBLEM 21-6A (a) Computation of equivalent units: Physical Units Units accounted for Transferred out Work in process, October 31 (60% materials, (40% conversion costs) Total units Equivalent Units Conversion Materials Costs 130,000 130,000 130,000 50,000 180,000 30,000 160,000 20,000 150,000 Computation of October unit costs Materials: $240,000 ÷ 160,000 equivalent units = $1.50 Conversion cost: $105,000 ÷ 150,000 equivalent units = .70 Total unit cost, October $2.20 (b) Cost Reconciliation Schedule Costs accounted for Transferred out (130,000 X $2.20) Work in process, October 31 Materials (30,000 X $1.50) Conversion costs (20,000 X $0.70) Total costs 21-32 $286,000 $45,000 14,000 59,000 $345,000 *PROBLEM 21-7A (a) The allocation of total manufacturing overhead using activity-based costing is as follows: Royale Cost Number Cost Number Cost Total Cost 16,000 5,000 100,000 10,000 $ 640,000 300,000 3,000,000 200,000 14,000 10,000 60,000 25,000 $ 560,000 600,000 1,800,000 500,000 $1,200,000 900,000 4,800,000 700,000 $4,140,000 $3,460,000 $7,600,000 (b) 30,000 10,000 (a) ÷ (b) $138 $346 Purchase orders Machine setups Machine hours Inspections ($40) ($60) ($30) ($20) Total assigned costs (a) Units produced Costs per unit Majestic (b) The cost per unit and gross profit of each model under ABC costing were: Direct materials Direct labor Manufacturing overhead Total cost per unit Royale $ 700 100 138 $ 938 Majestic $ 420 80 346 $ 846 Sales price per unit Cost per unit Gross profit $1,500 938 $ 562 $1,200 846 $ 354 (c) Management’s future plans for the two television models are not sound. Under ABC costing, the Royale model is $208 per unit more profitable than the Majestic model. 21-33 PROBLEM 21-1B (a) Physical units Units to be accounted for Work in process, January 1 Started into production Total units 0 35,000 35,000 Units accounted for Transferred out Work in process, January 31 Total units 30,000 5,000 35,000 (b) Equivalent units Materials Conversion Costs 30,000 30,000 Units transferred out Work in process, January 31 5,000 X 100% 5,000 X 40% Total equivalent units 5,000 2,000 32,000 35,000 (c) Unit Costs Materials Conversion costs Total manufacturing $17.00 ($595,000 ÷ 35,000) $10.00 ($320,000 ÷ 32,000) $27.00 ($17.00 + $10.00) (d) Costs accounted for Transferred out (30,000 X $27.00) Work in process, January 31 Materials (5,000 X $17.00) Conversion costs (2,000 X $10.00) Total costs 21-34 $810,000 $85,000 20,000 105,000 $915,000 PROBLEM 21-1B (Continued) (e) BICNELL CORPORATION Molding Department Production Cost Report For the Month Ended January 31, 2008 Quantities Physical Units Equivalent Units Conversion Materials Costs (Step 1) (Step 2) Units to be accounted for Work in process, January 1 Started into production Total units 0 35,000 35,000 Units accounted for Transferred out Work in process, January 31 Total units 30,000 5,000 35,000 Costs 30,000 5,000 35,000 Materials Unit costs (Step 3) Costs in January Equivalent units Unit costs (a) ÷ (b) (a) $595,000 35,000 (b) $17 30,000 2,000 (5,000 X 40%) 32,000 Conversion Costs $320,000 32,000 $10 Costs to be accounted for Work in process, January 1 Started into production Total costs Total $915,000 $27 $ 0 915,000 $915,000 Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (30,000 X $27) Work in process, January 31 Materials (5,000 X $17) Conversion costs (2,000 X $10) Total costs $810,000 $85,000 20,000 21-35 105,000 $915,000 PROBLEM 21-2B (a) (1) Physical units R12 Refrigerators F24 Freezers Units to be accounted for Work in process, June 1 Started into production Total units 0 20,000 20,000 0 18,000 18,000 Units accounted for Transferred out Work in process, June 30 Total units 16,000 4,000 20,000 15,500 2,500 18,000 (2) Equivalent units R12 Refrigerators Conversion Materials Costs Units transferred out Work in process, June 30 (4,000 X 100%) (4,000 X 75%) Total equivalent units 16,000 16,000 4,000 20,000 3,000 19,000 F24 Freezers Conversion Materials Costs 15,500 15,500 Units transferred out Work in process, June 30 (2,500 X 100%) (2,500 X 60%) Total equivalent units 2,500 18,000 21-36 1,500 17,000 PROBLEM 21-2B (Continued) (3) Unit costs Materials ($840,000 ÷ 20,000) ($684,000 ÷ 18,000) Conversion costs ($665,000 ÷ 19,000) ($442,000 ÷ 17,000) Total (4) R12 Refrigerators $42 F24 Freezers $38 35 $77 26 $64 R12 Refrigerators Costs accounted for Transferred out (16,000 X $77) ................. Work in process Materials (4,000 X $42)........................ $168,000 Conversion costs (3,000 X $35) ...................................... 105,000 Total costs ..................................... $1,232,000 273,000 $1,505,000 F24 Freezers Costs accounted for Transferred out (15,500 X $64)................. Work in process Materials (2,500 X $38)....................... Conversion costs (1,500 X $26) ..................................... Total costs .................................... 21-37 $ 992,000 $95,000 39,000 134,000 $1,126,000 PROBLEM 21-2B (Continued) (b) ATKINS CORPORATION Stamping Department—Plant A Production Cost Report For the Month Ended June 30, 2008 Quantities Physical Units Equivalent Units Conversion Materials Costs (Step 1) (Step 2) Units to be accounted for Work in process, June 1 Started into production Total units 0 20,000 20,000 Units accounted for Transferred out Work in process, June 30 Total units 16,000 4,000 20,000 Costs 16,000 4,000 20,000 Materials Unit costs (Step 3) Costs in June Equivalent units Unit costs (a) ÷ (b) (a) $840,000 20,000 (b) $42 16,000 3,000 19,000 Conversion Costs $665,000 19,000 $35 Costs to be accounted for Work in process, June 1 Started into production Total costs (4,000 X 75%) Total $1,505,000 $77 $ 0 1,505,000 $1,505,000 Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (16,000 X $77) Work in process, June 30 Materials (4,000 X $42) Conversion costs (3,000 X $35) Total costs $1,232,000 $168,000 105,000 21-38 273,000 $1,505,000 PROBLEM 21-3B 1. 2. 3. 4. 5. 6. 7. 8. 9. Raw Materials Inventory ..................................................... Accounts Payable........................................................ 25,000 Work in Process—Blending .............................................. Work in Process—Packaging ........................................... Raw Materials Inventory ............................................ 18,930 7,140 Factory Labor......................................................................... Wages Payable ............................................................. 20,770 Work in Process—Blending .............................................. Work in Process—Packaging ........................................... Factory Labor................................................................ 13,320 7,450 Manufacturing Overhead.................................................... Accounts Payable........................................................ 41,500 Work in Process—Blending (900 X $20) ....................... Work in Process—Packaging (300 X $20) .................... Manufacturing Overhead........................................... 18,000 6,000 Work in Process—Packaging ........................................... Work in Process—Blending ..................................... 44,940 Finished Goods Inventory ................................................. Work in Process—Packaging .................................. 67,490 Accounts Receivable........................................................... Sales................................................................................. 90,000 Cost of Goods Sold.............................................................. Finished Goods Inventory ........................................ 62,000 21-39 25,000 26,070 20,770 20,770 41,500 24,000 44,940 67,490 90,000 62,000 PROBLEM 21-4B (a) Physical Units Units to be accounted for Work in process, October 1 Started into production Total units 25,000 415,000 440,000 Units accounted for Transferred out Work in process, October 31 Total units 400,000 40,000 440,000 Materials cost Beginning work in process Added during month Total Equivalent units Cost per unit $ 29,000 1,071,000 $1,100,000 440,000 $2.50 Equivalent Units Conversion Materials Costs 400,000 40,000 440,000 Conversion costs Beginning work in process Added during month Total $ 26,200 228,200 $254,400 Equivalent units 424,000 Cost per unit 400,000 24,000 424,000 ($90,000 + $138,200) $.60 (b) Costs accounted for Transferred out (400,000 X $3.10) Work in process, October 31 Materials (40,000 X $2.50) Conversion costs (24,000 X $.60) Total costs 21-40 $1,240,000 $100,000 14,400 114,400 $1,354,400 PROBLEM 21-4B (Continued) (c) CROSBY COMPANY Assembly Department Production Cost Report For the Month Ended October 31, 2008 Quantities Physical Units Equivalent Units Conversion Materials Costs (Step 1) (Step 2) Units to be accounted for Work in process, October 1 Started into production Total units 25,000 415,000 440,000 Units accounted for Transferred out Work in process, October 31 Total units 400,000 40,000 440,000 Costs 400,000 40,000 440,000 Materials Unit costs (Step 3) Costs in October Equivalent units Unit costs (a) ÷ (b) (a) $1,100,000 440,000 (b) $2.50 400,000 24,000 (40,000 X 60%) 424,000 Conversion Costs $254,400 424,000 $.60 Costs to be accounted for Work in process, October 1 Started into production Total costs Total $1,354,400 $3.10 $ 55,200 1,299,200 $1,354,400 Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (400,000 X $3.10) Work in process, October 31 Materials (40,000 X $2.50) Conversion costs (24,000 X $.60) Total costs $1,240,000 $100,000 14,400 21-41 114,400 $1,354,400 PROBLEM 21-5B (a) (1) Physical Units (2) Units to be accounted for Work in process, May 1 Started into production Total units 500 1,000 1,500 Units accounted for Transferred out Work in process, May 31 Total units 900 600 1,500 Materials cost Beginning work in process Added during month Total Equivalent units Cost per unit $10,000 50,000 $60,000 1,500 $40 Equivalent Units Conversion Materials Costs Conversion costs Beginning work in process Added during month Total 900 600 1,500 $ 9,280 48,320 $57,600 Equivalent units 960 Cost per unit $60 900 60 960 ($18,320 + $30,000) (3) Costs accounted for Transferred out (900 X $100) Work in process, May 31 Materials (600 X $40) Conversion costs (60 X $60) Total costs 21-42 $ 90,000 $24,000 3,600 27,600 $117,600 PROBLEM 21-5B (Continued) (b) KILEY COMPANY Bicycle Department Production Cost Report For the Month Ended May 31, 2008 Quantities Physical Units Equivalent Units Conversion Materials Costs (Step 1) (Step 2) Units to be accounted for Work in process, May 1 Started into production Total units 500 1,000 1,500 Units accounted for Transferred out Work in process, May 31 Total units 900 600 1.500 900 600 1,500 Costs Unit costs (Step 3) Costs in May Equivalent units Unit costs (a) ÷ (b) (a) (b) 900 60 960 Materials Conversion Costs $60,000 1,500 $40 $57,600 960 $60 Costs to be accounted for Work in process, May 1 Started into production Total costs Total $117,600 $100 $ 19,280 98,320 $117,600 Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (900 X $100) Work in process, May 31 Materials (600 X $40) Conversion costs (60 X $60) Total costs $ 90,000 $24,000 3,600 21-43 27,600 $117,600 PROBLEM 21-6B (a) Computation of equivalent units: Physical Units Units accounted for Transferred out Work in process, March 31 (2/3 materials, (1/3 conversion costs) Total units Equivalent Units Conversion Materials Costs 95,000 95,000 95,000 15,000 110,000 10,000 105,000 5,000 100,000 Computation of March unit costs Materials: $210,000 ÷ 105,000 equivalent units = Conversion cost: $90,000 ÷ 100,000 equivalent units = Total unit cost, March $2.00 .90 $2.90 (b) Cost Reconciliation Schedule Costs accounted for Transferred out (95,000 X $2.90) Work in process, March 31 Materials (10,000 X $2.00) Conversion costs (5,000 X $.90) Total costs 21-44 $275,500 $20,000 4,500 24,500 $300,000 BYP 21-1 DECISION MAKING ACROSS THE ORGANIZATION (a) The unit cost suggests that Sid took the highest total costs and divided these costs by the units started into production. The highest total costs would be the total costs charged to the Mixing Department ($88,000 + $573,000 + $769,000) divided by the units started during July (91,000 gallons), which results in a per unit cost of $15.71 ($1,430,000 ÷ 91,000). (b) The principal errors made by Sid were: (1) he did not compute equivalent units of production; (2) he did not use the weighted-average costing method; and (3) he did not assign costs to ending work-in-process. 21-45 BYP 21-1 (Continued) (c) SUNSHINE BEACH COMPANY Mixing Department Production Cost Report For the Month Ended July 31, 2008 Quantities Physical Units Equivalent Units Conversion Materials Costs (Step 1) (Step 2) Units to be accounted for Work in process, July 1 Started into production Total units 8,000 91,000 99,000 Units accounted for Transferred out Work in process, July 31 Total units 94,000 5,000 99,000 Costs 94,000 5,000 99,000 Materials Unit costs (Step 3) Costs in July Equivalent units Unit costs (a) ÷ (b) (a) $594,000 99,000 (b) $6.00 94,000 1,000 95,000 Conversion Costs $836,000 95,000 $8.80 Costs to be accounted for Work in process, July 1 Started into production Total costs Total $1,430,000 $14.80 $ 88,000 1,342,000 $1,430,000 Cost Reconciliation Schedule (Step 4) Costs accounted for Transferred out (94,000 X $14.80) Work in process, July 31 Materials (5,000 X $6.00) Conversion costs (1,000 X $8.80) Total costs $1,391,200 $30,000 8,800 21-46 38,800 $1,430,000 BYP 21-2 MANAGERIAL ANALYSIS (a) The unit cost of materials is $140 ($420,000 ÷ 3,000). (b) The materials cost of the goods transferred out is $350,000 (2,500 X $140). Conversion costs, therefore, are $250,000 ($600,000 – $350,000), and per unit conversion cost is $100 ($250,000 ÷ 2,500). (c) There are 500 units in ending work-in-process inventory (3,000 started – 2,500 transferred out). The materials cost is $70,000 (500 X $140). Thus, the conversion costs in the inventory are $30,000. $30,000 divided by $100 per unit conversion cost equals 300 equivalent units or 60% (300 ÷ 500) complete. 21-47 BYP 21-3 EXPLORING THE WEB Answers will vary depending on companies chosen by students. 21-48 BYP 21-4 COMMUNICATION ACTIVITY To: Carol Gorden, Regional Sales Manager From: Student, Accounting Manager Re: Production Cost Reports Carol, congratulations again on your promotion! It’s going to be great working with you. It kind of reminds me of our days at Dairy-Freeze after school (although this work is more fun, and it certainly pays better!). I’ll try to clear up some of the questions you raised in your fax. Here in the Snack Foods Division we use process costing rather than the job order system that Special Projects uses. The reason for this is that we produce all our products in a more or less continuous process, even when we run occasional special orders. You see, all our workers are assigned a particular part of the process to control. One might be in charge of making sure the mixing machines work properly, while another verifies the weight of the finished products. Whichever job a worker is assigned, he or she stays with it to completion, or at least the completion of that particular process. That’s different from what you had in Special Projects, where workers moved from job to job. That’s why we don’t usually track the orders separately. Our special orders are for various quantities of the foods we produce, so only the Packing Department needs to be concerned with the particular set of products shipped to the particular customer—which is its ordinary concern anyway. Your next question was about what an equivalent unit is. Well, you know already that Special Projects bids on various jobs, and then costs are recorded when the jobs are complete. The costs accumulated on jobs that aren’t complete are reflected in Work in Process inventory. We in Snack Foods can’t use that method for a simple reason—we produce our products in huge batches that we keep going fairly continuously. Or, in other words, we don’t have a “job” that we can record as “complete.” A batch may contain enough of our product to fill thirty or more orders, so we may have thirty or more “jobs” in each batch. One job may happen to be filled from two batches. Since the cost of each batch is about the same, it isn’t worth keeping track of separately. 21-49 BYP 21-4 (Continued) At the end of the month, we need to record what we finished and what still remains undone. Equivalent units are the way we measure the amount of work we have done on our work in process. It’s kind of like comparing the contents of 4-ounce cups with the contents of 12-ounce cups. It doesn’t make sense to compare by counting the number of cups you have. You need to find out how many ounces you have in one set; then you can get a meaningful comparison with the ounces you have in the other set. We compare by the number of “units” of materials or labor that are required to finish a product completely. If it requires 12 ounces of flour and 15 minutes of labor for a finished bag of pretzels, for example, then the 12 ounces and 15 minutes are “finished equivalents.” If we have enough pretzels to fill 30 bags, but we’ve only spent 5 minutes (or 1/3 of the total required) of labor on them at the end of the month, we could have used the same amount of time and completely finished 10 bags. Thus, we have the “equivalent” of 10 bags worth of labor. Your last question is the easiest to answer. You get four reports because we use four processes here in Snack Foods Division. Each process has to report its status at the end of every month. It’s kind of like we have four miniature factories, each reporting “completion” of a certain number of products. The products from one department are used as raw materials for other departments, so we have a chain of reports. Notice that the units and costs transferred out of Process 1 are the same as the units and costs transferred in to Process 2, and so on. I hope this helps. Call, write, or email me any time! 21-50 BYP 21-5 ETHICS CASE (a) The stakeholders in this situation are:



Sue Wooten, molding department head. Fred Barando, quality control inspector. Customers of R. B. Patrick Company. The department manager of the assembly department. (b) Fred is placed in an ethical dilemma. He can offend his department head by disregarding Sue’s instructions and lose the support of his supervisor, and maybe lose his job. He can follow Sue’s instructions and be in violation of company policy. He can also report Sue’s instructions to supervisors (plant superintendent or vice-president of production). The company should make the position of quality control inspector responsible to someone other than the department head. Fred should not report to Sue. 21-51 BYP 21-6 ALL ABOUT YOU ACTIVITY The following activities and cost drivers might be submitted: (a) Activities Laundering Housekeeping Dietary Computing information technology Nursing care Surgery Clinical lab Imaging (X-ray, etc.) Pharmacy Emergency room Maintenance Billing and collecting (b) Cost drivers Pounds of linen Square footage: number of beds Number of meals Minutes of computer usage; or number of work stations Number of patients Number of procedures or operations Number of tests Number of images Number of prescriptions Number of cases or patients Square footage Number of invoices 21-52 CHAPTER 22 Cost-Volume-Profit Relationships ASSIGNMENT CLASSIFICATION TABLE Brief Exercises Exercises A Problems B Problems 1, 2, 3, 6 1 1, 2, 3 1A 1B * 2. Explain the significance of the relevant range. 4, 5 2 * 3. Explain the concept of mixed costs. 6, 7, 8 3, 4 1, 2, 3 1A 1B * 4. List the five components of cost-volume-profit analysis. 9 * 5. Indicate what contribution margin is and how it can be expressed. 10, 11 5 5, 7, 8 1A, 2A, 3A, 5A 1B, 2B, 3B, 5B * 6. Identify the three ways to determine the break-even point. 12, 13, 14 6 5, 6, 7, 8, 9 1A, 2A, 3A, 4A, 5A 1B, 2B, 3B, 4B, 5B * 7. Give the formulas for determining sales required to earn target net income. 16 7 9, 10 2A, 5A 2B, 5B * 8. Define margin of safety, and give the formulas for computing it. 15 8 5, 6 2A, 4A, 5A 2B, 4B, 5B * 9. Describe the essential features of a cost-volume-profit income statement. 17 9 11 2A, 4A 2B, 4B *10. Explain the difference between absorption costing and variable costing. 18, 19 10 12, 13 6A 6B Study Objectives Questions * 1. Distinguish between variable and fixed costs. 4 *Note: All asterisked Questions, Exercises, and Problems relate to material contained in the appendix*to the chapter. 22-1 ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Determine variable and fixed costs, compute break-even point, prepare a CVP graph, and determine net income. Simple 20–30 2A Prepare a CVP income statement, compute break-even point, contribution margin ratio, margin of safety ratio, and sales for target net income. Moderate 30–40 3A Compute break-even point under alternative courses of action. Simple 20–30 4A Compute break-even point and margin of safety ratio, and prepare CVP income statement before and after changes in business environment. Moderate 20–30 5A Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment. Moderate 20–30 Prepare income statements under absorption and variable costing. Moderate 30–40 *6A 1B Determine variable and fixed costs, compute break-even point, prepare a CVP graph, and determine net income. Simple 20–30 2B Prepare a CVP income statement, compute break-even point, contribution margin ratio, margin of safety ratio, and sales for target net income. Moderate 30–40 3B Compute break-even point under alternative courses of action. Simple 20–30 4B Compute break-even point and margin of safety ratio, and prepare CVP income statement before and after changes in business environment. Moderate 20–30 5B Compute break-even point and margin of safety ratio, and prepare a CVP income statement before and after changes in business environment. Moderate 20–30 *6B Prepare income statements under absorption and variable costing. Moderate 30–40 22-2 Study Objective Knowledge Comprehension E22-3 Q22-1 Q22-2 Q22-3 22-3 * 1. Distinguish between variable and fixed costs. * 2. Explain the significance of the relevant range. Q22-4 Q22-5 * 3. Explain the concept of mixed costs. E22-3 Q22-6 Q22-7 * 4. List the five components of cost-volume-profit analysis. E22-4 Q22-9 * 5. Indicate what contribution margin is and how it can be expressed. * 6. Identify the three ways to determine the break-even point. * 7. Application Analysis Synthesis Evaluation E22-2 P22-1A P22-1B Q22-6 BE22-1 E22-1 BE22-2 BE22-1 Q22-8 E22-1 BE22-4 BE22-3 E22-2 P22-1A P22-1B Q22-10 Q22-11 E22-5 E22-7 E22-8 BE22-5 P22-1A P22-2A P22-1B P22-2B P22-3A P22-3B P22-5A P22-5B Q22-12 Q22-14 Q22-13 BE22-6 E22-5 E22-7 E22-6 E22-8 P22-1A E22-9 P22-2A P22-1B P22-2B P22-3A P22-4A P22-3B P22-4B P22-5A P22-5B Give the formulas for determining sales required to earn target net income. Q22-16 BE22-7 E22-9 E22-10 P22-2A P22-2B * 8. Define margin of safety, and give the formulas for computing it. Q22-15 BE22-8 E22-5 E22-6 P22-2A P22-2B * 9. Describe the essential features of a cost-volume-profit income statement. Q22-17 BE22-9 E22-11 P22-2A P22-2B P22-4A P22-4B *10. Explain the difference between absorption costing and variable costing. E22-12 E22-13 BE22-10 P22-6A P22-6B Broadening Your Perspective Q22-18 Q22-19 P22-5A P22-5B P22-5A P22-5B Communication Real-World Focus Decision Making Exploring the Web Across the Organization P22-4A P22-4B Managerial Analysis Ethics Case All About You BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. (a) Cost behavior analysis is the study of how specific costs respond to changes in the level of activity within a company. (b) Cost behavior analysis is important to management in planning business operations and in deciding between alternative courses of action. 2. (a) The activity index identifies the activity that causes changes in the behavior of costs. Once the index is determined, it is possible to classify the behavior of costs in response to changes in activity levels into three categories: variable, fixed, or mixed. (b) Variable costs may be defined in total or on a per-unit basis. Variable costs in total vary directly and proportionately with changes in the activity level. Variable costs per unit remain the same at every level of activity. 3. Fixed costs remain the same in total regardless of changes in the activity level. In contrast, fixed costs per unit vary inversely with activity. As volume increases, fixed costs per unit decline and vice versa. 4. (a) The relevant range is the range of activity that a company expects to operate during the year. (b) Disagree. The behavior of both fixed and variable costs are linear only over a certain range of activity. 5. This is true. Most companies operate within the relevant range. Within this range, it is possible to establish a linear (straight-line) relationship for both variable and fixed costs. If a relevant range cannot be established, segregation of costs into fixed and variable becomes extremely difficult. 6. Apartment rent is fixed because the cost per month remains the same regardless of how much Ryan uses the apartment. Rent on a Hertz rental truck is a mixed or semivariable cost because the cost usually includes a per diem charge (a fixed cost) plus an activity charge based on miles driven (a variable cost). 7. For CVP analysis, mixed costs must be classified into their fixed and variable elements. One approach to the classification of mixed costs is the high-low method. 8. Variable cost per unit is $1.20, or ($60,000 ÷ 50,000). At any level of activity, fixed costs are $52,000 per month [$160,000 – (90,000 X $1.20)]. 9. No. Only two of the basic components of cost-volume-profit (CVP) analysis, unit selling prices and variable cost per unit, relate to unit data. The other components, volume and total fixed costs, are not based on per-unit amounts. 10. There is no truth in Jill’s statement. Contribution margin is sales less variable costs. It is the revenue that remains to cover fixed costs and to produce income (profit) for the company. 11. Contribution margin is $12 ($40 – $28). The contribution margin ratio is 30% ($12 ÷ $40). 12. Disagree. Knowledge of the break-even point is useful to management in deciding whether to introduce new product lines, change sales prices on established products, and enter new market areas. 13. $25,000 ÷ 25% = $100,000 22-4 Questions Chapter 22 (Continued) *14. (a) The breakeven point involves the plotting of three lines over the full range of activity: the total revenue line, the total fixed cost line, and the total cost line. The breakeven point is determined at the intersection of the total revenue and total cost lines. (b) The breakeven point in units is obtained by drawing a vertical line from the breakeven point to the horizontal axis. The breakeven point in sales dollars is obtained by drawing a horizontal line from the breakeven point to the vertical axis. *15. Margin of safety is the difference between actual or expected sales and sales at the breakeven point. 1,250 X $12 = $15,000; $15,000 – $12,000 = $3,000; $3,000 ÷ $15,000 = 20%. *16. At breakeven sales, the contribution margin is: $180,000 $600,000 = 30% The sales volume to achieve net income of $60,000 is as follows: $180,000 + $60,000 .30 *17. = $800,000 MALLON COMPANY CVP Income Statement Sales ................................................................................................................... Variable expenses Cost of goods sold................................................................................... Operating expenses................................................................................ Total variable expenses ................................................................ Contribution margin.......................................................................................... $900,000 $350,000 140,000 490,000 $410,000 *18. Under absorption costing, both variable and fixed manufacturing costs are considered to be product costs. Under variable costing, only variable manufacturing costs are product costs and fixed manufacturing costs are expensed when incurred. *19. (a) The rationale for variable costing centers on the purpose of fixed manufacturing costs, which is to have productive facilities available for use. Since these costs are incurred whether a company operates at zero or 100% capacity, it is argued that they should be expensed when they are incurred. Variable costing is useful in product costing internally by management and it is useful in controlling manufacturing costs. (b) Variable costing cannot be used in product costing in financial statements prepared in accordance with generally accepted accounting principles because it does not comply with the matching principle and thus understates inventory costs. 22-5 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 22-1 Indirect labor is a variable cost because it increases in total directly and proportionately with the change in the activity level. Supervisory salaries is a fixed cost because it remains the same in total regardless of changes in the activity level. Maintenance is a mixed cost because it increases in total but not proportionately with changes in the activity level. BRIEF EXERCISE 22-2 VARIABLE COST Relevant Range FIXED COST Relevant Range $10,000 $10,000 8,000 8,000 6,000 6,000 4,000 4,000 2,000 2,000 0 20 40 60 80 100 0 Activity Level 20 40 60 80 100 Activity Level 22-6 BRIEF EXERCISE 22-3 $80,000 Total Cost Line COST 60,000 Variable Cost Element 40,000 20,000 Fixed Cost Element 0 500 1,000 1,500 2,000 2,500 Direct Labor Hours BRIEF EXERCISE 22-4 High Low $15,000 – $13,600 = 8,500 – 7,500 = Difference $1,400 1,000 $1,400 ÷ 1,000 = $1.40—Variable cost per mile. Total cost Less: Variable costs 8,500 X $1.40 7,500 X $1.40 Total fixed costs High Low $15,000 $13,600 11,900 10,500 $ 3,100 $ 3,100 The mixed cost is $3,100 plus $1.40 per mile. 22-7 BRIEF EXERCISE 22-5 1. (a) (b) $80 = ($250 – $170) 32% ($80 ÷ $250) 2. (c) (d) $300 = ($500 – $200) 40% ($200 ÷ $500) 3. (e) (f) $1,000 = ($300 ÷ 30%) $700 ($1,000 – $300) BRIEF EXERCISE 22-6 (a) $400Q = $260Q + $210,000 + $0 $140Q = $210,000 Q = 1,500 units (b) Contribution margin per unit $140, or ($400 – $260) X = $210,000 ÷ $140 X = 1,500 units BRIEF EXERCISE 22-7 X = .70X + $210,000 + $60,000 .30X = $270,000 X = $900,000 If variable costs are 70% of sales, the contribution margin ratio is ($1 – $0.70) ÷ $1 = .30. Then, ($210,000 + $60,000) ÷ .30 = $900,000. BRIEF EXERCISE 22-8 Margin of safety = $1,200,000 – $900,000 = $300,000 Margin of safety ratio = $300,000 ÷ $1,200,000 = 25% 22-8 BRIEF EXERCISE 22-9 DILTS MANUFACTURING INC. Income Statement For the Quarter Ended March 31, 2008 Sales..................................................................................... Variable expenses Cost of goods sold................................................. Selling expenses..................................................... Administrative expenses...................................... Total variable expenses............................... Contribution margin........................................................ Fixed expenses Cost of goods sold................................................. Selling expenses..................................................... Administrative expenses...................................... Total fixed expenses..................................... Net income ......................................................................... $1,800,000 $760,000 95,000 79,000 934,000 866,000 540,000 60,000 66,000 666,000 $ 200,000 *BRIEF EXERCISE 22-10 MEMO To: Chief financial officer From: Student Re: Absorption and variable costing Under absorption costing, fixed manufacturing overhead is a product cost, while under variable costing, fixed manufacturing overhead is a period cost (expensed as incurred). Since units produced (50,000) exceeded units sold (47,000) last month, income under absorption costing will be higher than under variable costing. Some fixed overhead (3,000 units X $3 = $9,000) will be assigned to ending inventory and therefore not expensed under absorption costing, whereas all fixed overhead is expensed under variable costing. Therefore, absorption costing net income will be higher than variable costing net income by $9,000. 22-9 SOLUTIONS TO EXERCISES EXERCISE 22-1 (a) The determination as to whether a cost is variable, fixed, or mixed can be made by comparing the cost in total and on a per-unit basis at two different levels of production. Variable Costs Fixed Costs Mixed Costs Vary in total but remain constant on a per-unit basis. Remain constant in total but vary on a per-unit basis. Contain both a fixed element and a variable element. Vary both in total and on a per-unit basis. (b) Using these criteria as a guideline, the classification is as follows: Direct materials Direct labor Utilities Variable Variable Mixed Rent Maintenance Supervisory salaries Fixed Mixed Fixed EXERCISE 22-2 (a) Maintenance Costs: $4,900 – $2,400 $2,500 = = $5 variable cost per machine hour 800 – 300 500 800 Machine Hours Total costs Less: Variable costs 800 X $5 300 X $5 Total fixed costs $4,900 300 Machine Hours $2,400 4,000 $ 900 1,500 $ 900 Thus, maintenance costs are $900 per month plus $5 per machine hour. 22-10 EXERCISE 22-2 (Continued) (b) $5,000 Total Cost Line $4,900 $4,000 COSTS Variable Cost Element $3,000 $2,000 $1,000 $900 Fixed Cost Element 0 200 400 600 800 Machine Hours EXERCISE 22-3 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Wood used in the production of furniture. Fuel used in delivery trucks. Straight-line depreciation on factory building. Screws used in the production of furniture. Sales staff salaries. Sales commissions. Property taxes. Insurance on buildings. Hourly wages of furniture craftsmen. Salaries of factory supervisors. Utilities expense. Telephone bill. 22-11 Variable. Variable. Fixed. Variable. Fixed. Variable. Fixed. Fixed. Variable. Fixed. Mixed. Mixed. EXERCISE 22-4 MEMO To: Jim Thome From: Student Re: Assumptions underlying CVP analysis CVP analysis is a useful tool in analyzing the effects of changes in costs and volume on a company’s profits. However, there are some assumptions which underline CVP analysis. When these assumptions are not valid, the results of CVP analysis may be inaccurate. The five assumptions are: 1. The behavior of both costs and revenues is linear throughout the relevant range of the activity index. 2. All costs can be classified with reasonable accuracy as either fixed or variable. 3. Changes in activity are the only factors that affect costs. 4. All units produced are sold. 5. When more than one type of product is sold, the sales mix will remain constant. If you want further explanation of any of these assumptions, please contact me. EXERCISE 22-5 (a) Contribution margin (in dollars): Variable cost (per unit): Contribution margin (per unit): Contribution margin (ratio): (b) Breakeven sales (in dollars): Breakeven sales (in units): (c) Margin of safety (in dollars): Margin of safety (ratio): Sales = (2,700 X $30) = $81,000 Variable costs = $81,000 X .70 = 56,700 Contribution margin $24,300 $30 X .70 = $21. $30 – $21 ($30 X 70%) = $9. $9 ÷ $30 = 30%. $18,000 = $60,000. 30% $18,000 = 2,000 units. $9 $81,000 – $60,000 = $21,000. $21,000 ÷ $81,000 = 26%(rounded). 22-12 EXERCISE 22-6 (a) $3,200 Sales Line 2,800 DOLLARS (000) 2,400 Breakeven Point Total Cost Line 2,000 1,600 1,200 800 Fixed Cost Line 400 100 200 300 400 500 600 700 800 Number of Units (in thousands) (b) (1) Breakeven sales in units: $4X = $2.40X + $800,000 $1.60X = $800,000 X = 500,000 units (2) Breakeven sales in dollars: X = .60X + $800,000 .40X = $800,000 X = $2,000,000 (c) (1) Margin of safety in dollars: $2,500,000 – $2,000,000 = $500,000 (2) Margin of safety ratio: $500,000 ÷ $2,500,000 = 20% 22-13 EXERCISE 22-7 (a) Unit contribution margin = = Fixed costs Breakeven sales in units $105,000 ($350,000 ÷ $7) = $2.10 Variable cost per unit = Unit selling price – Unit contribution margin = $7.00 – $2.10 = $4.90 OR = 50,000 X $7.00 = 50,000X + $105,000 = where X = Variable cost per unit = Variable cost per unit = $4.90 Contribution margin ratio = $2.10 ÷ $7.00 = 30% (b) Fixed costs = Breakeven sales in units X Unit contribution margin = ($420,000 ÷ $7.00) X $2.10 = $126,000 OR Fixed costs = Breakeven sales X Contribution margin ratio = $420,000 X 30% = $126,000 Since fixed costs were $105,000 in 2008, the increase in 2009 is $21,000 ($126,000 – $105,000). 22-14 EXERCISE 22-8 (a) NIU COMPANY CVP Income Statement For the Month Ended September 30, 2008 Sales (620 video game consoles) ...................... Variable costs........................................................... Contribution margin ............................................... Fixed costs ................................................................ Net income................................................................. (b) Total $248,000 167,400 80,600 52,000 $ 28,600 Sales = Variable costs + Fixed costs $400X = $270X + $52,000 $130X = 52,000 X = 400 units (c) NIU COMPANY CVP Income Statement For the Month Ended September 30, 2008 Sales (400 video game consoles)....................... Variable costs ........................................................... Contribution margin................................................ Fixed costs................................................................. Net income ................................................................. Total $160,000 108,000 52,000 52,000 $ –0– EXERCISE 22-9 (a) Per Unit $400 270 $130 Sales = Variable cost + Fixed cost + Target net income $150X = $90X + $570,000 + $150,000 $60X = $720,000 X = 12,000 units 22-15 Per Unit $400 270 $130 EXERCISE 22-9 (Continued) OR Units sold in 2008 = $570,000 + $150,000 = 12,000 units $150 – $90 (b) Units needed in 2009 = $570,000 + $210,000 * = 13,000 units $150 – $90 *$150,000 + $60,000 = $210,000 (c) $570,000 + $210,000 = 12,000 units, where X = new selling price X – $90 $780,000 = 12,000X – $1,080,000 $1,860,000 = 12,000X X = $155 EXERCISE 22-10 1. Unit sales price = $350,000 ÷ 5,000 units = $70 Increase selling price to $77, or ($70 X 110%). Net income = $385,000 – $210,000 – $90,000 = $85,000. 2. Reduce variable costs to 55% of sales. Net income = $350,000 – $192,500 – $90,000 = $67,500. 3. Reduce fixed costs to $80,000, or ($90,000 – $10,000). Net income = $350,000 – $210,000 – $80,000 = $60,000. Alternative 1, increasing selling price, will produce the highest net income. 22-16 EXERCISE 22-11 POLZIN COMPANY CVP Income Statement (Current) For the Year Ended December 31, 2008 Sales (60,000 X $25) .................................................... Variable expenses (60,000 X $14)........................... Contribution margin.................................................... Fixed expenses ............................................................ Net income ..................................................................... Total $1,500,000 840,000 660,000 500,000 $ 160,000 Per Unit $25 14 $11 POLZIN COMPANY CVP Income Statement (with changes) For the Year Ended December 31, 2008 Sales [64,200 units (1) X $23.60 (2)]....................... Variable expenses [64,200 X $11.20 (3)]............... Contribution margin (64,200 X $12.40) ................. Fixed expenses ($500,000 + $60,000).................... Net income ..................................................................... Total $1,515,120 719,040 796,080 560,000 $ 236,080 (1) (60,000 X 107%). (2) $25.00 – ($2.80 X 50%) = $23.60. (3) $14.00 – ($14 X 20%) = $11.20. *EXERCISE 22-12 (a) Type of Cost Manufacturing Cost per Unit Direct materials Direct labor Variable manufacturing overhead Fixed manufacturing overhead Total cost 22-17 Variable Costing $1,000 1,500 300 0 $2,800 Per Unit $23.60 11.20 $12.40 *EXERCISE 22-12 (Continued) (b) TITUS EQUIPMENT COMPANY Income Statement For the Year Ended December 31, 2008 (Variable Costing) Sales (1,300 X $4,500) ................................. Variable expenses Variable cost of goods sold Inventory, January 1.................. Variable manufacturing costs........................................... Cost of goods available for sale....................................... Inventory, December 31 ........... Variable cost of goods sold............................................. Variable selling and administrative expenses ........................................... Total variable expenses.......................... Contribution margin .................................... Fixed expenses Manufacturing overhead................... Selling and administrative expenses ........................................... Total fixed expenses ................. Income from operations............................. (1) 1,500 X $2,800 (2) 200 X $2,800 (3) 1,300 X $70 22-18 $5,850,000 $ 0 4,200,000 (1) 4,200,000 560,000 (2) 3,640,000 91,000 (3) 3,731,000 2,119,000 1,400,000 100,000 1,500,000 $ 619,000 *EXERCISE 22-13 (a) COWELL CORPORATION Income Satement For the Month Ended October 31, 2008 (Absorption Costing) Sales (20,000 X $50)................................................................. Cost of goods sold (20,000 X $34*)..................................... Gross profit ................................................................................ Fixed costs ................................................................................. Net income.................................................................................. $1,000,000 680,000 320,000 30,000 $ 290,000 *$10 + $8 + $6 + ($250,000 ÷ 25,000) (b) COWELL CORPORATION Income Satement For the Month Ended October 31, 2008 (Variable Costing) Sales (20,000 X $50)................................................................. Cost of goods sold (20,000 X $24)..................................... Contribution margin ................................................................ Fixed costs ($250,000 + $30,000) ........................................ Net income.................................................................................. $1,000,000 480,000 520,000 280,000 $ 240,000 (c) Under variable costing, all fixed manufacturing costs ($250,000) are expensed. Under absorption costing, some of the fixed manufacturing costs have been deferred to a later period [5,000 X ($250,000/25,000) = $50,000]. 22-19 SOLUTIONS TO PROBLEMS PROBLEM 22-1A (a) Variable costs (per haircut) Barbers’ commission Barber supplies Utilities Total variable cost per haircut $5.50 .30 .20 $6.00 (b) $10.00X = $6.00X + $6,800 $ 4.00X = $6,800 X = 1,700 haircuts (c) Fixed costs (per month) Barbers’ salaries Manager’s extra salary Advertising Rent Utilities Magazines Total fixed 1,700 haircuts X $10 = $17,000 Breakeven Point 18 Sales Line Total Cost Line 15 DOLLARS (000) $5,000 500 200 900 175 25 $6,800 12 9 Fixed Cost Line 6 3 300 600 900 1,200 1,500 1,800 Number of Haircuts (d) Net income = $19,000 – [($6.00 X 1,900) + $6,800] = $800 22-20 PROBLEM 22-2A (a) UTECH COMPANY CVP Income Statement (Estimated) For the Year Ending December 31, 2008 Net sales .................................................................. Variable expenses Cost of goods sold ...................................... Selling expenses.......................................... Administrative expenses........................... Total variable expenses.................... Contribution margin............................................. Fixed expenses Cost of goods sold ...................................... Selling expenses.......................................... Administrative expenses........................... Total fixed expenses.......................... Net income .............................................................. $1,800,000 $1,098,000* 70,000 20,000 1,188,000 612,000 283,000 65,000 60,000 408,000 $ 204,000 *Direct materials $430,000 + direct labor $352,000 + variable manufacturing overhead $316,000. (b) Variable costs = 66% of sales ($1,188,000 ÷ $1,800,000) or $.33 per bottle ($.50 X 66%). Total fixed costs = $408,000. (1) $.50X = $.33X + $408,000 $.17X = $408,000 X = 2,400,000 units (2) 2,400,000 X $.50 = $1,200,000 (c) Contribution margin ratio = ($.50 – $.33) ÷ $.50 = 34% Margin of safety ratio = ($1,800,000 – $1,200,000) ÷ $1,800,000 = 33% (rounded) (d) Required sales X= $408,000 + $238,000 = $1,900,000 .34 22-21 PROBLEM 22-3A (a) Sales were $2,400,000, variable expenses were $1,560,000 (65% of sales), and fixed expenses were $980,000. Therefore, the breakeven point in dollars is: $980,000 = $2,800,000 .35 (b) 1. The effect of this alternative is to increase the selling price per unit to $4.80 ($4 X 120%). Total sales become $2,880,000 (600,000 X $4.80). Thus, the contribution margin ratio changes to 46% [($2,880,000 – $1,560,000) ÷ $2,880,000]. The new breakeven point is: $980,000 = $2,130,435 (rounded) .46 2. The effects of this alternative are to change total fixed costs to $830,000 ($980,000 – $150,000) and to change the contribution margin to 30% [($2,400,000 – $1,560,000 – $120,000) ÷ $2,400,000]. The new breakeven point is: $830,000 = $2,766,667 (rounded) .30 3. The effects of this alternative are variable and fixed cost of goods sold become $1,134,000 and $966,000 respectively. As a result, total variable cost becomes $1,254,000 ($1,134,000 + $72,000 + $48,000) and total fixed cost becomes $1,286,000 ($966,000 + $168,000 + $152,000). The new breakeven point is: X = ($1,254,000 ÷ $2,400,000)X + $1,286,000 X = .52X + $1,286,000 .48X = $1,286,000 X = $2,679,167 (rounded) Alternative 1 is the recommended course of action because it has the lowest breakeven point. 22-22 PROBLEM 22-4A (a) Current breakeven point: $40X = $22X + $270,000 (where X = pairs of shoes) $18X = $270,000 X = 15,000 pairs of shoes New breakeven point: $38X = $22X + ($270,000 + $34,000) $16X = $304,000 X = 19,000 pairs of shoes (b) Current margin of safety percentage = (20,000 X $40) – (15,000 X $40) (20,000 X $40 0) = 25% New margin of safety percentage = (24,000 X $38) – (19,000 X $38) (24,000 X $3 38) = 21% (rounded) (c) VALUE SHOE STORE CVP Income Statement Sales (20,000 X $40) Variable expenses (20,000 X $22) Contribution margin Fixed expenses Net income Current New $800,000 440,000 360,000 270,000 $ 90,000 $912,000 528,000 384,000 304,000 $ 80,000 (24,000 X $38) (24,000 X $22) The proposed changes will raise the breakeven point 4,000 units. This is a significant increase. Margin of safety is 4% lower and net income is $10,000 lower. The recommendation is to not accept the proposed changes. 22-23 PROBLEM 22-5A (a) (1) Current Year $1,600,000 Net sales Variable costs Direct materials Direct labor Manufacturing overhead ($360,000 X .70) Selling expenses ($240,000 X .40) Administrative expenses ($280,000 X .20) Total variable costs Contribution margin Sales Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin 511,000 285,000 252,000 96,000 56,000 1,200,000 $ 400,000 Current Year $1,600,000 X 1.1 511,000 285,000 252,000 96,000 56,000 1,200,000 $ 400,000 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 X 1.1 Projected Year $1,760,000 562,100 313,500 277,200 105,600 61,600 1,320,000 $ 440,000 (2) Fixed Costs Current Year Manufacturing overhead ($360,000 X .30) $108,000 Selling expenses ($240,000 X .60) 144,000 Administrative expenses ($280,000 X .80) 224,000 $476,000 Total fixed costs 22-24 Projected year $108,000 144,000 224,000 $476,000 PROBLEM 22-5A (Continued) (b) Unit selling price = $1,600,000 ÷ 100,000 = $16 Unit variable cost = $1,200,000 ÷ 100,000 = $12 Unit contribution margin = $16 – $12 = $4 Contribution margin ratio = $4 ÷ $16 = .25 Break-even point in units = Fixed costs ÷ Unit contribution margin 119,000 units = $476,000 ÷ $4 Break-even point in dollars = Fixed costs ÷ Contribution margin ratio $1,904,000 = $476,000 ÷ .25 (c) Sales dollars required for = (Fixed costs + Target net income) ÷ Contribution margin ratio target net income $3,144,000 = ($476,000 + $310,000) ÷ .25 (d) Margin of safety = (Expected sales – Break-even sales) ÷ Expected sales ratio 39.4% = ($3,144,000 – $1,904,000) ÷ $3,144,000 (e) (1) Projected Year $1,600,000 Net sales Variable costs Direct materials Direct labor ($285,000 – $104,000) Manufacturing overhead ($360,000 X .30) Selling expenses ($240,000 X .90) Administrative expenses ($280,000 X .20) Total variable costs Contribution margin 22-25 511,000 181,000 108,000 216,000 56,000 1,072,000 $ 528,000 PROBLEM 22-5A (Continued) (2) Contribution margin ratio = $528,000 ÷ $1,600,000 = .33 (3) Break-even point in dollars = $500,000 ÷ .33 = $1,515,152 (rounded) Fixed cost Manufacturing overhead ($360,000 X .70) Selling expenses ($240,000 X .10) Administrative expenses ($280,000 X .80) Total fixed costs $252,000 24,000 224,000 $500,000 The break-even point in dollars declined from $1,904,000 to $1,515,152. This means that overall the company’s risk has declined because it doesn’t have to generate as much in sales. The two changes actually had opposing effects on the break-even point. By changing to a more commission based approach to compensating its sales staff the company reduced its fixed costs, and therefore reduced its break-even point. In contrast, the purchase of the new equipment increased the company’s fixed costs (by increasing its equipment depreciation) and reduced its variable direct labor cost, both of which would increase the break-even point. 22-26 *PROBLEM 22-6A (a) TLR COMPANY Income Statement For the Year Ended December 31 (Variable Costing) Sales................................................................... Variable expenses Variable cost of goods sold Inventory, January 1.................. Variable manufacturing costs .......................................... Cost of goods available for sale....................................... Inventory, December 31 ........... Variable cost of goods sold............................................. Variable selling expenses ................. Total variable expenses ........... Contribution margin...................................... Fixed expenses Manufacturing overhead.................... Administrative....................................... Total fixed expenses ................. Income from operations .............................. 2008 Computations (1) 6,000 X $1,000 X .15 (2) 1,000 X $1,000 X .15 (3) 5,000 X $1,000 X .10 2009 Computations (4) 5,000 X $1,000 X .15 (5) 6,000 X $1,000 X .10 22-27 2008 2009 $5,000,000 $6,000,000 0 150,000 900,000 (1) 750,000 (4) 900,000 150,000 (2) 900,000 0 750,000 500,000 (3) 1,250,000 3,750,000 2,100,000 500,000 2,600,000 $1,150,000 900,000 600,000 (5) 1,500,000 4,500,000 2,100,000 500,000 2,600,000 $1,900,000 *PROBLEM 22-6A (Continued) (b) TLR COMPANY Income Statement For the Year Ended December 31 (Absorption Costing) Sales ............................................................................. Cost of goods sold Inventory, January 1 ..................................... Cost of goods manufactured..................... Cost of goods available for sale............... Inventory, December 31............................... Cost of goods sold........................................ Gross profit ................................................................ Operating expenses Selling expenses............................................ Administrative expenses ............................ Total operating expenses................... Income from operations......................................... 2009 $5,000,000 $6,000,000 0 3,000,000 (1) 3,000,000 500,000 (2) 2,500,000 2,500,000 500,000 500,000 1,000,000 $1,500,000 2008 Computations (1) (2) 2008 500,000 2,850,000 (3) 3,350,000 0 3,350,000 2,650,000 600,000 500,000 1,100,000 $1,550,000 2009 Computations 6,000 X [($1,000 X .15) + ($2,100,000 ÷ 6,000)] 1,000 X [($1,000 X .15) + ($2,100,000 ÷ 6,000)] (3) 5,000 X [($1,000 X .15) + ($2,100,000 ÷ 5,000)] (c) The variable costing and the absorption costing income from operations can be reconciled as follows: 2008 Variable costing income Fixed manufacturing overhead expensed with variable costing Less: Fixed manufacturing overhead expensed with absorption costing Difference Absorption costing income 2009 $1,150,000 $1,900,000 $2,100,000 $2,100,000 (1,750,000) (1) (2,450,000) (2) 350,000 $1,500,000 (1) In 2008, with absorption costing $1,750,000 (350,000) $1,550,000   5, 000 units sold  $2,100, 000 X 6, 000 units manuufactured  of the fixed manufacturing overhead is expensed as part of cost of goods sold, and $350,000  1, 000 units in inventory   $2,100, 000 X 6, 000 unnits manufactured  is included in the ending inventory. 22-28 *PROBLEM 22-6A (Continued) (2) In 2009, with absorption costing $2,450,000 of fixed manufacturing overhead is expensed as part of cost of goods sold. This includes the fixed manufacturing overhead for 2009 of $2,100,000 plus $350,000 of fixed manufacturing overhead from 2008 that was included in the beginning inventory for 2009. (d) Income is more sensitive to change in sales under variable costing as seen in the increase in income from operations in 2009 when 1,000 additional units were sold. In contrast, under absorption costing, income is also strongly influenced by production as seen in the higher income from operations in 2008 when production exceeded sales by 1,000 units. 22-29 PROBLEM 22-1B (a) Variable costs (per haircut) Barbers’ commission $3.00 Rent .60 Barber supplies .40 Total variable $4.00 Fixed costs (per month) Barbers’ salaries $7,400 Rent 700 Depreciation 500 Utilities 300 Advertising 100 Total fixed $9,000 (b) $10X = $4X + $9,000 $6X = $9,000 X = 1,500 haircuts 1,500 haircuts X $10 = $15,000 (c) 18 Breakeven Point Sales Line Total Cost Line DOLLARS (000) 15 12 9 Fixed Cost Line 6 3 300 600 900 1,200 1,500 1,800 Number of Haircuts (d) Net income = $17,000 – [($4.00 X 1,700) + $9,000] = $1,200 22-30 PROBLEM 22-2B (a) WILKS COMPANY CVP Income Statement (Estimated) For the Year Ending December 31, 2008 Net sales ......................................................... Variable expenses Cost of goods sold ............................. Selling expenses................................. Administrative expenses.................. Total variable expenses........... Contribution margin.................................... Fixed expenses Cost of goods sold ............................. Selling expenses................................. Administrative expenses.................. Total fixed expenses................. Net income ..................................................... $2,000,000 $1,220,000 (1) 100,000 40,000 1,360,000 640,000 220,000 150,000 78,000 448,000 $ 192,000 (1) Direct materials $360,000 + direct labor $590,000 + variable manufacturing overhead $270,000. (b) Variable costs = 68% of sales ($1,360,000 ÷ $2,000,000) or $.34 per bottle ($.50 X 68%). Total fixed costs = $448,000. (1) $.50X = $.34X + $448,000 $.16X = $448,000 X = 2,800,000 units (breakeven) (2) 2,800,000 X $.50 = $1,400,000 (c) Contribution margin ratio = ($.50 – $.34) ÷ $.50 = 32% Margin of safety ratio = ($2,000,000 – $1,400,000) ÷ $2,000,000 = 30% (d) Required sales X= $448,000 + $272,000 = $2,250,000 .32 22-31 PROBLEM 22-3B (a) Sales were $1,500,000 and variable expenses were $900,000, which means contribution margin was $600,000 and CM ratio was 40%. Fixed expenses were $760,000. Therefore, the breakeven point in dollars is: $760,000 = $1,900,000 .40 (b) 1. The effect of this alternative is to increase the selling price per unit to $30 ($25 X 120%). Total sales become $1,800,000 (60,000 X $30). Thus, the contribution margin ratio changes to 50% ($900,000 ÷ $1,800,000). The new breakeven point is: $760,000 = $1,520,000 .50 2. The effects of this alternative are to change total fixed costs to $590,000 ($760,000 – $170,000) and to change the contribution margin to .34 [($1,500,000 – $900,000 – $90,000) ÷ $1,500,000]. The new breakeven point is: $590,000 = $1,735,294 (rounded) .34 3. The effects of this alternative are: (1) variable and fixed cost of goods sold become $600,000 each, (2) total variable costs become $720,000 ($600,000 + $65,000 + $55,000), and (3) total fixed costs are $940,000 ($600,000 + $275,000 + $65,000). The new breakeven point is: X = ($720,000 ÷ $1,500,000)X + $940,000 X = .48X + $940,000 .52X = $940,000 X = $1,807,692 (rounded) Alternative 1 is the recommended course of action using breakeven analysis because it has the lowest breakeven point. 22-32 PROBLEM 22-4B (a) Current breakeven point: $30X = $13X + $204,000 (where X = pairs of shoes) $17X = $204,000 X = 12,000 pairs of shoes New breakeven point: $28X = $13X + ($204,000 + $51,000) $15X = $255,000 X = 17,000 pairs of shoes (b) Current margin of safety percentage = (16,000 X $30) – (12,000 X $30) (16,000 X $3 30) = 25% New margin of safety percentage = (21,000 X $28) – (17,000 X $28) (21,000 X $2 28) = 19% (rounded) (c) THRIFTY SHOE STORE CVP Income Statement Sales (16,000 X $30) Variable expenses (16,000 X $13) Contribution margin Fixed expenses Net income Current New $480,000 208,000 272,000 204,000 $ 68,000 $588,000 273,000 315,000 255,000 $ 60,000 (21,000 X $28) (21,000 X $13) No, the changes should not be made because net income will be lower than the net income currently earned. In addition, the breakeven point would be higher by 5,000 units and the margin of safety percentage would decrease from 25% to 19%. 22-33 PROBLEM 22-5B (a) (1) Current Year $2,400,000 Net sales Variable costs Direct materials Direct labor Manufacturing overhead ($540,000 X .50) Selling expenses ($360,000 X .30) Administrative expenses ($420,000 X .40) Total variable costs Contribution margin Sales Variable costs Direct materials Direct labor Manufacturing overhead Selling expenses Administrative expenses Total variable costs Contribution margin 626,500 507,500 270,000 108,000 168,000 1,680,000 $ 720,000 Current Year $2,400,000 X 1.2 626,500 507,500 270,000 108,000 168,000 1,680,000 $ 720,000 X 1.2 X 1.2 X 1.2 X 1.2 X 1.2 X 1.2 X 1.2 Projected Year $2,880,000 751,800 609,000 324,000 129,600 201,600 2,016,000 $ 864,000 (2) Fixed Costs Current Year Manufacturing overhead ($540,000 X .50) $270,000 Selling expenses ($360,000 X .70) 252,000 Administrative expenses ($420,000 X .60) 252,000 $774,000 Total fixed costs 22-34 Projected year $270,000 252,000 252,000 $774,000 PROBLEM 22-5B (Continued) (b) Unit selling price = $2,400,000 ÷ 200,000 = $12.00 Unit variable cost = $1,680,000 ÷ 200,000 = $8.40 Unit contribution margin = $12.00 – $8.40 = $3.60 Contribution margin ratio = $3.60 ÷ $12.00 = .30 Break-even point in units = Fixed costs ÷ Unit contribution margin 215,000 units = $774,000 ÷ $3.60 Break-even point in dollars = Fixed costs ÷ Contribution margin ratio $2,580,000 = $774,000 ÷ .30 (c) Sales dollars required for = (Fixed costs + Target net income) ÷ Contribution margin ratio target net income $4,646,667 = ($774,000 + $620,000) ÷ .30 (d) Margin of safety = (Expected sales – Break-even sales) ÷ Expected sales ratio 44.5% = ($4,646,667 – $2,580,000) ÷ 4,646,667 (e) (1) Projected Year $2,400,000 Net sales Variable costs Direct materials Direct labor ($507,500 – $240,000) Manufacturing overhead ($540,000 X .30) Selling expenses ($360,000 X .80) Administrative expenses ($420,000 X .40) Total variable costs Contribution margin 22-35 626,500 267,500 162,000 288,000 168,000 1,512,000 $ 888,000 PROBLEM 22-5B (Continued) (2) Contribution margin ratio = $888,000 ÷ $2,400,000 = .37 (3) Break-even point in dollars = $702,000 ÷ .37 = $1,897,297 (rounded) Fixed costs Manufacturing overhead ($540,000 X .70) Selling expenses ($360,000 X .20) Administrative expenses ($420,000 X .60) Total fixed costs $378,000 72,000 252,000 $702,000 The break-even point in dollars declined from $2,580,000 to $1,897,297. This means that overall the company’s risk has declined because it doesn’t have to generate as much in sales. The two changes actually had opposing effects on the break-even point. By changing to a more commission based approach to compensating its sales staff the company reduced its fixed costs, and therefore reduced its break-even point. In contrast, the purchase of the new equipment increased the company’s fixed costs (by increasing its equipment depreciation) and reduced its variable direct labor cost, both of which would increase the break-even point. 22-36 *PROBLEM 22-6B (a) YANCEY METAL COMPANY Income Statement For the Year Ended December 31 (Variable Costing) Sales .................................................................... Variable expenses Variable cost of goods sold Inventory, January 1 ................... Variable manufacturing costs ............................................ Cost of goods available for sale ........................................ Inventory, December 31............. Variable cost of goods sold .............................................. Variable selling expenses .................. Total variable expenses............. Contribution margin ....................................... Fixed expenses Manufacturing overhead .................... Administrative........................................ Total fixed expenses................... Income from operations .............................. 2008 Computations (1) (2) (3) 50,000 X $15 10,000 X $15 40,000 X $7 2009 Computations (4) 40,000 X $15 (5) 50,000 X $7 22-37 2008 2009 $2,400,000 $3,000,000 0 150,000 750,000 (1) 600,000 (4) 750,000 150,000 (2) 750,000 0 600,000 280,000 (3) 880,000 1,520,000 1,100,000 230,000 1,330,000 $ 190,000 750,000 350,000 (5) 1,100,000 1,900,000 1,100,000 230,000 1,330,000 $ 570,000 *PROBLEM 22-6B (Continued) (b) YANCEY METAL COMPANY Income Statement For the Year Ended December 31 (Absorption Costing) Sales ............................................................................... Cost of goods sold Inventory, January 1 ....................................... Cost of goods manufactured....................... Cost of goods available for sale................. Inventory, December 31................................. Cost of goods sold.......................................... Gross profit .................................................................. Operating expenses Selling expenses.............................................. Administrative expenses .............................. Total operating expenses..................... Income from operations........................................... 2009 $2,400,000 $3,000,000 0 1,850,000 (1) 1,850,000 370,000 (2) 1,480,000 920,000 280,000 230,000 510,000 $ 410,000 2008 Computations (1) (2) 2008 370,000 1,700,000 (3) 2,070,000 0 2,070,000 930,000 350,000 230,000 580,000 $ 350,000 2009 Computations 50,000 X [$15 + ($1,100,000 ÷ 50,000)] 10,000 X $37 (3) 40,000 X [$15 + ($1,100,000 ÷ 40,000)] (c) The variable costing and the absorption costing income from operations can be reconciled as follows: 2008 Variable costing income Fixed manufacturing overhead expensed with variable costing Less: Fixed manufacturing overhead expensed with absorption costing Difference Absorption costing income (1) 2009 $190,000 $1,100,000 $570,000 $1,100,000 (880,000) (1) (1,320,000) (2) 220,000 $410,000 In 2008, with absorption costing $880,000 (220,000) $350,000   40, 000 units sold  $1,100, 000 X 50, 000 units maanufactured  of the fixed manufacturing overhead is expensed as part of cost of goods sold, and $220,000  10, 000 units in inventory   $1,100, 000 X 50, 000 units manufactured  is included in the ending inventory. 22-38 *PROBLEM 22-6B (Continued) (2) In 2009, with absorption costing $1,320,000 of fixed manufacturing overhead is expensed as part of cost of goods sold. This includes the fixed manufacturing overhead for 2009 of $1,100,000 plus $220,000 of fixed manufacturing overhead from 2008 that was included in the beginning inventory for 2009. (d) Income is more sensitive to changes in sales under variable costing as seen in the increase in income from operations in 2009 when 10,000 additional units were sold. In contrast, under absorption costing, income is also strongly affected by changes in production as seen in the higher income from operations in 2008 when production exceeded sales by 10,000 units. 22-39 BYP 22-1 (1) DECISION MAKING ACROSS THE ORGANIZATION Capital-Intensive Fixed manufacturing costs Incremental selling expenses Total fixed costs Selling price Variable costs Direct materials Direct labor Variable overhead Selling expenses Contribution margin (2) $2,508,000 502,000 $3,010,000 $30.00 $5.00 6.00 3.00 2.00 Total fixed costs (1) 16.00 $14.00 $3,010,000 Contribution margin per unit (2) Breakeven in units (1) ÷ (2) $14.00 215,000 Labor-Intensive Fixed manufacturing costs Incremental selling expenses Total fixed costs Selling price Variable costs Direct materials Direct labor Variable overhead Selling expenses Contribution margin $1,538,000 502,000 $2,040,000 $30.00 $5.50 8.00 4.50 2.00 Total fixed costs (1) Contribution margin per unit (2) Breakeven in units (1) ÷ (2) 20.00 $10.00 $2,040,000 $10.00 204,000 (b) Gagliano Company would be indifferent between the two manufacturing methods at the volume (X) where total costs are equal. $16X + $3,010,000 = $20X + $2,040,000 $4X = $970,000 X = 242,500 units (c) Gagliano should employ the capital-intensive manufacturing method if annual sales are expected to exceed 242,500 units and the labor-intensive manufacturing method if annual sales are not expected to exceed 242,500 units. The labor-intensive method is more profitable for sales up to 242,500 units because the fixed costs are lower. The capital-intensive method is more profitable for sales above 242,500 units because its contribution margin is higher. 22-40 BYP 22-2 MANAGERIAL ANALYSIS (a) The variable costs per unit are: Cost of goods sold ($600,000 ÷ 200,000) Selling expenses ($140,000 ÷ 200,000) Administrative expenses ($40,000 ÷ 200,000) Total $3.00 .70 .20 $3.90 The breakeven points are: X = ($3.90 ÷ $6.00) X + $460,000 X = .65X + $460,000 .35X = $460,000 X = $1,314,286 (rounded) $6.00X = $3.90X + $460,000 $2.10X = $460,000 X = 219,048 units (rounded) (b) Variable unit cost of goods sold = $3.25 ($600,000 ÷ 200,000 = $3.00; $3.00 + $.25) Sales volume = 260,000 units (200,000 X 130%) Total sales = 260,000 X $6.25 = $1,625,000 Net income computation: Sales................................................................. Variable expenses Cost of goods sold ............................. (260,000 X $3.25) Selling expenses................................. (260,000 X $.70) Administrative expenses (260,000 X $.20) .............................. Total variable expenses........... Contribution margin.................................... Fixed expenses Cost of goods sold ............................. Selling expenses................................. Administrative expenses.................. Total fixed expenses................. Net income ..................................................... 22-41 $1,625,000 $845,000 182,000 52,000 1,079,000 546,000 $200,000 140,000 120,000 460,000 $ 86,000 BYP 22-2 (Continued) X = ($1,079,000 ÷ $1,625,000)X + $460,000 X = .66X + $460,000 .34X = $460,000 X = $1,352,941 (rounded) Profits and the break-even point would both increase. (c) Sales [320,000 (1) X ($6.00 – $.30)] .................. Variable expenses Cost of goods sold ...................................... (320,000 X $3.00) Selling expenses (320,000 X $.79) .......... Administrative expenses (320,000 X $.20) ....................................... Total variable expenses .................... Contribution margin ............................................. Fixed expenses Cost of goods sold ...................................... Selling expenses .......................................... ($140,000 + $35,000) Administrative expenses ........................... Total fixed expenses .......................... Net income............................................................... $1,824,000 $960,000 252,800 64,000 1,276,800 547,200 $200,000 175,000 120,000 495,000 $ 52,200 (1) Sales volume = 200,000 X 160% = 320,000 X = ($1,276,800 ÷ $1,824,000)X + $495,000 X = .70X + $495,000 .30X = $495,000 X = $1,650,000 Profits and the break-even point would both increase. (d) Terri’s plan should be accepted. It produces a higher net income and a lower breakeven point than Jerry’s plan. 22-42 BYP 22-3 REAL-WORLD FOCUS (a) Sweeteners and packaging are a variable cost to Coca-Cola because their use is directly proportional to the amount of product produced. If the unit cost of a variable cost item increases, the contribution margin will decline. This will lead to a decline in net income unless the company can increase its selling price, increase the number of units it sells, or reduce other costs. (b) This description makes the marketing expenditures sound like they are a variable cost, since it suggests that they vary with the amount of units sold. However, unlike variable costs, the relationship of marketing costs is not directly proportional to sales, since other factors also influence units sold. Thus, it is not a pure variable cost. However, it is also not a fixed cost, in that there usually is a relationship between marketing expenditures and sales. For CVP purposes, it might best be handled as a mixed cost, having both a fixed and variable component. (c) The first measure, gallon shipments of concentrates and syrups, is the activity index, since it best reflects the company’s production and sales activity at the wholesale level, its primary line of business. The second measure, unit cases of finished product, indicates the amount of activity by Coke’s primary customers, the bottlers. Coke also keeps track of this since it provides information about what is happening at the retail level. 22-43 BYP 22-4 EXPLORING THE WEB (a) The description of the production process is as follows: The production of hard candy begins with the blending, cooking, and kneading of ingredients. Workers add flavoring and coloring when the candy is kneaded. The candy is then pressed out and a roll of thick chocolate is placed in the middle of the candy. Workers then roll each end of the product over the middle to form a pillow shape. The roll is stretched by hand at the chicken bone machine so that the width of the roll is the width of the average chicken bone, a difficult procedure. Next, the elongated roll is fed into the cutting machine. The end result is a candy which tastes of sweet cinnamon and has a luscious surprise of chocolate in the middle. (b) The following costs might be identified as variable: labor (stretching chicken bones, feeding into cutting machine), materials (flavoring, coloring, chocolate). The following costs might be identified as fixed: depreciation of machinery, indirect labor, and utilities. 22-44 BYP 22-5 COMMUNICATION ACTIVITY To: My Roommate From: Your Roommate Subject: Cost-Volume-Profit Questions In response to your request for help, I provide you the following: (a) The mathematical formula for breakeven sales is: Breakeven Sales = Variable Costs + Fixed Costs Breakeven sales in dollars is found by expressing variable costs as a percentage of unit selling price. For example, if the percentage is 70%, the breakeven formula becomes X = .70X + Fixed Costs. The answer will be in sales dollars. Breakeven sales in units is found by using unit selling price and unit variable costs in the formula. For example, if the selling price is $300 and variable costs are $210, the breakeven formula becomes $300X = $210X + Fixed Costs. The answer will be in sales units. (b) The formulas for contribution margin per unit and contribution margin ratio differ as shown below: Unit Selling Price – Unit Variable Costs = Contribution Margin per Unit Contribution Margin per Unit ÷ Unit Selling Price = Contribution Margin Ratio You can see that CM per Unit is used in computing the CM ratio. (c) When contribution margin is used to determine breakeven sales, total fixed costs are divided by either the contribution margin ratio or contribution margin per unit. Using the CM ratio results in determining the breakeven point in dollars. Using CM per unit results in determining the breakeven point in units. 22-45 BYP 22-5 (Continued) The formula for determining breakeven sales in dollars is: Fixed Costs ÷ Contribution Margin Ratio = Breakeven Sales in Dollars The formula for determining breakeven sales in units is: Fixed Costs ÷ Contribution Margin per Unit = Breakeven Sales in Units I hope this memo answers your questions. 22-46 BYP 22-6 ETHICS CASE (a) The stakeholders in this situation are:
Kenny Hampton, accountant of Bartley Company.
The dislocated personnel of Bartley.
The senior management who made the decision. (b) Kenny is hiding an error and is knowingly deceiving the company’s management with inaccurate data. (c) Kenny’s alternatives are:
Keep quiet.
Confess his mistake to management. The students’ recommendations should recognize the practical aspects of the situation but they should be idealistic and ethical. If the students can’t be totally ethical when really nothing is at stake, how can they expect to be ethical under real-world pressures? 22-47 BYP 22-7 ALL ABOUT YOU ACTIVITY (a) The variable gasoline cost of going one mile in the hybrid car would be $0.075 ($3.00/40). The variable gasoline cost of going one mile in the traditional car would be $0.10 ($3.00/30). (b) The savings per mile of driving the hybrid vehicle would be $0.025 ($0.10 – $0.075). (c) In order to break-even on your investment you would need to drive 120,000 miles. This is determined by dividing the additional fixed cost of $3,000 by the contribution margin per mile of $0.025. (d) There are many other factors that you would want to consider in your analysis. For example, do the vehicles differ in their expected repair bills, insurance costs, licensing fees, or ultimate resale value. Also, some states and some employers offer rebates for the purchase of hybrid vehicles. In addition, your decision might be influenced by non-financial factors, such as a desire to reduce emissions. 22-48 CHAPTER 23 Budgetary Planning ASSIGNMENT CLASSIFICATION TABLE Brief Exercises A Problems B Problems 1, 2, 3, 4, 5, 6, 7, 8, 9, 10, 11 1A, 2A, 3A 1B, 2B, 3B 8 11 1A, 2A, 3A, 6A 1B, 2B, 3B 19, 20 9 12, 13, 14 15, 16 4A, 6A 4B 21, 22 10 3, 15, 16, 17 5A 5B Study Objectives Questions 1. Indicate the benefits of budgeting. 1, 2, 4 1 2. State the essentials of effective budgeting. 3, 5, 6, 7, 8 1 3. Identify the budgets that comprise the master budget. 9, 10, 11, 12, 13, 14, 15, 16 1, 2, 3, 4, 5, 6, 7 4. Describe the sources for preparing the budgeted income statement. 17, 18 5. Explain the principal sections of a cash budget. 6. Indicate the applicability of budgeting in nonmanufacturing companies. 23-1 Exercises ASSIGNMENT CHARACTERISTICS TABLE Problem Number Description Difficulty Level Time Allotted (min.) 1A Prepare budgeted income statement and supporting budgets. Simple 30–40 2A Prepare sales, production, direct materials, direct labor, and income statement budgets. Simple 40–50 3A Prepare sales and production budgets and compute cost per unit under two plans. Moderate 30–40 4A Prepare cash budget for two months. Moderate 30–40 5A Prepare purchases and income statement budgets for a merchandiser. Simple 30–40 6A Prepare budgeted income statement and balance sheet. Complex 40–50 1B Prepare budgeted income statement and supporting budgets. Simple 30–40 2B Prepare sales, production, direct materials, direct labor, and income statement budgets. Simple 40–50 3B Prepare sales and production budgets and compute cost per unit under two plans. Moderate 30–40 4B Prepare cash budget for two months. Moderate 30–40 5B Prepare purchases and income statement budgets for a merchandiser. Simple 30–40 23-2 23-3 Study Objective Knowledge Comprehension 1. Indicate the benefits of budgeting. Q23-1 Q23-2 Q23-4 E23-1 2. State the essentials of effective budgeting. Q23-3 Q23-5 Q23-6 Q23-7 Q23-8 E23-1 3. Identify the budgets that comprise the master budget. Q23-9 Q23-10 Q23-11 E23-1 Q23-12 Q23-13 Q23-14 Q23-15 Q23-16 BE23-2 BE23-3 BE23-4 BE23-5 BE23-6 BE23-7 E23-2 E23-3 E23-4 E23-5 E23-6 E23-7 E23-8 4. Describe the sources for preparing the budgeted income statement. Q23-18 Q23-17 BE23-8 E23-11 P23-1A P23-1B P23-2A P23-2B P23-6A 5. Q23-19 Explain the principal sections of a cash budget. Q23-20 BE23-9 E23-12 E23-13 E23-14 P23-6A E23-15 P23-4B E23-16 P23-4A 6. Indicate the applicability of budgeting in non-manufacturing companies. Broadening Your Perspective Q23-21 Q23-22 Application BE23-10 E23-3 E23-15 E23-16 Real-World Focus All About You Analysis E23-9 BE23-1 E23-10 E23-11 P23-1A P23-2A P23-1B P23-2B Synthesis Evaluation P23-3A P23-3B P23-3A P23-3B E23-17 P23-5A P23-5B Manag. Analysis Decision Making Ethics Case Decision Making Across the Communication Across the Real-World Focus Organization Manag. Analysis Organization Communication All About You BLOOM’S TAXONOMY TABLE Correlation Chart between Bloom’s Taxonomy, Study Objectives and End-of-Chapter Exercises and Problems ANSWERS TO QUESTIONS 1. (a) A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms. (b) A budget aids management in planning because it represents the primary means of communicating agreed-upon objectives throughout the organization. Once adopted, a budget becomes an important basis for evaluating performance. 2. The (1) (2) (3) 3. The essentials of effective budgeting are: (1) a sound organizational structure, (2) research and analysis, and (3) acceptance by all levels of management. 4. (a) Disagree. Accounting information makes major contributions to the budgeting process. Accounting provides the starting point of budgeting by providing historical data on revenues, costs, and expenses. Accounting becomes the translator of the budget and communicates the budget to all areas of responsibility. It also prepares periodic budget reports that compare actual results with planned objectives and provide a basis for evaluating performance. (b) The budget itself, and the administration of the budget, are the responsibility of management. 5. The budget period should be long enough to provide an attainable goal under normal business conditions. The budget period should minimize the impact of seasonal and cyclical business fluctuations, but it should not be so long that reliable estimates are impossible. The most common budget period is one year. 6. Disagree. Long-range planning usually encompasses a period of at least five years. It involves the selection of strategies to achieve long-term goals and the development of policies and plans to implement the strategies. In addition, long-range planning reports contain considerably less detail than budget reports. 7. Participative budgeting involves the use of a “bottom to top” approach, which requires input from lower level management during the budgeting process so as to involve employees from various levels and areas within the company. The potential benefits of this approach are lower level managers have more detailed knowledge of the specifics of their job, and thus should be able to provide better budgetary estimates. In addition, by involving lower level managers in the process, it is more likely that they will perceive the budget as being fair and reasonable. One disadvantage of participative budgeting is that it takes more time, and thus costs more. Another disadvantage of participative budgeting is that it may enable managers to game the system through such practices as budgetary slack. primary benefits of budgeting are: It requires all levels of management to plan ahead and to formalize goals on a recurring basis. It provides definite objectives for evaluating performance at each level of responsibility. It creates an early warning system for potential problems, so that management can make changes before things get out of hand. (4) It facilitates the coordination of activities within the business by correlating the goals of each segment with overall company objectives. (5) It results in greater management awareness of the entity’s overall operations and the impact of external factors such as economic trends. (6) It motivates personnel throughout the organization to meet planned objectives. 23-4 Questions Chapter 23 (Continued) 8. Budgetary slack is the amount by which a manager intentionally underestimates budgeted revenues or overestimates budgeted expenses in order to make it easier to achieve budgetary goals. Managers may have an incentive to create budgetary slack in order to increase the likelihood of receiving a bonus, or decrease the likelihood of losing their job. 9. A master budget is a set of interrelated budgets that constitutes a plan of action for a specified time period. The master budget is developed within the framework of a sales forecast. 10. The sales budget is the starting point in preparing the master budget. An inaccurate sales budget may adversely affect net income. An overly optimistic sales budget may result in excessive inventories and a very conservative sales budget may lead to inventory shortages. 11. The statement is false. The production budget only shows the units that must be produced to meet anticipated sales and ending inventory requirements. 12. The required units of production are 165,000 (160,000 + 20,000 = 180,000 – 15,000 = 165,000). 13. The desired ending direct materials units are 19,000 (64,000 + 7,000 = 71,000 – 52,000 = 19,000). 14. Total budgeted direct labor costs are $640,000 (80,000 X .5 X $16 = $640,000). 15. (a) Manufacturing overhead rate based on direct labor cost is 60% [$198,000 + $162,000 = $360,000; $360,000 ÷ (160,000 X 1/4 X $15/hr.) = 60%]. (b) Manufacturing overhead rate per direct labor hour is $9 ($360,000 ÷ 40,000). 16. The first quarter budgeted selling and administrative expenses are $70,000 [(10% X $200,000) + $50,000]. The second quarter total is $75,000 [(10% X $250,000) + $50,000]. 17. The budgeted cost per unit of product is $48 ($10 + $20 + $18). Gross profit per unit is $21 ($69 – $48). Total budgeted gross profit is $525,000 (25,000 X $21). 18. The supporting schedules are the budgets for sales, direct materials, direct labor, and manufacturing overhead. 19. The three sections of a cash budget are: (1) cash receipts, (2) cash disbursements, and (3) financing. The cash budget also shows the beginning and ending cash balances. 20. Cash collections are: January—$500,000 X 45% = $225,000. February—$500,000 X 50% = $250,000. March—$500,000 X 5% = $25,000. 21. The formula is: Budgeted cost of goods sold plus desired ending merchandise inventory minus beginning merchandise inventory equals required merchandise purchases. 22. In a service enterprise, expected revenues can be obtained from expected output or expected input. The former is based on anticipated billings of clients for services rendered. The latter is based on expected billable time of the professional staff. 23-5 SOLUTIONS TO BRIEF EXERCISES BRIEF EXERCISE 23-1 Sales Budget Production Budget Direct Materials Budget Direct Labor Budget Manufacturing Overhead Budget Operating Budgets Budgeted Balance Sheet Financial Budgets Selling and Administrative Expense Budget Budgeted Income Statement Capital Expenditure Budget Cash Budget 23-6 BRIEF EXERCISE 23-2 GOODY COMPANY Sales Budget For the Year Ending December 31, 2008 Quarter 1 Expected unit sales Unit selling price Total sales 3 4 12,000 14,000 18,000 54,000 $80 X $80 X $800,000 $960,000 X $80 $1,120,000 X $80 $1,440,000 X $80 $4,320,000 10,000 2 Year BRIEF EXERCISE 23-3 GOODY COMPANY Production Budget For the Six Months Ending June 30, 2008 Quarter 1 Expected unit sales Add: Desired ending finished goods Total required units Less: Beginning finished goods inventory Required production units a 12,000 X .20 b 10,000 X .20 c 14,000 X .20 23-7 10,000 2,400 a 12,400 2,000 b 10,400 Six Months 2 12,000 2,800 c 14,800 2,400 12,400 22,800 BRIEF EXERCISE 23-4 ORTIZ COMPANY Direct Materials Budget For the Month Ending January 31, 2009 Units to be produced Direct materials per unit Total pounds required for production Add: Desired ending inventory (20% X 5,500 X 2) Total materials required Less: Beginning materials inventory Direct materials purchases Cost per pound Total cost of direct materials purchases 4,000 X 2 8,000 2,200 10,200 1,600 8,600 X $6 $51,600 BRIEF EXERCISE 23-5 EVERLY COMPANY Direct Labor Budget For the Six Months Ending June 30, 2008 Quarter Units to be produced Direct labor time (hours) per unit Total required direct labor hours Direct labor cost per hour Total direct labor cost 23-8 1 2 Six Months 5,000 X 1.5 7,500 X $14 $105,000 6,000 X 1.5 9,000 X $14 $126,000 $231,000 BRIEF EXERCISE 23-6 JUSTUS INC. Manufacturing Overhead Budget For the Year Ending December 31, 2008 Quarter 1 Variable costs Fixed costs Total manufacturing overhead 2 3 4 Year $20,000 $24,000 $28,000 $32,000 $104,000 35,000 35,000 35,000 35,000 140,000 $55,000 $59,000 $63,000 $67,000 $244,000 BRIEF EXERCISE 23-7 MIZE COMPANY Selling and Administrative Expense Budget For the Year Ending December 31, 2008 Quarter 1 2 3 4 Year $25,000 $30,000 $35,000 $40,000 $130,000 Variable expenses 40,000 40,000 40,000 40,000 160,000 Fixed expenses Total selling and administrative expenses $65,000 $70,000 $75,000 $80,000 $290,000 BRIEF EXERCISE 23-8 PERINE COMPANY Budgeted Income Statement For the Year Ending December 31, 2008 Sales Cost of goods sold (50,000 X $22) Gross profit Selling and administrative expenses Income before income taxes Income tax expense Net income $2,000,000 1,100,000 900,000 300,000 600,000 150,000 $ 450,000 23-9 BRIEF EXERCISE 23-9 Credit Sales January, $200,000 February, $260,000 March, $310,000 Collections from Customers January February March $ 60,000 $140,000 $ 78,000 182,000 217,000 $140,000 $242,000 $295,000 BRIEF EXERCISE 23-10 Budgeted cost of goods sold ($400,000 X 60%) Add: Desired ending inventory ($475,000 X 60% X 20%) Total inventory required Less: Beginning inventory ($400,000 X 60% X 20%) Required merchandise purchases for April 23-10 $240,000 57,000 297,000 48,000 $249,000 SOLUTIONS TO EXERCISES EXERCISE 23-1 MEMO To Jack Bruno From: Student Re: Budgeting I am glad Black Rose Company is considering preparing a formal budget. There are many benefits derived from budgeting, as I will discuss later in this memo. A budget is a formal written statement of management’s plans for a specified future time period, expressed in financial terms. The master budget generally consists of operating budgets such as the sales budget, production budget, direct materials budget, direct labor budget, manufacturing overhead budget, selling and administrative expense budget, and budgeted income statement; and financial budgets such as the capital expenditure budget, cash budget, and budgeted balance sheet. The primary benefits of budgeting are: 1. It requires all levels of management to plan ahead and formalize their goals. 2. It provides definite objectives for evaluating performance. 3. It creates an early warning system for potential problems. 4. It facilitates the coordination of activities within the business. 5. It results in greater management awareness of the entity’s overall operations. 6. It motivates personnel throughout the organization to meet planned objectives. In order maximize these benefits, it is essential that budgeting takes place within a sound organizational structure, so authority and responsibility for all phases of operations are clearly defined. Also, the budget should be based on research and analysis that results in realistic goals. Finally, the effectiveness of a budget program is directly related to its acceptance by all levels of management. If you want further explanation of any of these assumptions, please contact me. 23-11 EXERCISE 23-2 ZELLER ELECTRONICS INC. Sales Budget For the Six Months Ending June 30, 2008 23-12 Product Units XQ-103 XQ-104 Totals 20,000 12,000 32,000 Quarter 1 Selling Total Price Sales $12 25 $240,000 300,000 $540,000 Units 25,000 15,000 40,000 Quarter 2 Selling Total Price Sales $12 25 $300,000 375,000 $675,000 Units 45,000 27,000 72,000 Six Months Selling Total Price Sales $12 25 $ 540,000 675,000 $1,215,000 EXERCISE 23-3 ROCHE AND YOUNG, CPAs Sales Revenue Budget For the Year Ending December 31, 2008 Dept. Auditing Tax Consulting Totals Billable Hours 2,200 3,000 1,500 23-13 Dept. Auditing Tax Consulting Totals a Billable Hours 8,200a 9,900b 6,000c Quarter 1 Billable Total Rate Rev. $ 80 $176,000 90 270,000 100 150,000 $596,000 Year Billable Rate $ 80 90 100 2,200 + 1,600 + 2,000 + 2,400 3,000 + 2,400 + 2,000 + 2,500 c 1,500 X 4 b Billable Hours 1,600 2,400 1,500 Total Rev. $ 656,000 891,000 600,000 $2,147,000 Quarter 2 Billable Rate $ 80 90 100 Total Rev. 128,000 216,000 150,000 $494,000 Billable Hours 2,000 2,000 1,500 Quarter 3 Billable Total Rate Rev. $ 80 $160,000 90 180,000 100 150,000 $490,000 Billable Hours 2,400 2,500 1,500 Quarter 4 Billable Total Rate Rev. $ 80 $192,000 90 225,000 100 150,000 $567,000 EXERCISE 23-4 TURNEY COMPANY Production Budget For the Year Ending December 31, 2008 Product HD-240 Quarter Expected unit sales Add: Desired ending finished goods units(1) Total required units Less: Beginning finished goods units Required production units 1 2 5,000 7,000 8,000 3,500 8,500 4,000 11,000 5,000 13,000 3,250 (2) 13,250 2,500 6,000 3,500 7,500 4,000 9,000 5,000 8,250 (1) 50% of next quarter’s sales. 50% X (5,000 X 130%). (2) 23-14 3 4 Year 10,000 30,750 EXERCISE 23-5 MORENO INDUSTRIES Direct Materials Purchases Budget For the Quarter Ending March 31, 2009 January Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials (pounds)* Total materials required Less: Beginning direct materials (pounds) Direct materials purchases Cost per pound Total cost of direct materials purchases 10,000 X 3 30,000 February 8,000 X 3 24,000 March 5,000 X 3 15,000 7,200 37,200 4,500 28,500 3,600 18,600 9,000 28,200 X $2 7,200 21,300 X $2 4,500 14,100 X $2 $56,400 $42,600 $28,200 *30% of next month’s production needs. EXERCISE 23-6 (a) BATISTA COMPANY Production Budget For the Six Months Ending June 30, 2009 Quarter 1 Expected unit sales Add: Desired ending finished goods units Total required units Less: Beginning finished goods units Required production units (1) 30% X 6,000. 30% X 7,000. (3) 30% X 5,000. (2) 23-15 2 Six Months 5,000 6,000 1,800 (1) 6,800 1,500 (3) 5,300 2,100 (2) 8,100 1,800 6,300 11,600 EXERCISE 23-6 (Continued) (b) BATISTA COMPANY Direct Materials Budget For the Six Months Ending June 30, 2009 Quarter 1 Units to be produced Direct materials per unit Total pounds needed for production Add: Desired ending direct materials (pounds) Total materials required Less: Beginning direct materials (pounds) Direct materials purchases Cost per pound Total cost of direct materials Purchases 5,300 X 3 15,900 2 6,300 X 3 18,900 9,450 (1) 25,350 Six Months 10,875 (2) 29,775 7,950 (3) 9,450 17,400 20,325 X $4 X $4 0000,000 $69,600 $150,900 $81,300 (1) 50% X 18,900. 7,250 X (3 X 50%). (3) 50% X 15,900. (2) EXERCISE 23-7 NEELY, INC. Direct Labor Budget For the Year Ending December 31, 2008 Quarter 1 Units to be produced Direct labor time (hours) per unit Total required direct labor hours Direct labor cost per hour Total direct labor cost 2 20,000 X 1.6 3 25,000 X 1.6 4 35,000 X 1.6 Year 30,000 X 1.6 32,000 40,000 56,000 48,000 X $15 $480,000 X $15 $600,000 X $16 $896,000 X $16 $768,000 23-16 110,000 .2 $2,744,000 EXERCISE 23-8 HARDIN COMPANY Manufacturing Overhead Budget For the Year Ending December 31, 2008 Quarter 1 Variable costs Indirect materials ($.70/hour) $10,500 Indirect labor ($1.20/hour) 18,000 Maintenance ($.50/hour) 7,500 Total variable 36,000 Fixed costs Supervisory salaries 35,000 Depreciation 16,000 Maintenance 12,000 Total fixed 63,000 Total manufacturing overhead $99,000 Direct labor hours Manufacturing overhead rate per direct labor hour ($439,200 ÷ 78,000) 15,000 2 3 4 Year $ 12,600 21,600 9,000 43,200 $ 14,700 25,200 10,500 50,400 $ 16,800 28,800 12,000 57,600 $ 54,600 93,600 39,000 187,200 35,000 16,000 12,000 63,000 $106,200 35,000 16,000 12,000 63,000 $113,400 35,000 16,000 12,000 63,000 $120,600 140,000 64,000 48,000 252,000 $439,200 18,000 21,000 24,000 78,000 $5.63 EXERCISE 23-9 EDINGTON COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2008 Quarter Budgeted sales in units 1 20,000 2 22,000 Variable expenses (1) Sales commissions Delivery expense Advertising Total variable $20,000 8,000 12,000 40,000 $22,000 8,800 13,200 44,000 23-17 Six Months $42,000 16,800 25,200 84,000 EXERCISE 23-9 (Continued) EDINGTON COMPANY Selling and Administrative Expense Budget (Continued) For the Six Months Ending June 30, 2008 Quarter Fixed expenses Sales salaries Office salaries Depreciation Insurance Utilities Repairs expense Total fixed Total selling and administrative expenses 1 2 Six Months 10,000 6,000 4,200 1,500 800 600 23,100 $63,100 10,000 6,000 4,200 1,500 800 600 23,100 $67,100 20,000 12,000 8,400 3,000 1,600 1,200 46,200 $130,200 (1) Variable costs per dollar of sales are: Sales commissions $.05, Delivery expense $.02, and Advertising $.03. EXERCISE 23-10 (a) TYSON CHANDLER COMPANY Production Budget For the Two Months Ending February 28, 2008 ____________________________________________________________ January February Expected unit sales .................................................... 10,000 12,000 3,250* Add: desired ending finished goods 3,000* inventory ........................................................................ Total required units .................................................... 13,000 15,250 3,000 Less: beginning finished goods inventory........ 2,500** Required production units ....................................... 10,500 12,250 *25% X next month’s expected sales **25% X 10,000 23-18 EXERCISE 23-10 (Continued) (b) TYSON CHANDLER COMPANY Direct Materials Budget For the Year Ending January 31, 2008 ____________________________________________________________ Units to be produced........................................................................ Direct material pounds per unit.................................................... Total pounds needed for production.......................................... Add: desired pounds in ending materials inventory............ Total materials required .................................................................. Less: beginning direct materials (pounds)............................... Direct materials purchases ............................................................ Cost per pound .................................................................................. Total cost of direct materials purchases................................... *(12,250 X 2) X 40% January 10,500 X 2 21,000 9,800* 30,800 8,400** 22,400 X $3 $67,200 **(10,500 X 2) X 40% EXERCISE 23-11 (a) FUQUA COMPANY Computation of Cost of Goods Sold For the Year Ending December 31, 2008 Cost of one unit of finished goods: Direct materials (2 X $5) ............................................................................. Direct labor (3 X $12) ................................................................................... Manufacturing overhead (3 X $6) ............................................................ Total.......................................................................................................... 30,000 units X $64 = $1,920,000. 23-19 $10 36 18 $64 EXERCISE 23-11 (Continued) (b) FOQUA COMPANY Budgeted Income Statement For the Year Ending December 31, 2008 Sales (30,000 X $80) ............................................................................... Cost of goods sold (see part (a)) ....................................................... Gross profit ............................................................................................... Selling and administrative expenses ............................................... Income before income taxes ............................................................... Income tax expense ($280,000 X 30%)............................................. Net income ................................................................................................ $2,400,000 1,920,000 480,000 200,000 280,000 84,000 $ 196,000 EXERCISE 23-12 GARZA COMPANY Cash Budget For the Two Months Ending February 28, 2008 January Beginning cash balance ................................................. Add: Receipts Collections from customers ........................... Sale of marketable securities......................... Total receipts ....................................................... Total available cash ......................................................... Less: Disbursements Direct materials................................................... Direct labor........................................................... Manufacturing overhead.................................. Selling and administrative expenses........... Total disbursements ......................................... Excess (deficiency) of available cash over cash disbursements .............................................................. Financing Borrowings ............................................................... Repayments ............................................................. Ending cash balance ....................................................... 23-20 $ 46,000 February $ 26,000 85,000 10,000 95,000 141,000 150,000 0 150,000 176,000 50,000 30,000 20,000 15,000 115,000 70,000 45,000 24,000 20,000 159,000 26,000 17,000 0 0 $ 26,000 3,000 0 $ 20,000 EXERCISE 23-13 PINK MARTINI CORPORATION Cash Budget For the Quarter Ended March 31, 2008 Beginning cash balance........................................................................ Add: Receipts Collections from customers.................................................. Sale of equipment..................................................................... Total receipts ...................................................................... Total available cash................................................................................ Less: Disbursements Direct materials ......................................................................... Direct labor ................................................................................. Manufacturing overhead ........................................................ Selling and administrative expense ................................... Purchase of securities ............................................................ Total disbursements ........................................................ Excess of available cash over disbursements.............................. Financing Borrowings ................................................................................. Repayments................................................................................ Ending cash balance.............................................................................. 23-21 $ 31,000 180,000 3,500 183,500 214,500 41,000 70,000 35,000 45,000 12,000 203,000 11,500 13,500 –0– $ 25,000 EXERCISE 23-14 (a) NIU COMPANY Expected Collections from Customers March cash sales (40% X $270,000)............................................. Collection of March credit sales [(60% X $270,000) X 10%]............................................................ Collection of February credit sales [(60% X $220,000) X 50%]............................................................ Collection of January credit sales [(60% X $200,000) X 36%]............................................................ Total collections................................................................... (b) March $108,000 16,200 66,000 43,200 $233,400 NIU COMPANY Expected Payments for Direct Materials March cash purchases (50% X $41,000)..................................... Payment of March credit purchases [(50% X $41,000) X 40%].............................................................. Payment of February credit purchases [(50% X $35,000) X 60%].............................................................. Total payments..................................................................... 23-22 March $20,500 8,200 10,500 $39,200 EXERCISE 23-15 (a) (1) ENVIRONMENTAL LANDSCAPING INC. Schedule of Expected Collections From Clients For the Quarter Ending March 31, 2008 January November ($90,000) ....... December ($80,000) ....... January ($100,000) ......... February ($120,000) ....... March ($130,000)............. Total collections ...... February $ 9,000 24,000 60,000 $ ______ _______ $93,000 $110,000 March Quarter $ 8,000 30,000 72,000 $ 10,000 36,000 78,000 $124,000 9,000 32,000 100,000 108,000 78,000 $327,000 (2) ENVIRONMENTAL LANDSCAPING INC. Schedule of Expected Payments for Landscaping Supplies For the Quarter Ending March 31, 2008 _______________________________________________________ January December ($14,000) ....... January ($12,000) ........... February ($15,000).......... March ($18,000) ............... Total payments......... (b) $ 8,400 4,800 $13,200 February $ 7,200 6,000 $13,200 March Quarter $ 9,000 7,200 $16,200 $ 8,400 12,000 15,000 7,200 $42,600 (1) Accounts receivable at March 31, 2008: ($120,000 X 10%) + ($130,000 X 40%) = $64,000 (2) Accounts payable at March 31, 2008: ($18,000 X 60%) = $10,800 23-23 EXERCISE 23-16 DONNEGAL DENTAL CLINIC Cash Budget For the Two Quarters Ending June 30, 2008 1st Quarter Beginning cash balance ............................................... Add: Receipts Collections from clients.............................. Sale of equipment ......................................... Investment interest....................................... Total receipts ........................................... Total cash available ....................................................... Less: Disbursements Professional salaries ................................... Overhead costs.............................................. Selling and administrative costs ............. Equipment purchase.................................... Payment of income taxes ........................... Total disbursements ............................. Excess (deficiency) of cash available over cash disbursements........................................ Financing Borrowings................................................................... Repayments ................................................................. Ending cash balance ..................................................... *$50,000 – $3,000 **$70,000 – $3,000 23-24 $ 30,000 2nd Quarter $ 25,000 230,000 15,000 0 245,000 275,000 380,000 0 5,000 385,000 410,000 140,000 75,000 47,000* 0 0 262,000 140,000 100,000 67,000** 50,000 4,000 361,000 13,000 49,000 12,000 0 $ 25,000 0 12,300 $ 36,700 EXERCISE 23-17 (a) DALBY STORES Merchandise Purchases Budget For the Month Ending June 30, 2008 Budgeted cost of goods sold ($500,000 X 70%)...................... Add: Desired ending merchandise inventory ($600,000 X 70% X 40%) .............................................................. Total........................................................................................................ Less: Beginning merchandise inventory ($350,000 X 40%) .............................................................. Required merchandise purchases............................................... (b) $350,000 168,000 518,000 140,000 $378,000 DALBY STORES Budgeted Income Statement For the Month Ending June 30, 2008 Sales.............................................................................. Cost of goods sold (70% X $500,000) ................ Gross profit................................................................. 23-25 $500,000 350,000 $150,000 SOLUTIONS TO PROBLEMS PROBLEM 23-1A DANNER FARM SUPPLY COMPANY Sales Budget For the Six Months Ending June 30, 2009 Quarter Expected unit sales.......................... Unit selling price ............................... Total sales ........................................... 1 2 28,000 X $60 $1,680,000 42,000 X $60 $2,520,000 Six Months 70,000 X $60 $4,200,000 DANNER FARM SUPPLY COMPANY Production Budget For the Six Months Ending June 30, 2009 Quarter 1 Expected unit sales ............................................... Add: Desired ending finished goods units ........................................................ Total required units ............................................... Less: Beginning finished goods units........... Required production units.................................. 23-26 28,000 2 42,000 12,000 40,000 8,000 32,000 18,000 60,000 12,000 48,000 Six Months 80,000 PROBLEM 23-1A (Continued) DANNER FARM SUPPLY COMPANY Direct Materials Budget—Gumm For the Six Months Ending June 30, 2009 Quarter 1 2 32,000 Units to be produced........................................... Direct materials per unit..................................... X4 Total pounds needed for production ............. 128,000 Add: Desired ending direct materials (pounds) ............................................... 10,000 Total materials required ..................................... 138,000 Less: Beginning direct materials (pounds) ............................................... 9,000 Direct materials purchases ............................... 129,000 Cost per pound...................................................... X $4 Total cost of direct materials purchases ........................................................... $516,000 Six Months 48,000 X 4 192,000 13,000 205,000 10,000 195,000 X $4 $780,000 $1,296,000 DANNER FARM SUPPLY COMPANY Direct Labor Budget For the Six Months Ending June 30, 2009 Quarter 1 Units to be produced.................................. Direct labor time (hours) per unit........... Total required direct labor hours ........... Direct labor cost per hour......................... Total direct labor cost ................................ 23-27 32,000 X 1/4 8,000 X $14 $112,000 2 48,000 X 1/4 12,000 X $14 $168,000 Six Months $280,000 PROBLEM 23-1A (Continued) DANNER FARM SUPPLY COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2009 Quarter Budgeted sales in units Variable (.15 X sales)................................ Fixed.............................................................. Total............................................................... Six Months 1 28,000 2 42,000 70,000 $252,000 175,000 $427,000 $378,000 175,000 $553,000 $630,000 350,000 $980,000 DANNER FARM SUPPLY COMPANY Budgeted Income Statement For the Six Months Ending June 30, 2009 Sales............................................................................................................. Cost of goods sold (70,000 X $33.75)* .............................................. Gross profit ................................................................................................ Selling and administrative expenses ................................................ Income from operations......................................................................... Income tax expense (30%) .................................................................... Net income ................................................................................................. $4,200,000 2,362,500 1,837,500 980,000 857,500 257,250 $ 600,250 *Cost Per Bag Cost Element Quantity Direct materials Gumm ................................................... 4 pounds Tarr ........................................................ 6 pounds Direct labor .............................................. 1/4 hour Manufacturing overhead (150% of direct labor cost)............. Total................................................. 23-28 Unit Cost Total $ 4.00 1.50 14.00 $16.00 9.00 3.50 5.25 $33.75 PROBLEM 23-2A (a) LARUSSA INC. Sales Budget For the Year Ending December 31, 2009 Expected unit sales ............. Unit selling price................... Total sales............................... (b) JB 50 JB 60 Total 400,000 X $20 $8,000,000 200,000 X $25 $5,000,000 000,000,0 $13,000,000 LARUSSA INC. Production Budget For the Year Ending December 31, 2009 Expected unit sales ................................... Add: Desired ending finished goods units............................... Total required units ................................... Less: Beginning finished goods units ............................................ Required production units...................... 23-29 JB 50 JB 60 400,000 200,000 25,000 425,000 15,000 215,000 30,000 395,000 10,000 205,000 Total 600,000 PROBLEM 23-2A (Continued) (c) LARUSSA INC. Direct Materials Budget For the Year Ending December 31, 2009 JB 50 Units to be produced........................ Direct materials per unit.................. Total pounds needed for production ....................................... Add: Desired ending direct materials (pounds)........ Total materials required .................. Less: Beginning direct materials (pounds)........ Direct materials purchases ............ Cost per pound................................... Total cost of direct materials purchases ...................................... (d) JB 60 395,000 X 2 205,000 X 3 790,000 615,000 30,000 820,000 15,000 630,000 40,000 780,000 X $3 10,000 620,000 X $4 $2,340,000 $2,480,000 Total $4,820,000 LARUSSA INC. Direct Labor Budget For the Year Ending December 31, 2009 JB 50 Units to be produced........................ Direct labor time (hours) per unit ..................................................... Total required direct labor hours ................................................. Direct labor cost per hour............... Total direct labor cost...................... JB 60 Total 395,000 205,000 650,000 X .4 X .6 — 158,000 X $12 $1,896,000 123,000 X $12 $1,476,000 301,000 X $10 $3,372,000 23-30 PROBLEM 23-2A (Continued) (e) LARUSSA INC. Budgeted Income Statement For the Year Ending December 31, 2009 JB 50 Sales............................................ Cost of goods sold ................. Gross profit ............................... Operating expenses Selling expenses................. Administrative expenses........................... Total operating expenses.................. Income before income taxes........................................ Income tax expense (30%) ....................................... Net income ................................ $8,000,000 4,800,000 (1) 3,200,000 JB 60 Total $5,000,000 $13,000,000 4,200,000 (2) 9,000,000 800,000 4,000,000 660,000 360,000 1,020,000 540,000 340,000 880,000 1,200,000 700,000 1,900,000 $2,000,000 $ 100,000 2,100,000 630,000 $ 1,470,000 (1) 400,000 X $12. 200,000 X $21. (2) 23-31 PROBLEM 23-3A (a) COLT INDUSTRIES Sales Budget For the Year Ending December 31, 2009 Plan A Expected unit sales ........................................... Unit selling price................................................. Total sales............................................................. (1) 760,000 (1) X $8.40 $6,384,000 Plan B 950,000 (2) X $7.50 $7,125,000 $6,400,000 ÷ $8 = 800,000 X 95% = 760,000. 800,000 + 150,000 = 950,000. (2) (b) COLT INDUSTRIES Production Budget For the Year Ending December 31, 2009 Plan A Expected unit sales ...................................................... Add: Desired ending finished goods units ........ Total required units ...................................................... Less: Beginning finished goods units .................. Required production units ......................................... Plan B 950,000 760,000 (1) 50,000 38,000 798,000 1,000,000 40,000 40,000 758,000 960,000 (1) 760,000 X 5% (c) Variable costs = $5.00 per unit ($1.80 + $2.00 + $1.20) for both plans. Plan A Total variable costs Total fixed costs Total costs (a) Total units (b) Unit cost (a) ÷ (b) Plan B $3,790,000 (758,000 X $5.00) 1,895,000 $5,685,000 $4,800,000 (960,000 X $5.00) 1,895,000 $6,695,000 758,000 960,000 $7.50 $6.97 The difference is due to the fact that fixed costs are spread over a larger number of units (202,000) in Plan B. 23-32 PROBLEM 23-3A (Continued) (d) Gross Profit Plan A Sales Cost of goods sold Gross profit Plan B $6,384,000 5,700,000 (760,000 X $7.50) $ 684,000 $7,125,000 6,621,500 (950,000 X $6.97) $ 503,500 Plan A should be accepted because it produces a higher gross profit than Plan B. 23-33 PROBLEM 23-4A (a) (1) Expected Collections from Customers November ($260,000) ...................................... December ($320,000) ...................................... January ($350,000) .......................................... February ($400,000) ........................................ Total collections.................................... (2) January $ 52,000 96,000 175,000 . $323,000 February $ 0 64,000 105,000 200,000 $369,000 Expected Payments for Direct Materials January December ($100,000) ...................................... January ($110,000) .......................................... February ($130,000) ........................................ Total payments ...................................... 23-34 February $ 40,000 66,000 . $106,000 $ 0 44,000 78,000 $122,000 PROBLEM 23-4A (Continued) (b) HAAS COMPANY Cash Budget For the Two Months Ending February 28, 2009 January Beginning cash balance ......................................... Add: Receipts Collections from customers ................ [See Schedule (1)] Notes receivable...................................... Sale of securities..................................... Total receipts................................... Total available cash.................................................. Less: Disbursements Direct materials ...................................... [See Schedule 2] Direct labor .............................................. Manufacturing overhead ..................... Selling and administrative expenses* ............................................ Withdrawal by owner............................ Total disbursements.................... Excess (deficiency) of available cash over cash disbursements .................................. Financing Borrowings ....................................................... Repayments ..................................................... Ending cash balance ............................................... $ 60,000 February $ 54,000 323,000 369,000 15,000 338,000 398,000 6,000 375,000 429,000 106,000 122,000 90,000 70,000 100,000 75,000 78,000 344,000 85,000 5,000 387,000 54,000 42,000 0 0 $ 54,000 8,000 0 $ 50,000 *Selling and administrative expenses less $1,000 depreciation. 23-35 PROBLEM 23-5A (a) DELEON COMPANY San Miguel Store Merchandise Purchases Budget For the Months of May and June, 2009 May Budgeted cost of goods sold................................. $600,000 Add: Desired ending merchandise inventory......... 132,000 (2) Total ................................................................................ 732,000 Less: Beginning merchandise inventory ........... 120,000 (4) Required merchandise purchases ....................... $612,000 (1) June $660,000 (1) 145,200 (3) 805,200 132,000 $673,200 $800,000 X 110% = $880,000; $880,000 X 75% = $660,000. $660,000 X 20% = $132,000. (3) $880,000 X 110% = $968,000; $968,000 X 75% = $726,000; $726,000 X 20% = $145,200. (4) $600,000 X 20% = $120,000. (2) 23-36 PROBLEM 23-5A (Continued) (b) DELEON COMPANY San Miguel Store Budgeted Income Statement For the Months of May and June, 2009 Sales................................................................................ Cost of goods sold Beginning inventory.......................................... Purchases............................................................. Cost of goods available for sale ................... Less: Ending inventory................................... Cost of goods sold ................................... Gross profit................................................................... Operating expenses Sales salaries ...................................................... Advertising* ......................................................... Delivery** .............................................................. Sales commissions*** ...................................... Rent ........................................................................ Depreciation......................................................... Utilities................................................................... Insurance .............................................................. Total............................................................... Income from operations ........................................... Income tax expense (30%) ....................................... Net income .................................................................... *5% of sales. **3% of sales. ***4% of sales. 23-37 May June $800,000 $880,000 120,000 612,000 732,000 132,000 600,000 200,000 132,000 673,200 805,200 145,200 660,000 220,000 30,000 40,000 24,000 32,000 5,000 800 600 500 132,900 67,100 20,130 $ 46,970 30,000 44,000 26,400 35,200 5,000 800 600 500 142,500 77,500 23,250 $ 54,250 PROBLEM 23-6A GLENDO INDUSTRIES Budgeted Income Statement For the Year Ending December 31, 2009 Sales (8,000 X $35)............................................................. Cost of goods sold Finished goods inventory, January 1................. Cost of goods manufactured ($69,400 + $56,600 + $54,000) ........................... Cost of goods available for sale .......................... Finished goods inventory, December 31 (3,000 X $20) ........................................................... Cost of goods sold .......................................... Gross profit .......................................................................... Selling and administrative expenses .......................... Income from operations................................................... Interest expense ................................................................. Income before income taxes .......................................... Income tax expense (30%) .............................................. Net income ........................................................................... 23-38 $280,000 $ 30,000 180,000 210,000 60,000 150,000 130,000 76,000 54,000 3,500 50,500 15,150 $ 35,350 PROBLEM 23-6A (Continued) GLENDO INDUSTRIES Budgeted Balance Sheet December 31, 2009 Assets Current assets Cash .................................................................................. Accounts receivable ($84,000 X 40%).................... Finished goods inventory (3,000 units X $20).................................................... Total current assets ............................................ Property, plant, and equipment Equipment ($40,000 + $19,000) ................................ Less: Accumulated depreciation ($10,000 + $4,000)........................................ Total assets............................................................ $ 7,950 33,600 60,000 $101,550 $59,000 14,000 45,000 $146,550 Liabilities and Stockholders’ Equity Liabilities Notes payable ($25,000 – $8,000) ............................ Accounts payable ($8,500* + $5,700) ..................... Income taxes payable.................................................. Total liabilities....................................................... Stockholders’ equity Common stock .............................................................. Retained earnings ($30,000 + $35,350 – $5,000) ................................. Total stockholders’ equity ................................ Total liabilities and stockholders’ equity................................................................... *$17,000 X 50% 23-39 $17,000 14,200 5,000 $ 36,200 $50,000 60,350 110,350 $146,550 PROBLEM 23-1B KRAUSE FARM SUPPLY COMPANY Sales Budget For the Six Months Ending June 30, 2008 Quarter 1 Expected unit sales....................... Unit selling price ............................ Total sales ........................................ 2 60,000 X $60 $3,600,000 40,000 X $60 $2,400,000 Six Months 100,000 X $60 $6,000,000 KRAUSE FARM SUPPLY COMPANY Production Budget For the Six Months Ending June 30, 2008 Quarter Expected unit sales............................................. Add: Desired ending finished goods units ...................................................... Total required units............................................. Less: Beginning finished goods units ........ Required production units................................ 23-40 1 2 40,000 60,000 15,000 55,000 10,000 45,000 20,000 80,000 15,000 65,000 Six Months 110,000 PROBLEM 23-1B (Continued) KRAUSE FARM SUPPLY COMPANY Direct Materials Budget—Crup For the Six Months Ending June 30, 2008 Quarter 1 2 45,000 Units to be produced...................................... X 6 Direct materials per unit................................ Total pounds needed for production ........ 270,000 Add: Desired ending direct materials (pounds) .......................................... 12,000 Total materials required ................................ 282,000 Less: Beginning direct materials (pounds) .......................................... 9,000 Direct materials purchases .......................... 273,000 Cost per pound................................................. X $4 Total cost of direct materials purchases ...................................................... $1,092,000 Six Months 65,000 X 6 390,000 15,000 405,000 12,000 393,000 X $4 $1,572,000 $2,664,000 KRAUSE FARM SUPPLY COMPANY Direct Labor Budget For the Six Months Ending June 30, 2008 Quarter Units to be produced............................... Direct labor time (hours) per unit........ Total required direct labor hours ........ Direct labor cost per hour...................... Total direct labor cost ............................. 23-41 1 2 Six Months 45,000 X .25 11,250 X $12 $135,000 65,000 X .25 16,250 X $12 $195,000 $330,000 PROBLEM 23-1B (Continued) KRAUSE FARM SUPPLY COMPANY Selling and Administrative Expense Budget For the Six Months Ending June 30, 2008 Quarter 1 Budgeted sales in units Variable (.10 X sales) ............................... Fixed.............................................................. Total............................................................... Six Months 2 40,000 60,000 100,000 $240,000 150,000 $390,000 $360,000 150,000 $510,000 $600,000 300,000 $900,000 KRAUSE FARM SUPPLY COMPANY Budgeted Income Statement For the Six Months Ending June 30, 2008 Sales............................................................................................................ Cost of goods sold (100,000 X $45) .................................................. Gross profit ............................................................................................... Selling and administrative expenses ............................................... Income from operations........................................................................ Income tax expense (30%) ................................................................... Net income ................................................................................................ $6,000,000 4,500,000 1,500,000 900,000 600,000 180,000 $ 420,000 Cost Per Bag Cost Element Direct materials Crup .................................................... Dert...................................................... Direct labor ........................................... Manufacturing overhead (100% of direct labor cost) .......... Total............................................... 23-42 Quantity Unit Cost Total 6 pounds 10 pounds .25 hour $ 4.00 1.50 12.00 $24.00 15.00 3.00 3.00 $45.00 PROBLEM 23-2B (a) MERCER INC. Sales Budget For the Year Ending December 31, 2008 Expected unit sales .................. Unit selling price ....................... Total sales ................................... (b) LN 35 LN 40 Total 300,000 X $20 $6,000,000 180,000 X $30 $5,400,000 000,000,0 $11,400,000 MERCER INC. Production Budget For the Year Ending December 31, 2008 Expected unit sales .................................... Add: Desired ending finished goods units ................................. Total required units .................................... Less: Beginning finished goods units............................................... Required production units....................... 23-43 LN 35 LN 40 300,000 180,000 30,000 330,000 25,000 205,000 20,000 310,000 15,000 190,000 Total 500,000 PROBLEM 23-2B (Continued) (c) MERCER INC. Direct Materials Budget For the Year Ending December 31, 2008 Units to be produced........................ Direct materials per unit.................. Total pounds needed for production ....................................... Add: Desired ending direct materials (pounds)........ Total materials required .................. Less: Beginning direct materials (pounds)........ Direct materials purchases ............ Cost per pound................................... Total cost of direct materials purchases........................................ (d) LN 35 LN 40 310,000 X 2 190,000 X 3 620,000 570,000 50,000 670,000 20,000 590,000 40,000 630,000 X $2 10,000 580,000 X $3 $1,260,000 $1,740,000 Total $3,000,000 MERCER INC. Direct Labor Budget For the Year Ending December 31, 2008 Units to be produced.......................... Direct labor time (hours) per unit ....................................................... Total required direct labor hours ................................................... Direct labor cost per hour................. Total direct labor cost........................ LN 35 LN 40 Total 310,000 190,000 550,000 X .5 X .75 155,000 X $12 $1,860,000 142,500 X $12 $1,710,000 23-44 322,500 X $10 $3,570,000 PROBLEM 23-2B (Continued) (e) MERCER INC. Budgeted Income Statement For the Year Ending December 31, 2008 LN 35 Sales............................................. Cost of goods sold .................. Gross profit ................................ Operating expenses Selling expenses.................. Administrative expenses............................ Total operating expenses................... Income before income taxes......................................... Income tax expense (30%) ........................................ Net income ................................. $6,000,000 3,300,000 (1) 2,700,000 560,000 440,000 1,000,000 420,000 380,000 800,000 980,000 820,000 1,800,000 $1,720,000 $ 980,000 2,700,000 810,000 $ 1,890,000 (1) (2) LN 40 Total $5,400,000 $11,400,000 3,600,000 (2) 6,900,000 1,800,000 4,500,000 300,000 X $11. 180,000 X $20. 23-45 PROBLEM 23-3B (a) LITWIN INDUSTRIES Sales Budget For the Year Ending December 31, 2009 Plan A Expected unit sales .......................................... Unit selling price................................................ Total sales............................................................ 630,000 (1) X $7.60 $4,788,000 Plan B 800,000 (2) X $6.65 (3) $5,320,000 (1) 700,000 X 90% = 630,000. 700,000 + 100,000 = 800,000. (3) $7.00 X 95% = $6.65. (2) (b) LITWIN INDUSTRIES Production Budget For the Year Ending December 31, 2009 Plan A Expected unit sales ....................................................... Add: Desired ending finished goods units ......... Total required units ....................................................... Less: Beginning finished goods units ................... Required production units .......................................... 630,000 90,000 720,000 70,000 650,000 Plan B 800,000 100,000 900,000 70,000 830,000 (c) Variable costs = $4.00 per unit ($2.00 + $1.50 + $.50) for both plans. Plan A Total variable costs Total fixed costs Total costs (a) Total units (b) Unit cost (a) ÷ (b) Plan B $2,600,000 (650,000 X $4.00) 975,000 $3,575,000 $3,320,000 (830,000 X $4.00) 975,000 $4,295,000 650,000 830,000 $5.50 $5.17 The difference is due to the fact that fixed costs are spread over a larger number of units (180,000) in Plan B. 23-46 PROBLEM 23-3B (Continued) (d) Gross Profit Plan A Sales Cost of goods sold Gross profit Plan B $4,788,000 3,465,000 (630,000 X $5.50) $1,323,000 $5,320,000 4,136,000 (800,000 X $5.17) $1,184,000 Plan A should be accepted because it produces a higher gross profit than Plan B. 23-47 PROBLEM 23-4B (a) (1) Expected Collections from Customers January November ($200,000) .......................................... $ 20,000 84,000 December ($280,000) .......................................... January ($320,000) .............................................. 192,000 February ($400,000) ............................................ Total collections........................................ $296,000 (2) February $ 0 28,000 96,000 240,000 $364,000 Expected Payments for Direct Materials December ($90,000) ........................................... January ($80,000)................................................ February ($110,000) ........................................... Total payments ......................................... 23-48 January February $63,000 24,000 $ 0 56,000 33,000 $89,000 $87,000 PROBLEM 23-4B (Continued) (b) ORTON COMPANY Cash Budget For the Two Months Ending February 28, 2009 January Beginning cash balance .......................................... Add: Receipts Collections from customers......................... [See Schedule (1)] Interest receivable ........................................... Sale of securities.............................................. Total receipts............................................ Total available cash .................................................. Less: Disbursements Direct materials ....................................... [See Schedule 2] Direct labor ............................................... Manufacturing overhead ...................... Selling and administrative expenses............................................... Purchase of land ..................................... Total disbursements..................... Excess (deficiency) of available cash over cash disbursements................................... Financing Borrowings ........................................................ Repayments ...................................................... Ending cash balance ................................................ 23-49 $ 60,000 February $ 52,000 296,000 364,000 3,000 299,000 359,000 5,000 369,000 421,000 87,000 89,000 85,000 60,000 115,000 75,000 75,000 307,000 80,000 20,000 379,000 52,000 42,000 0 0 $ 52,000 8,000 0 $ 50,000 PROBLEM 23-5B (a) URBINA COMPANY Westwood Store Merchandise Purchases Budget For the Months of July and August, 2008 July August Budgeted cost of goods sold................................... $256,000 $288,000 80,000 (2) Add: Desired ending merchandise inventory ..... 72,000 (1) Total .................................................................................. 328,000 368,000 Less: Beginning merchandise 64,000 (3) 72,000 inventory........................................................ Required merchandise purchases ....................... $264,000 $296,000 (1) $288,000 X 25% = $72,000. $500,000 X 64% = $320,000; $320,000 X 25% = $80,000. (3) $256,000 X 25% = $64,000. (2) 23-50 PROBLEM 23-5B (Continued) (b) URBINA COMPANY Westwood Store Budgeted Income Statement For the Months of July and August, 2008 Sales................................................................................ Cost of goods sold Beginning inventory.......................................... Purchases............................................................. Cost of goods available for sale ................... Less: Ending inventory................................... Cost of goods sold ............................................ Gross profit................................................................... Operating expenses Sales salaries ...................................................... Advertising* ......................................................... Delivery expense**............................................. Sales commissions*** ...................................... Rent ........................................................................ Depreciation......................................................... Utilities................................................................... Insurance .............................................................. Total............................................................... Income from operations ........................................... Income tax expense (30%) ....................................... Net income .................................................................... *4% of sales **2% of sales ***3% of sales 23-51 July August $400,000 $450,000 64,000 264,000 328,000 72,000 256,000 144,000 72,000 296,000 368,000 80,000 288,000 162,000 40,000 16,000 8,000 12,000 3,000 700 500 300 80,500 63,500 19,050 $ 44,450 40,000 18,000 9,000 13,500 3,000 700 500 300 85,000 77,000 23,100 $ 53,900 BYP 23-1 DECISION MAKING ACROSS THE ORGANIZATION (a) The budget at Lanier Corporation is an imposed “top-down” budget which fails to consider both the need for realistic data and the human interaction essential to an effective budgeting/control process. The president has not given any basis for his goals, so one cannot know whether they are realistic for the company. True participation of company employees in preparation of the budget is minimal and limited to mechanical gathering and manipulation of data. This suggests there will be little enthusiasm for implementing the budget. The budget process is the merging of the requirements of all facets of the company on a basis of sound judgment and equity. Specific instances of poor procedures other than the approach and goals include the following: 1. The sales by product line should be based upon an accurate sales forecast of potential market. Therefore, the sales by product line should have been developed first to derive the sales target rather than the reverse. 2. Production costs probably would be the easiest and most certain costs to estimate. Given variable and fixed production costs, one could estimate the sales volume needed to cover manufacturing costs plus the costs of other aspects of the operation. This would be helpful before budgets for marketing costs and corporate office expenses are set. 3. The initial meeting between the vice president of finance, executive vice president, marketing manager, and production manager should be held earlier. This meeting is held too late in the budgeting process. (b) Lanier Corporation should consider the adoption of a “bottom to top” (participative) budget process. This means that the people responsible for performance under the budget would participate in the decisions by which the budget is established. In addition, this approach requires initial and continuing involvement of sales, financial, and production personnel to define sales and profit goals which are realistic within the constraints under which management operates. Although time-consuming, the approach should produce a more acceptable, honest, and workable goal-control mechanism. It also provides for goal congruence possibilities for both individuals and departments within the firm. 23-52 BYP 23-1 (Continued) The sales forecast should be developed considering internal sales forecasts as well as external factors. Costs within departments should be divided into fixed and variable, discretionary and nondiscretionary. (c) The functional areas should not necessarily be expected to cut costs when sales volume falls below budget. The time frame of the budget (one year) is short enough so that many costs are relatively fixed in amount. For those costs which are fixed, there is little hope for a reduction as a consequence of short-run changes in volume. However, the functional areas should be expected to cut costs should sales volume fall below target when: 1. Control is exercised over the costs within their function. 2. Budgeted costs were more than adequate for the originally targeted sales; i.e., slack was present. 3. Budgeted costs vary to some extent with changes in sales. 4. There are discretionary costs which can be delayed or omitted with no serious effect on the department. (CMA adapted) 23-53 BYP 23-2 MANAGERIAL ANALYSIS (a) Direct materials Either lower quality materials resulting in an inferior product and possible lost sales, or fewer units produced resulting in lost sales. Direct labor Reduced production resulting in lost sales, or reduction in quality of product resulting in lost sales. Insurance Less coverage; may increase risk beyond acceptable levels. Depreciation To reduce depreciation, fixed assets would have to be disposed of. Could result in less production and lost sales. Machine repairs Less efficient operations, or lost production and sales. Sales salaries Lost sales. Office salaries Less effective administrative functions. Factory salaries Lost production due to inefficiency, and therefore lost sales. (b) Given the nature of their product, a decline in quality should be avoided, since this could result in lower future sales. Direct materials represent the largest single cost, and thus perhaps the greatest potential savings. Perhaps substitute materials of similar quality can be found, or less expensive materials can be used for aspects of the product where quality is not as critical. Additionally, it may be possible to renegotiate prices with the supplier. Bedner & Flott should be very reluctant to reduce repair costs, since in the long run this can be very expensive. Perhaps salaried and hourly employees can be encouraged to take pay cuts if a profit-sharing mechanism is introduced. 23-54 BYP 23-3 REAL-WORLD FOCUS (a) The factors that affect the budgeting process at Network Computing Devices, Inc. are general economic conditions affecting industry demand for computer products, the timing and market acceptance of new products of the Company and its competitors, the timing of significant orders from large customers, periodic changes in product pricing and discounting due to competitive factors, and the availability of key product components (raw materials). In addition, the budgeting process will be affected by the Company’s success with its products, its product and customer mix, and the level of competition it experiences. (b) Internationally, third quarter sales are adversely affected because European customers reduce their business activity in August. In addition, international sales are denominated in U.S. dollars and any change in the value of the dollar relative to foreign currencies could make the Company’s products more or less competitive in foreign markets. 23-55 BYP 23-4 COMMUNICATION ACTIVITY Date 2009 Mrs. Julie Fleming, CEO Life Protection Products Dear Mrs. Fleming: Allow me to congratulate you on the success of your new venture! The growth in sales you have experienced is phenomenal. You have managed the business side of the venture very well also. At the same time, I understand your concern about cash flow. You are selling these kits as fast as you can make them, and yet you are running out of cash. There is a solution to your problem. Before describing that, it may be helpful for you to understand why this situation occurred. The primary reason is that you are purchasing kit supplies at least two months in advance of sales. As your business expands, these materials costs continue to increase. Sales do not “catch up” until the Drs. Fleming have a seminar. You did not describe in detail how often these seminars are, but I would guess that they tend to run in cycles rather than being regularly spaced. Eventually, as sales stabilize, you will find that cash inflows exceed cash outflows, and your need for additional cash will subside. Presently, I think it would be a good idea to try to borrow additional funds. I have not seen all your financial data, but judging only from the cash budget you showed me, it appears that you have the basis of a very successful company. If so, your banker will be able to see the potential in your business and should be happy to provide the cash you need. You will need to prepare a full set of financial statements. I will be happy to assist you, if you desire. There is also a possibility that you have underpriced your product. You are providing a valuable service in assembling this information and these materials. The fact that every seminar results in a sellout of the materials may mean that you have priced your product too low. I know that your husband wishes to have these materials available to every family, but increasing the price a little may not make the price too high, and would better compensate you for your efforts. 23-56 BYP 23-4 (Continued) However, even if you raised prices, you will find that you need additional cash as long as the business continues to expand. It certainly does not mean that you and Amy are doing anything wrong. It just means that you will be investing additional funds as long as you continue to grow. In my opinion, the best way to make sure these kits are available to as many families as possible is for you and Amy to have a consultant evaluate and determine the size of the market for you. Then you can decide whether to expand to meet the need, or whether to keep your own business small and allow competitors to imitate your product. Congratulations again on a very successful product. Call or email this office if we may be of further assistance preparing financial statements or providing additional advice. Sincerely, Ima Student Best and Superior, Certified Public Accountants 23-57 BYP 23-5 ETHICS CASE (a) At best, if you disclose the errors in your calculations, you will be embarrassed. At worst, you will be dismissed without a recommendation for another job. (b) The president will continue making presentations using data that are grossly overstated. In time, your error may be detected when the events you projected do not materialize. (c) The most ethical scenario would be to admit your error, let the president know about the error, provide the president with corrected projections, and allow the president to decide how to alter his presentations during the second week of his speech-making. 23-58 BYP 23-6 ALL ABOUT YOU ACTIVITY Personal Budget Typical Month Income: Wages and bonuses ................................................ Interest income.......................................................... Income subtotal...................................................................... Income taxes withheld ......................................................... Spendable income.................................................... Expenses: Mortgage or rent .................................................................... Utilities Electricity .................................................................... Telephones ................................................................. Food: Groceries..................................................................... Eating out.................................................................... Insurance.................................................................................. Transportation ........................................................................ Student loans.......................................................................... Entertainment /recreation.................................................... Savings ..................................................................................... Miscellaneous ......................................................................... Total investments and expenses............... Surplus/Shortage................................................................... 23-59 $2,000 50 2,050 300 $1,750 400 22 90 80 150 100 150 275 250 50 110 1,677 $ 73