College Accounting, 15th Edition Jeffrey Slater Instructor Manual

Type:

Instructor Manual

Resource:

College Accounting

Edition:

15th Edition

Author(s):

Jeffrey Slater Mike Deschamps

Instructor's Resource Manual for

College Accounting: A practical Approach

College Accounting Fifteenth Edition

Jeffrey Slater Mike Deschamps

Chapter 1 Accounting Concepts and Procedures Chapter Overview The chapter begins with an introduction to accounting and the organizational forms of business: sole proprietorships, partnerships, corporations, and limited liability companies. Learning Unit 1-1 has assets, liabilities, and equities defined and explained through examples and the accounting equation. Learning Unit 1-2 illustrates the steps necessary to prepare a balance sheet. Learning Unit 1-3 expands the accounting equation to include revenues, expenses, and withdrawals. Each element of the equation is further defined. A variety of transactions are analyzed along with their impact on the accounting equation. Learning Unit 1-4 discusses the income statement, the statement of owner’s equity, and the balance sheet. The accounting equation is used to illustrate how three of the financial statements: income statement, statement of owner’s equity, and balance sheet are developed and interrelated. The net income from the income statement is carried to the statement of owner’s equity, and the ending capital is carried from the statement of owner’s equity to the balance sheet. The demonstration problem and the solution tips help students record the effect of transactions on the accounting equation and to ultimately prepare financial statements.

Learning Objectives After studying Chapter 1, your students should gain proficiency in the following: 1. Explain Accounting, Business, and the Accounting Equation.

2. Prepare a Balance Sheet.

3. Record Transactions into the Expanded Accounting Equation.

4. Prepare the Three Financial Statements.

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Chapter 1 Assignment Grid Assignment Topic(s) Discussion Questions and Critical Thinking/Ethical Case 1 Functions of Accounting 2 Types of Businesses 3 Business Classifications 4 Bookkeeping and technology 5 Accounting equation 6 Capital 7 Accounting equation 8 Balance sheet 9 Account categories 10 Account categories 11 Account categories 12 Expenses 13 Income statement 14 Statement of owner’s equity 15 Ethical case 16 Pandemic impact on operations Concept Checks 1 Classifying Accounts 2 The Accounting Equation 3 Shift versus Increase in Assets 4 The Balance Sheet 5 The Accounting Equation Expanded 6 Identifying Assets 7 The Accounting Equation Expanded 8 Preparing Financial Statements 9 Preparing Financial Statements Exercises (Set A) 1A-1 Accounting Equation 1A-2 Accounting Equation 1A-3 Balance Sheet 1A-4 Accounting Equation – Expanded 1A-5 Financial Statements Exercises (Set B) 1B-1 Accounting Equation 1B-2 Accounting Equation 1B-3 Balance Sheet 1B-4 Accounting Equation – Expanded 1B-5 Financial Statements Problems (Set A) 1A-1 Accounting Equation 1A-2 Balance Sheet 1A-3 Accounting Equation Expanded 1A-4 Financial Statements 1A-5 Financial Statements .

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Learning Unit(s)

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1 1 1 1 1 1 1 2 3 3 3 3 4 4 4 4

5 5 5 5 5 5 5 10 5 5 5 5 5 5 5 10

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Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

Problems (Set B) 1B-1 Accounting Equation 1B-2 Balance Sheet 1B-3 Accounting Equation Expanded 1B-4 Financial Statements 1B-5 Financial Statements

1 2 3 4 3, 4

15 15 20 30 45

Easy Medium Medium Medium Hard

Financial Report Problem Reading Amazon’s Annual Reports/Internet Project

2

5

Easy

Keeping It Real Suarez Digital Services

3, 4

45

Medium

Assignment Topic(s)

Learning Unit 1-1: Accounting, Business, and the Accounting Equation Summary: Accounting is the language of business. It provides financial information to users and helps the decision making process. The accounting process analyzes, records, classifies, summarizes, reports, and interprets financial information for decision makers. The four main categories of business organizations are (1) sole proprietorships, (2) partnerships, (3) corporations, and limited liability companies. Business organizations can also be classified into service, merchandise, or manufacturing businesses according to the need that they fulfill. Generally accepted accounting principles are the set of procedures and guidelines developed to assure the consistent preparation and interpretation of the accounting reports. The main difference between bookkeeping and accounting is the level of analysis and scope of duties.

The basic accounting equation is presented as: Assets = Liabilities + Owner’s Equities. The assets are properties (resources) of value that the firm or business owns. Examples are cash, land, supplies, office equipment, buildings, and other properties of value. Liabilities are obligations that come due in the future or claims of the creditors to assets. An example is accounts payable. The owner’s equity is the rights or financial claims to the assets of a business. The owner’s investment of equity is called capital.

A shift in assets indicates that the makeup of the assets has changed, but the sum total of the assets remains the same. An increase of assets reflects an increase in the total amount of assets owned.

Remember that the left-hand-side total of assets must always equal the right-hand-side total of liabilities and owner’s equity.

Key Concepts: Accounting, sole proprietorship, partnership, corporation, limited liability company, service company, merchandise company, manufacturer, generally accepted accounting principles (GAAP), International Financial Reporting Standards (IFRS), bookkeeping, assets, equities, liabilities, creditor, owner’s equity, basic accounting equation, capital, supplies, shift in assets, accounts payable Lecture Outline: .

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1) Accounting is the language of business. It provides information to managers, owners, investors, government agencies, and others inside and outside the organization.

2) Businesses can be classified into one of four types of organizations: a) Sole Proprietorships are businesses that have one owner. i) Easy to form ii) Owner can lose personal assets to meet obligations of business iii) Ends with death of owner or closing of business b) Partnerships are businesses that have at least two owners. i) Easy to form ii) Partners could lose personal assets to meet obligations of partnership iii) Ends with death of partner or closing of business c) Corporations are businesses owned by stockholders. i) More difficult to form ii) Limited personal risk – stockholders’ loss is usually limited to their stock investment iii) Continues indefinitely d) Limited Liability Company (LLC) i) More difficult to form ii) Limited liability or limited personal risk – members’ loss is limited to their investment in the company iii) May end with death of member 3) Businesses can be classified into service, merchandise, and manufacturing businesses. a) Service company – Business that provides a service b) Merchandise company – Business that makes its own products or buys a product from a manufacturing company and sells it to its customers c) Manufacturer – Business that makes a product and sells it to its customers 4) Accounting (also called the accounting process) is a system that measures the activities of a business in financial terms, provides written reports and financial statements about those activities, and communicates these reports to decision makers and others. It does this by performing the following functions: a) Analyzing: looking at what happened in the past and how the business was affected b) Recording: Putting the information into the accounting system c) Classifying: Grouping all the same activities (e.g., all purchases) together d) Summarizing: Totaling the results e) Reporting: Issuing the statements that tell the results of the previous functions f) Interpreting: Examining the statements to determine how the various pieces of information they contain relate to each other g) Communication: Providing the reports and financial statements to people who are interested in the information, such as the business’s decision makers, investors, creditors, and government agencies 5) Difference between Bookkeeping and Accounting Bookkeeping is the recording function of the accounting process. Digital devices and software are used for routine bookkeeping operations. Bookkeepers need to be trained to use the latest software including QuickBooks and Excel. Accounting uses the bookkeeping prepared information to prepare the financial statements used to analyze the company’s financial position. An accountant prepares tax forms, prepares budgets, and performs further analysis of financial information.

6) The accounting equation illustrates the relationship between assets, liabilities, and equities. a) Assets are properties (resources) of value owned by a firm: Assets = Liabilities + Owner’s Equity b) Equities are the rights or financial claim of creditors (liabilities) and owners (owner’s equity) who supply the assets to the firm. c) Liabilities are obligations that come due in the future.

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7) A business transaction is an event that affects the financial position of a business and may be reliably recorded.

8) The accounting equation must balance after each business transaction is recorded.

Teaching Tips/Strategy: The instructor may begin by discussing the accounting goals and the relationship with the business activities. In addition, the instructor can present the accounting function and how it helps business organizations identify key activities and help on the decision making process. To aid students in understanding accounting, provide an example of how accounting can help in the decision making process. To explain business classification concepts, the instructor may use a group-based activity that consists of listing familiar business names and indicate classification, category, and type of each business organization. This group-based interaction will aid in evaluating the level of understanding of this topic. Utilize as reference Tables 1.1 and 1.2 for the students as examples of categories and classifications. Table 1.1 illustrates the types of business organizations and characteristics of each organization type, and Table 1.2 illustrates examples of Service, Merchandise, and Manufacturing Businesses.

Teaching Tips/Strategy: Utilize a group-based activity to aid in explaining the accounting equation elements. Present familiar business organizations and identify what assets and liabilities they are likely to have. Concept Checks 1 and 2 can be used to assess the student’s knowledge of account classifications and the accounting equation elements. Concept Check 3 can aid in understanding the shift in assets versus the increase in assets. Exercises 1-A1 and 1-A2 are excellent as additional practice and/or homework assignment to evaluate the basic accounting equation understanding. Exercise 1-A1 involves solving for unknows in the accounting equation while Exercise 1-A2 is an analysis of the the impact of transactions on the elements of the accounting equation.

Use the Success Coach “Do It Right Now Checkup” True and False questions to reinforce Learning Unit 1-1 Concepts.

Learning Unit 1-2: The Balance Sheet Summary: The balance sheet or statement of financial position shows the financial position of a business as of a particular date. The balance sheet amounts represent the basic accounting equation. The assets appear on the left-hand side of the statement while liabilities and owner’s equity appear on the right-hand side Key Concepts: Balance sheet Lecture Outline: The balance sheet is a statement, as of a particular date, that shows the amount of assets owned by a business as well as the amount of claims (liabilities and owner’s equity) against these assets. Statement of financial position is another name for a balance sheet. The proper form for the balance sheet contains: a) Heading: the company name, the statement name, the statement date b) Shows assets, liabilities, and equity amounts c) Dollar signs appear to the left of each column’s top amount and to the left of the column’s total d) A single underline appears above a total and a double underline appears beneath it e) It is important to align numbers f) Provides a look at the financial position of the business Teaching Tips/Strategy: .

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Concept check 4 can be used as an introduction to balance sheet preparation as well as exercise 1A-3.

Both can be used during a lecture to present and prepare a step-by-step balance sheet during lecture. Use the Figure 1-7 as reference for the proper presentation.

As the exercise is finalized, comment on the various details of how the balance sheet has been presented (monetary unit/ dollar signs, single and double underlines, and the alignment) and why these particular details are essential to the reader. Students can comment or present their opinions/comments on the financial situation of the business for which the balance sheet was prepared. This activity will enhance their understanding of the basic elements of an accounting equation and help develop critical thinking and analytical skills.

Exercise 1B-3 is a good assignment to evaluate the student’s basic knowledge of the balance sheet statement and its proper presentation.

Use the Success Coach “Do It Right Now Checkup” True and False questions to reinforce reinforce Learning Unit 1-2 Concepts.

Learning Unit 1-3: The Accounting Equation Expanded: Revenue, Expenses, and Withdrawals Summary: As a part of doing business, all organizations earn revenue and incur expenses.

A service company earns revenue when it provides services to its clients. When revenue is earned, the owner’s equity is increased. In effect, revenue is a subdivision of owner’s equity. A business’s expenses are the costs the company incurs in carrying out necessary operations in its effort to generate revenue.

Expenses are also a subdivision of owner’s equity. When expenses are incurred, they decrease owner’s equity. Expenses can be paid for in cash or they can be charged. When revenue totals more than expenses, the result is called net income. When expenses total more than revenue, the result is net loss. When owners need to withdraw cash or other assets from the business to pay living or other personal expenses that do not relate to the business, the transaction will be recorded in an account called withdrawals or owner’s drawing account. The withdrawals account is a subdivision of owner’s equity that records personal expenses not related to the business. Hence, withdrawals result in a decrease in the owner’s equity (see Figure 1.3). It is important to remember the difference between expenses and withdrawals.

Expenses relate to business operations. Withdrawals are the result of personal needs outside the normal operations of the business. All business transactions are recorded in the expanded accounting equation that include withdrawals, revenues, and expenses.

Key Concepts: Cash basis, accrual basis, revenue, accounts receivable, expense, net income, net loss, withdrawals, expanded accounting equation Lecture Outline: 1) The accounting equation expands to include revenue, expenses, and withdrawals: Assets = Liabilities + Capital - Withdrawals + Revenue - Expenses. a) Revenue is earned by a company when it provides services for its clients or sells goods to its customers. b) Expenses are the costs the company incurs in carrying on operations in its effort to create revenue. c) Net Income occurs when total revenues are greater than expenses. Net Loss occurs when total expenses are greater than revenues. d) Withdrawals are the recording of the owner’s withdrawing cash or other assets from the business to pay living or other personal expenses that do not relate to the business. .

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2) The owner’s equity portion of the accounting equation expands to illustrate beginning capital plus additional investment from owners, plus revenues, less expenses, and less withdrawals. a) Owner’s Equity can be thought of as having subdivisions: accounts such those that keep track of capital, owner withdrawals, revenues earned, and expenses incurred.

3) Various transactions are used to illustrate the transactional effects on the accounting equation.

Teaching Tips/Strategy: Concept check 5 can be used to clarify which types of accounts are subdivisions of owner’s equity while Concept check 7 quizzes the student on revenue and expense impact on the accounting equation. Use the Success Coach “Do It Right Now Checkup” True and False questions to reinforce the Learning Unit 1-3 concepts.

Learning Unit 1-4: Prepare the Three Financial Statements Summary: The financial statements present how well the business has performed over a specific period of time. An income statement is an accounting statement that shows business results in terms of revenue and expenses. If revenues are greater than expenses, the report shows net income. If expenses are greater than revenues, the report shows net loss. An income statement typically covers 1, 3, 6, or 12 months. The statement shows the result of all revenues and expenses throughout the entire period and not just as of a specific date. An example income statement for Jess Bora’s Computer Consulting business is shown in Figure 1.4. The second statement, the statement of owner’s equity, shows for a certain period of time what changes occurred in the capital account. Examples of the statement of owner’s equity are shown in Figure 1.5 and Figure 1.6. The third statement, the balance sheet, utilizes the expanded accounting equation (see Figure 1.7) to present the asset accounts (cash, accounts receivable, and computer equipment) appear on the left side of the balance sheet, and the accounts payable and capital accounts appear on the right side. The ending balance of capital can be calculated within the accounting equation or can be found on the statement of owner’s equity as the ending capital amount.

Key Concepts: Income statement, statement of owner’s equity, ending capital Lecture Outline: 1) The accounting equation maintains totals for each component of the equation.

2) The Income Statement is an accounting statement that shows business results in terms of revenue and expenses for a specific time period. The proper form for the income statement: a) Cannot cover more than one year b) Heading – the company name, the statement name, the period covered by the statement c) Shows revenue, expenses, and net income or net loss d) Revenue is listed first e) Expenses are listed in alphabetical order, from largest amount to smallest, or a pattern established by the accountant f) Net income or net loss is the difference between revenue and expenses 3) The Statement of Owner’s Equity shows changes in capital. Proper form for the statement of owner’s equity includes: a) Heading – the company name, the statement name, the period covered by the statement b) Shows the beginning equity balance, investments by owner, net income or net loss, withdrawals by owner, and the ending equity balance i) Make the point that a withdrawal is not a business expense; not involved in the calculation of net income or net loss on the income statement.

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4) The Balance Sheet illustrates the balance in the accounting equation: assets equal liabilities plus owner’s equity. This statement was addressed earlier in the chapter.

5) A fourth financial statement is the Statement of Cash Flows a) The Statement of Cash Flows is not covered in this chapter.

Teaching Tips/Strategy: A “walk through” of figures 1.4, 1.5 1.6 and 1.7 help students to see the basic content of the statements and the relationship between them. Use the Exercise 1A-5 as a classroom demonstration to reinforce the proper form and procedures while completing financial statements and follow-up with exercise 1B-5 as an excellent way to complete a team-based activity to reinforce this objective or assign it as homework assignment that each student is individually responsible to complete.

Use the Success Coach “Do It Right Now Checkup” True and False questions to reinforce Learning Unit 1-4 Concepts.

Teaching Tips/Strategy: Each chapter contains a Try It! at the end of each Learning Unit. The Try its! are intended as practice for students and/or as checking of student understanding. There is also a Demonstration Summary Problem with each chapter to provide an overview of all the chapter concepts.

Students can study and review these problems to view how all the chapter concepts fit together. Finally, as you wrap up this chapter, think about using the “Ten-Minute Quiz”, located on the last page of this instructor’s manual, as a quick in-class exercise to assess learning outcomes.

This chapter introduces the Suarez Digital Services software simulation problem, which can be used with QuickBooks Online, as a continuing problem (present from one chapter to the next). Each chapter’s version of this problem, puts a focus on the learning experiences of the chapter, adding more information to the case as the business of Suarez Digital Services grows while demonstrating to the student how critical the knowledge of accounting is to a business decision maker.

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Name

Date

Section

CHAPTER 1 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Select the accounts affected by the following transaction: TJ Rex invests $50,000 to open a music store. a. Assets and Owner’s Equity b. Assets and Liabilities c. Liabilities and Owner’s Equity d. Capital and Owner’s Equity 2.

Select the accounts affected by the following transaction: TJ Rex uses credit to buy musical instruments to sell in the store. a. Assets and Owner’s Equity b. Assets and Liabilities c. Liabilities and Owner’s Equity d. Capital and Owner’s Equity

3.

Select the accounts affected by the following transaction: TJ Rex provides guitar lessons for $25 cash. a. Cash and Accounts Payable b. Cash and Revenue c. Accounts Receivable and Revenue d. Cash and Expenses

4.

Select the accounts affected by the following transaction: TJ Rex receives $100 for previous lessons provided on account. a. Cash and Accounts Receivable b. Cash and Revenue c. Accounts Receivable and Revenue d. Cash and Expenses

5.

Select the accounts affected by the following transaction: TJ Rex receives the utility bill but will wait and pay it next month. a. Cash and Accounts Receivable b. Cash and Revenue c. Accounts Receivable and Revenue d. Accounts Payable and Expenses

6.

Which of the following is not an asset? a. Cash b. Land c. Mortgage Payable d. Patents

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7.

Which of the following is reported on the balance sheet? a. Accounts Payable b. Fees Earned c. Depreciation Expense d. Withdrawals

8.

Which of the following is represented on the income statement? a. Cash received from sale of equipment b. Accounts Payable c. Office Equipment d. Net loss

9.

Which of the following will not appear on the statement of owner’s equity? a. Net income b. Withdrawals c. Capital d. Fees Earned

10.

Which financial statement illustrates the accounting equation? a. Statement of Owner’s Equity b. Income Statement c. Balance Sheet d. Statement of Cash Flows

Answer Key to Chapter 1 Quiz 1.

2.

3.

4.

5.

a b b a d

6. c 7. a 8. d 9. d 10. c

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Chapter 2 Debits and Credits: Analyzing and Recording Business Transactions Chapter Overview This chapter transitions from analyzing transactions and listing each account in a potentially long accounting equation to double entry accounting. There are five steps used to analyze a transaction: 1) determining which accounts are affected; 2) determining which categories the accounts belong to (assets, liabilities, capital, withdrawals, revenue, or expenses); 3) determining whether the accounts increase or decrease; 4) using the debit and credit rules to determine if the result of steps 2 and 3 results in a journal entry debit or credit; and 5) computing the balance in the T account. T accounts are used to illustrate debits and credits and how to evaluate each account’s balance. A T account is a simpler way to illustrate an account. It has a debit and credit side and can be used to compute the balance in that account. Several examples are used to illustrate transaction analysis and the resulting journal entry and T account balance.

Next, how to use the balances in the T accounts to prepare a trial balance is illustrated. A trial balance is a listing of a company’s accounts and its resulting debit or credit balance in the proper debit or credit column.

The information from the trial balance is used to prepare financial statements. Finally, the interrelationship between the financial statements is emphasized. The income or loss from the income statement is carried to the statement of owner’s’ equity. The ending balance in the statement of owner’s equity is carried to the balance sheet.

Learning Objectives After studying Chapter 2, your students should gain proficiency in the following: 1. Explain T Accounts and How to Foot and Balance.

2. Use a Chart of Accounts to Record Transactions in T Accounts According to the Rules of Debits and Credits.

3. Prepare a Trial Balance and the Financial Statements.

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Chapter 2 Assignment Grid Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Define ledger 1 2 Debit side of the account 1 3 Footings and balancing 1 4 Accounting cycle and end product 2 5 Transaction Analysis Chart 2 6 Transaction Analysis Chart 2 7 Computers and double entry bookkeeping 2 8 Trial Balance 3 9 Financial Statements 3 10 Financial Statements 3 11 Trial Balance 3 12 Ethics, Pandemic, and remote work 2,3,4 Concept Checks 1 The T account 1 2 Transaction Analysis 2 3 Transaction Analysis 2 4 Trial Balance 3 5 Trial Balance/ Financial Statements 3 Exercises (Set A) 2A-1 Chart of accounts 2 2A-2 Transaction analysis 2 2A-3 Transaction analysis 2 2A-4 Account analysis 2 2A-5 Financial Statements 3 Exercises (Set B) 2B-1 Chart of accounts 2 2B-2 Transaction analysis 2 2B-3 Transaction analysis 2 2B-4 Account analysis 2 2B-5 Financial Statements 3 Problems (Set A) 2A-1 Transaction Analysis 2 2A-2 Transaction Analysis 2 2A-3 Trial Balance 1, 3 2A-4 Financial Statements 3 2A-5 Transactions, Trial Balance, & Financial Prep 1,2, 3 Problems (Set B) 2B-1 Transaction Analysis 2 2B-2 Transaction Analysis 2 2B-3 Trial Balance 1, 3 2B-4 Financial Statements 3 2B-5 Transactions, Trial Balance, & Financial Prep 1,2, 3

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Estimated Time in Minutes

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5 5 5 5 5 5 5 5 5 5 5 10

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Assignment Topic(s) Financial Report Problem Reading Amazon’s Annual Reports/Internet Project Keeping It Real Suarez Digital Services

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

2

5

Easy

1, 2, 3

60

Medium

Learning Unit 2-1: The T Account and How to Foot and Balance Summary: The T account is a tool to demonstrate the increases and decreases in each account. The T account is a skeleton version of a standard account. A standard account form is the formal structure required for each account. All T accounts have three parts: account title, debit (left) and credit (right). The T accounts are footed to determine the balance or ending balance for the specific account. Foot is to (sum) add all debits and add (sum) all credits, and footing is totaling each individual column. The column balances are subtracted to compute the final total or ending balance for each account. The ending balance is always presented on the bigger or normal side. To record transactions, the accountant determines which accounts are credited or debited utilizing the debit and credit rules. The double-entry bookkeeping is an accounting system in which the recording of each transaction affects two or more accounts. You must include at least one debit and one credit per transaction, and the total amount of debits is equal to the total amount of credits.

Key Concepts: account, standard account, ledger, T account, debit, credit, footings, ending balance Lecture Outline: 1) Each transaction is recorded in the accounting equation under specific accounts: assets, liabilities, capital, withdrawals, revenue, expenses, and so on. a) Accounts are also called “ledger accounts”, from the days when each account was a type of paper business form, placed in a book called the ledger.

2) Accounts are used to record increases and decreases of business transactions relating to individual elements of the accounting equation: a) assets, b) liabilities, c) capital, d) withdrawals, e) revenue, f) and expenses.

3) The subdivisions or account categories (account classification) are: a) asset accounts, b) liability accounts, c) owner’s equity accounts, d) revenue accounts, e) and expense accounts.

4) The standard account form includes: a) columns for date, b) explanation, .

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c) posting reference, d) debit, e) credit, f) and total columns.

5) The ledger has all the individual accounts, and all transactions affecting an account are recorded on the form. a) A ledger is a book of accounts that records data from business transactions. b) Prepared manually in a traditional accounting format. c) Ledger accounts in a computerized system are updated automatically by software.

6) For simplicity’s sake, use the T account form for demonstration purposes. T account simple form includes: a) the title, which expresses the name of the account b) debit (left) side or Dr. c) credit (right) side or Cr. 7) Footing: (the totals for each column) a) process of adding all items on the debit side, b) adding all items on the credit side c) calculate the T account ending balance. d) Balance the difference between the amounts on each side of the T account. i) Total the debits (Dr.) ii) Total the credits (Cr.) iii) Subtract the debits and credits iv) The ending balance will be on the side that has the greater number.

Teaching Tips/Strategy: Use the “Success Coach” LU 2-1 and the five true/false questions to assess the understanding of the T account. Normally, the assets will increase by the left or debit. Items to the right of the equal sign, such as liabilities and equity, increase by the right. The subdivisions of equity (revenue, expenses, capital, and withdrawals) will increase or decrease based on their relationship to equity. The revenue or capital accounts will increase the equity. Therefore, the account increases by the right or credit.

If the account is an expense or a withdrawal, it decreases equity. The account increases by left or debit.

For lecture practice, utilize the Concept Check 1 to use T accounts to foot and balance each account.

Learning Unit 2-2: The Chart of Accounts: Recording Transactions in T Accounts According to Rules of Debits and Credits.

Summary: The accounting recording process starts with a business transaction, an exchange between two or more parties, sharing items of equal value. The double-entry analysis of transactions presents two or more accounts that are affected and the total of debits and credits that are equal. This double-entry system helps in checking the recording of business transactions. All business transactions are recorded in accounts.

An account is a tool used to record and summarize the effects of the organization’s transactions. The basic accounting equation contains the following account categories: assets, liabilities, capital, withdrawals, revenues, and expenses. The chart of accounts is a system of accounts that summarizes increases and decreases of all individual accounts. This numbering system of accounts allows accounts to be located quickly. For example, 100s are assets, 200s are liabilities, 300s are equity, 400s are revenues and 500s are expenses (See Table 2.2). A compound entry is a transaction that involves more than one debit or more than one credit.

The debit and credit rules are: 1. Assets increase by debit side (left) and decrease by credit side (right) .

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2. Liabilities increase by credit side (right) and decrease by debit side (left).

3. Equity accounts increase by credit side (right) and decrease by debit side (left). The equity subdivisions or categories will use the debit and credit rules to present the effect on the organization’s equity. a. The equity subdivision rules are: 1. Revenues increase the organization’s equity in the business. Revenue accounts increase by credit and decrease by debit (same as the equity).

2. The expenses decrease the organization’s equity. Therefore, all expense accounts will increase by debit and decrease by credit. (Note that any item that decreases the equity, the behavior is opposite to the main equity account.)

3. Capital accounts increase the organization’s equity. Therefore, any capital transaction will increase by credit and decrease by debit. Withdrawals by owner decrease the organization’s equity.

Therefore, any withdrawal increases are recorded on the debit side.

Key Concepts: normal balance of an account, chart of accounts, compound entry, double-entry bookkeeping Lecture Outline: 1) Refer to Table 2.1 for the rules of debit and credit using T accounts affecting the accounting equation. a) For assets increases are on the debit (left) side. b) For liabilities increases are on the credit (right) side. c) For capital increases are on the credit (right) side. d) For revenue increases are on the credit side which is the same as for capital. e) For withdrawals and expenses increases are on the debit side which is the opposite of how capital increases are. f) A normal balance of an account is the side that increases by the rules of debit and credit. g) The accounting equation balance must be maintained when transactions occur.

2) A chart of accounts is a numbered list of all of a business’s accounts. a) Assets use 100s (as an example). b) Liabilities use 200s. c) Owner’s Equity uses 300s. d) Revenues use 400s. e) Expenses use 500s.

3) Transaction analysis: five steps: a) Determine which accounts are affected. b) Determine which categories the accounts belong to assets, liabilities, capital, withdrawals, revenue, or expenses. c) Determine whether the accounts increase or decrease. d) What do the rules of debit and credit say? e) What does the T account look like?

4) Compound entry is a transaction involving more than one debit or credit.

5) Double-entry bookkeeping refers to an accounting system in which the recording of each transaction affects two or more accounts, and the total of the debits is equal to the total of credits.

Teaching Tips/Strategy: Use the “Success Coach” LU 2-2 (end of the chapter) and its five true/false questions to review the debit and credit rules. After reviewing the concepts, complete the Concept Checks 2 and 3 to check the debit and credit rules. Exercises 2A-1, 2A-2, 2A-3, and 2A-4 are excellent classroom practice to reinforce the objective 2 concepts.

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Learning Unit 2-3: The Trial Balance and Preparation of Financial Statements Summary: The trial balance is a list of all accounts with their balances in the same order as they appear in the chart of accounts. A trial balance is not a financial statement although it is used to prepare financial statements. A trial balance is a listing of each account with each account balance listed in its proper debit or credit column. Balances on the trial balance are taken directly from footings and ending balances on the T accounts. The total of the debit column should equal the total of the credit column.

The financial statements include income statement, statement of owner’s equity, and the balance sheet. All financial statements have two columns. The columns are used for subtotals and NOT for debit and credit format. There are no debits and credits on the financial statements. The income statement summarizes the revenues and expenses to calculate the net income or net loss. The statement of owner’s equity updates the ending capital balance for the period. It includes the beginning and ending balances of capital accounts, the net income or net loss, and the withdrawals account. The balance sheet is the representation of the accounting equation as the last day of the period or as a “snapshot”. The balance sheet includes all assets, liabilities, and the ending balance of equity.

Key Concepts: Trial balance Lecture Outline: 2) The trial balance: a) is a list of all accounts with their balances, b) the order of accounts is the same as they appear in the chart of accounts, c) is not a financial statement but is a tool used to prepare financial statements, d) is a list of ending balances from the ledger, e) and the total of the debit column should equal the total of the credit column.

6) Preparing financial statements: a) All financial statements are related: i) the net income or net loss from the income statement flows to the statements of owner’s equity, ii) the ending balance of capital on the owner’s equity statement flows to the balance sheet. b) The dollar sign or currency sign is used at the top of each column and on the final total amounts. c) One underline represents a list to subtotal d) Two underlines represent the end of the statement or the final “bottom line” number.

7) The Income Statement: (is generally prepared first) f) includes revenues and expenses g) includes gains or losses h) Net Income – revenues are greater than expenses. (Revenues – Expenses) i) Net Loss – expenses are greater than revenues. (Expenses – Revenues) j) The net income or net loss is carried to the statement of owner’s equity.

8) The Statement of Owner’s Equity: a) Start with the capital balance as of the beginning of the period b) Add: Net income (from the income statement) c) Add: additional investments from the owners d) Deduct: Net Loss (from the income statement) e) Deduct: any withdrawals f) Calculate the new ending balance for the capital account or owner’s equity. g) The new balance for owner’s equity is carried to the Balance Sheet.

9) The Balance Sheet: .

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a) Lists all assets, liabilities and the new equity or capital account balance. b) The total of assets = total of liabilities and equity.

Teaching Tips/Strategy: Use the “Success Coach” LU 2-3 and its five true/false questions to review trial balance and financial statement concepts. After reviewing the concepts, complete the Concept Checks 4 to confirm to order in which various accounts appear on the trial balance and assure that students understand that the order is the same as how the accounts appear in the chart of accounts and the order of general ledger.

The instructor can use the Concept Check 5 as a demonstration exercise identify which accounts on which financial statements. Exercises 2A-5 and 2B-5 are excellent classroom practice to reinforce the learning objective 3 concepts. Use the “Ten-Minute Quiz”, located on the last page of this instructor’s manual, as an quick in- class exercise to assess learning outcomes.

Teaching Tips/Strategy: Each chapter contains a Try It! at the end of each Learning Unit. The Try its! are intended as practice for students and/or as checking of student understanding. There is also a Demonstration Summary Problem with each chapter to provide an overview of all the chapter concepts. Students can study and review this problem to view how all the chapter concepts fit together.

.

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Name

Date CHAPTER 2 TEN-MINUTE QUIZ

Circle the letter of the best response.

1.

Although debits increase assets, they also a. increase revenues b. increase expenses c. increase owner's equity d. increase liabilities 2.

The right side of a T account is the a. increase side b. decrease side c. credit side d. debit side

3.

A compound entry is a. an entry involving more than one debit or credit b. an entry involving multiple transactions c. an entry involving more than one date d. an entry increasing and decreasing the same account

4.

Which of the following accounts has a normal debit balance? a. Mia Wong, Capital b. Cash c. Accounts Payable d. Fees Earned

5.

Which of the following accounts has a normal credit balance? a. Office Equipment b. Salaries Expense c. Accounts Receivable d. Accounts Payable

6.

Payment of salaries to employees is recorded as a(n) a. asset b. liability c. revenue d. expense

7.

The trial balance a. shows the income earned during the year b. shows the total amount of assets c. shows the accuracy of the general ledger d. is the first financial statement prepared

8.

Which account is shown on the balance sheet? a. Cash b. Utilities Expense .

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Section

c. Withdrawals by owner d. Revenue 9.

Which account is shown on the income statement? a. Equipment b. Owner, Capital Account c. Accounts Payable d. Rent Expense

10.

Which account is shown on the statement of owner's equity? a. Fees Earned b. Accounts Receivable c. Owner, Withdrawals d. Accounts Payable

Answer Key to Chapter 2 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

b c a b d d c a d c

.

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Chapter 3 Beginning the Accounting Cycle Chapter Overview The chapter begins by explaining the accounting cycle is the accounting procedures performed over a period of time and the accounting cycle takes place over a period of time called a fiscal year. The accounting cycle has several steps: the transaction occurs, is analyzed, recorded as a journal entry in the general journal, and posted to the general ledger. The information in the general ledger is used to prepare the trial balance. While the trial balance is not a formal financial statement, it is used to prepare formal financial statements: the income statement, the statement of owner’s equity, and the balance sheet.

Transaction analysis is used to understand how to record a business transaction as a journal entry.

Examples of increasing assets, decreasing liabilities, increasing expenses, etc. are used to illustrate the many possible types of journal entries. Posting the same journal entries to the general ledger is then illustrated. A trial balance is prepared from the general ledger information while the text also explains ways to troubleshoot if the trial balance does not balance. Demonstration Problems illustrate the entire process and offer tips to journalizing and posting.

Learning Objectives After studying Chapter 3, your students should gain proficiency in the following: 1. Analyze and Record Business Transactions into a Journal.

2. Posting to the Ledger.

3. Preparing the Trial Balance.

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Chapter 3 Assignment Grid Assignment Topic(s)

Estimated Time in Minutes

Level of Difficulty

1 1 1 1 2 2 1 1 2 2 2 2 3 3 3

5 5 5 5 5 5 5 5 5 5 5 5 5 10 5

Easy Easy Easy Easy Easy Easy Easy Easy Medium Easy Medium Medium Medium Medium Medium

1 2 2 3 3

5 5 5 15 5

Easy Easy Easy Medium Easy

1 1 2 1, 2, 3 3 3

10 10 10 20 15 10

Easy Easy Easy Medium Medium Medium

1 1 2 1, 2, 3 3 3

10 10 10 20 15 10

Easy Easy Easy Medium Medium Medium

1 1, 2, 3 1, 2, 3

30 45 45

Medium Hard Hard

1 1, 2, 3 1, 2, 3

30 45 45

Medium Hard Hard

Learning Objective(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Accounting Cycle 2 Accounting Period 3 Accounting Period 4 Interim Financial Stmts.

5 General Ledger 6 Posting and Balancing 7 General Journal 8 General Journal 9 Posting and Balancing 10 Posting and Balancing 11 Posting and Balancing 12 Posting and Balancing 13 Accounting Errors 14 Ethical Issue, Pandemic and Remote Work 15 Ethical Issue Concept Checks 1 General Journal 2 General Journal 3 Posting and Balancing 4 Trial Balance 5 Correcting Entry Exercises (Set A) 3A-1 Journal Entries 3A-2 Journal Entries 3A-3 Posting 3A-4 Journalizing, Posting, Trial Balance 3A-5 Trial Balance 3A-6 Error Correction Exercises (Set B) 3B-1 Journal Entries 3B-2 Journal Entries 3B-3 Posting 3B-4 Journalizing, Posting, Trial Balance 3B-5 Trial Balance 3B-6 Error Correction Problems (Set A) 3A-1 Journalizing 3A-2 Journalizing, Posting, Trial Balance 3A-3 Journalizing, Posting, Trial Balance Problems (Set B) 3B-1 Journalizing 3B-2 Journalizing, Posting, Trial Balance 3B-3 Journalizing, Posting, Trial Balance

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Assignment Topic(s)

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

3

5

Easy

1, 2, 3

45

Medium

Financial Report Problem Reading Amazon’s Annual Report/Internet Project Keeping It Real Suarez Digital Services

Chapter 3 Beginning the Accounting Cycle Summary: The accounting cycle consists of normal accounting procedures that take place over a period of time. The cycle begins with the recording of business transactions into a journal and ends with the completion of a post-closing trial balance. The accounting period is the span of time in which the accounting cycle takes place. Although the accounting period may vary, usually, it is one year long.

The fiscal year is the 12-month period a business chooses for its accounting year. The calendar year is the 12-month period between January 1 and December 31. The natural business year is the business’s fiscal year that ends at the same time as a slow seasonal period begins. While yearly financial statements are prepared at the end of the fiscal year, interim reports are prepared during the fiscal year. Interim financials may be prepared monthly, quarterly, or over other time periods deemed appropriate by management.

Learning Unit 3-1: Analyzing and Recording Business Transactions into a Journal (Steps 1 and 2 of the Accounting Cycle) Summary: The General Journal is the simplest journal and records transaction information in chronological order according to the transaction date. This journal records the journal entry in its entirety.

The general journal is the record of business transactions and is organized in chronological order according to the transaction date. The Journal is the first formal record of a business transaction occurring and is also called the book of original entry and the Ledger is considered the book of final entry.

As transactions occur, they are summarized into accounting form and recorded as a journal entry in the general journal. Compound journal entries are entries that have more than one debit and/or credit.

Key Concepts: Accounting cycle, accounting period, calendar year, interim reports, journal, journal entry, journalizing, book of original entry, book of final entry, compound journal entry Lecture Outline: 1. General journal or Journal: a. is the simplest form of a journal b. records information in chronological order as they occur c. links the debit and credit parts of transactions together d. called the “book of original entry” e. records the first formal information about business transactions Copyright © 2023 Pearson Education, Inc.

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f. the journal and the ledger are separate books 2. Journal entry: a. The format that transactions (debits and credits) are recorded once it is analyzed. b. Journal entries rules: i. The debit portion of the transaction is always recorded first. ii. The credit portion of a transaction is indented a ½ inch and placed below the debit portion. iii. The explanation of the journal entry follows immediately after the credit and 1 inch from the date column. iv. One line space follows each transaction and explanation. v. Finally, as always, the total amount of debits must equal the total amount of credits.

3. Journalizing: a. The process of recording a transaction entry into the general journal. b. The accountant must refer to the business’s chart of accounts for the account names to be used in the journal. c. Understand the facts of each transaction. d. Determine the two or more account titles involved. e. For each account, determine if the account is increased or decreased. f. Determine whether the amount is a debit (left) or credit (right) entry, 4. Compound journal entry: a. A journal entry that affects more than two accounts on the debit or the credit side.

5. These are examples of the most common types of business transactions: a. The owner investing cash (asset) in the business. (Fig. 3.2 on page 68) Dr. Cash XX Cr. Capital XX Initial investment by the owner b. The purchase of equipment with a down payment (cash) and the rest on credit. (Fig.3.3 on page 68) This is an example of a compound entry: a journal entry that affects more than two accounts on the debit or the credit side.

Dr. Computer Equipment XX Cr. Cash XX Cr. Accounts Payable XX Purchase of computer equipment c. Prepayment of rent with cash (Fig. 3.4 on page 69).

Dr. Prepaid Rent (asset) XX Cr. Cash XX Rent paid in advance d. Purchasing of computer supplies on account (Fig. 3.5 on page 69).

Dr. Computer Supplies (asset) XX Cr. Accounts Payable XX Purchase computer supplies on account e. Recording of fees earned (revenue) and (cash) received (Fig. 3.6 on page 69).

Dr. Cash XX Cr. Graphic Design Fees (revenue) XX Cash received for services rendered f. Recording of salaries paid (Fig. 3.7 on page 70).

Dr. Office Salaries Expense XX Cr. Cash XX Payment of office salaries g. Receive advertising bill (but unpaid) (Fig. 3.8 on page 70) Copyright © 2023 Pearson Education, Inc.

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Dr. Advertising Expense XX Cr .Accounts Payable XX Receive the advertising bill h. Withdrawal of funds (cash) for personal use (Fig. 3.9 on page 70) Dr. Withdrawals XX Cr. Cash XX Owner withdraws cash for personal use i. Recording of fees earned (revenue) but not received (accounts receivable). (Fig. 3.10 on page 71) Dr. Accounts Receivable XX Cr. Graphic Design Fees (revenue) XX Bill customer for fees earned j. Payment of office salaries (Fig. 3.11 on page 71) Dr. Office Salaries Expense XX Cr. Cash XX Payment of office salaries k. Partial payment (cash) of an amount owed (accounts payable). (Fig 3.12 on page 71) Dr. Accounts Payable XX Cr. Cash XX Paid half of the amount owed l. Payment of the telephone bill (Fig. 3.13 page 72).

Dr. Telephone Expense XX Cr. Cash XX Payment of the telephone bill Teaching Tips/Strategy: As classwork, your students should complete the Learning Unit 3-1 Try It! (page 72) and discuss the Demonstration Summary Problem (page 83) to review the basic concepts.

Indicate and distinguish keyword included on each transaction to facilitate the recording process.

Example of transactions keywords are: Paid – indicate a check or a payment done = cash is decreased (credit) Fees earned - indicate revenue was earned = revenue increases (credit) Cash received – indicate customers paid the business = cash increases (debit) Owner invested - the equity of the owner increases (credit) Personal use – indicate the owner took cash or property from the business = withdrawal debit Purchase on account – asset purchase on credit = accounts payable increases (debit) Payment of a debt – satisfying a debt, not purchasing again = accounts payable (debit) The Exercises 3A-1 and 3A-2 are excellent to teach how to analyze transactions and complete journal entries. Problem 3A-1 is a comprehensive problem to assess the full understanding of the learning objective concept. Review the “Success Coach LU 3-1” and the true/false questions (page 87) and) and the “Ten-Minute Quiz” questions 3 through 10 to reinforce the Learning Objective 3-1 concepts.

Learning Unit 3-2: Posting to the Ledger (Step 3 of the Accounting Cycle) Copyright © 2023 Pearson Education, Inc.

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Summary: The transactions from the general journal are entered (or posted) to the general ledger which is also called the book of final entry. The General Ledger lists the balances and changes to each account within the business. The general ledger records all of the transactions in one location. A business needs to know these account balances in order to operate successfully and prepare financial statements. We do this by transferring the information from the general journal to the general ledger. This transferring is called posting. The general ledger is organized by accounts and in the order of the accounting equation: A = L + OE. The general ledger usually consists of four-column account forms that include the debit or credit from the journal and the debit or credit running account balance. Cross-referencing is the process of adding to the PR (Posting Reference) column of the journal the account number of the ledger that was updated from the journal.

Key Concepts: Posting, four-column account, cross-referencing Lecture Outline: 1. The General Ledger: a. lists the balances and changes to each account within the business, b. records all of the transactions in one location, c. is organized by accounts and in the order of the accounting equation: A = L + OE, d. is a four-column account that includes the debit or credit from the journal, e. and the debit or credit running account balance.

2. Posting: transferring the information from the general journal to the general ledger.

Steps for posting to the ledger: a. Record the date. b. Record the journal page number in the posting reference (PR) column of ledger. c. Record debit or credit amount in the appropriate debit or credit column. Compute the updated balance of the account. Record the updated balance in the appropriate debit or credit balance column. d. Record the ledger account number in the posting reference (PR) column of the journal.

3. Posting References: a. Journal PR column illustrates which transactions have and have not been recorded. b. Ledger PR column in the ledger traces back to the original entry in the journal.

Teaching Tips/Strategy: As classwork, your students should complete the Learning Unit 3-2 Try It! (page 78) to review posting. Review the Demonstration Summary Problem (page 83) for an example of posting to ledger accounts.

Use the “Success Coach LU 3-2 and the true/false questions to check understanding of the objective concepts. Assign Exercise 3A-3 or 3B-3 to provide an opportunity to practice posting journal entries to the ledger.

Learning Unit 3-3: Preparing the Trial Balance (Step 4 of the Accounting Cycle) Summary: A Trial Balance is an informal listing of the ledger accounts and their balances in the ledger that aids in proving the equality of debits and credits. It is prepared by listing all accounts and recording their balances in the appropriate debit or credit columns. The accounts are listed in the accounting equation order or balance sheet order. The debit and credit columns are totaled and compared for accuracy. Both credit and debit columns must balance and match.

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Key Concepts: Trial balance, slide, transposition Lecture Outline: 1. Trial balance is the list of the individual accounts with their balances from the ledger. (Figure 3.17 shows an example trial balance.)

2. If the information is NOT journalized or posted correctly, the trial balance will not be correct.

3. A trial balance is not a formal financial statement and will NOT show the beginning capital balance if additional investments were made during the year.

4. If the trial balance does not balance, double check the transactions for journalizing and posting 5. Errors in posting need to have an audit trail and be initialed by the person changing or correcting them.

6. Understand common mistakes made when preparing a trial balance: a. Mathematical errors often result in amounts being off by 10, 100, 1,000, etc. b. A posting could have been missed if the difference between total debits and credits is equal to an individual account balance in the ledger. c. Divide the difference by 2, then check to see if a debit was posted as a credit, or vice versa. d. Slide – the error that results in adding or deleting zeros in the writing of a number. For example: 79,200 slides to 7,920 by dropping a zero. The difference between the two numbers is divisible by 9. e. Transposition – the accidental rearrangement of digits of a number. For example, 152 can be transposed to 125. The difference between the two numbers is divisible by 9. f. Compare the balances in the ledger with those in the trial balance to determine if the balances were copied correctly. g. Recompute balances in each ledger account. h. Trace all postings from the journal to the ledger.

7. Correcting mistakes when journalizing and posting: a. If the mistake was made before the posting, draw a line through the wrong information in the journal, write the correct information above it and initial the change. b. If the mistake was made after posting to the correct account, draw a line through the wrong information in the ledger including the wrong balance, write the correct information above it, initial the change, and calculate the new balance. c. If the mistake was made after posting to the wrong account, make a new correcting entry.

Teaching Tips/Strategy: Indicate that a trial balance is not a financial statement but is used as a tool to verify the accuracy of the account ending balances before financial statements are completed.

Use the “Success Coach LU 3-3 and the true/false questions (page 87) to check understanding of the objectives concepts. Concept Check 4 is excellent as a critical thinking activity to identify the errors presented on the indicated trial balance. Exercises 3A-4 and 3B-4 give students the opportunity to prepare journal entries, post to the ledger and prepare a trial balance. Assign problem 3A-3 or 3B-3 as an excellent way to tie all the concepts together. If you are introducing QuickBooks Online in your course, the Keeping it Real: Suarez Digital Services problem (page 99) is a good way to introduce source documents and review all three of the chapter’s learning objectives. Finally, as you wrap up this chapter, think about using the “Ten-Minute Quiz”, located on the last page of this instructor’s manual, as a quick in-class exercise to assess learning outcomes.

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Name

Date

Section

CHAPTER 3 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which of the following illustrates the accounting cycle?

1-The Trial Balance is prepared.

2-Postings are made into the General Ledger 3-Journal entries are recorded 4-Transactions occur a. 1, 2, 3, 4 b. 1, 3, 2, 4 c. 4, 3, 2, 1 d. 4, 2, 3, 1 2.

Which is not a General Journal? a. Book of original entry c. Journal

b. Book of final entry d. Simplest form of journal

3.

Select the transaction that would increase assets. a. Purchase inventory for cash b. Provided consulting services for cash c. Received cash from a bill sent to customers last month d. Paid insurance for the next 3 months

4.

Select the transaction that increases owner's equity. a. Received cash from a bill sent to customers last month b. Paid insurance for the next 3 months c. Purchase inventory for cash d. Provided consulting services for cash

5.

Select the transaction that increases liabilities. a. Paid insurance for the next 3 months b. Purchase inventory for cash c. Received utility bill d. Received cash from a bill sent to customers last month

6.

The proper journal entry to record the $100 purchase of supplies on account would be: a. Office Supplies 100 Accounts payable 100 b. Cash 100 Office Supplies 100 c. Office Supplies 100 Cash 100 d. Accounts payable 100 Office Supplies 100

7.

The proper journal entry to record the $200 rent paid in advance would be: a. Prepaid Rent 200 Accounts payable 200 b. Cash 200 Prepaid Rent 200 c. Prepaid Rent 200 Copyright © 2023 Pearson Education, Inc.

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Cash d. Accounts payable Prepaid Rent

200 200 200

8.

The proper journal entry to record receiving the $150 advertising bill would be: a. Cash 150 Advertising Expense 150 b. Advertising Expense 150 Accounts payable 150 c. Advertising Expense 150 Cash 150 d. Accounts payable 150 Advertising Expense 150

9.

The proper journal entry to record the $150 payment of last month's advertising bill would be: a. Cash 150 Advertising Expense 150 b. Advertising Expense 150 Accounts payable 150 c. Advertising Expense 150 Cash 150 d. Accounts payable 150 Cash 150

10.

The proper journal entry to record the $170 receipt of a bill sent to a customer last month would be: a. Cash 170 Accounts Receivable 170 b. Fees Earned 170 Accounts Receivable 170 c. Fees Earned 170 Cash 170 d. Accounts Receivable 170 Cash 170

Answer Key to Chapter 3 Quiz 1. c 2. b 3. b 4. d 5. c 6. a 7. c 8. b 9. d 10. a

Copyright © 2023 Pearson Education, Inc.

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Chapter 4 The Accounting Cycle Continued Chapter Overview The chapter begins with an introduction to adjusting entries. Some transactions cannot be observed by the company and, therefore, are not recorded as often as a sales or cash payment entry. Examples of these transactions are wear and tear on equipment or the expiration of insurance. Adjusting entries are used to allocate revenue and expenses properly based upon the accounting period used and to adjust the balance sheet accounts and income statement accounts to reflect an accurate balance. At the end of the accounting period and after preparing a trial balance, businesses record adjusting entries. They utilize a worksheet to organize and check the financial data before preparing financial statements.

A worksheet consists of a trial balance, adjusting entries, and an adjusted trial balance. Each of these areas has its own debit and credit columns to help review the account balances. For each of these areas, the total debits will equal the total credits. The worksheet also contains columns showing the ledger accounts arranged according to financial statement location. There are debit and credit columns for the balance sheet accounts and for the income statement accounts. For each of these financial statements, the total debit and credit columns do not equal each other but are “off” by the same dollar amount. In order to balance the debit and credits, one financial statement needs that dollar amount added as a debit and the other as a credit. This amount is equal to the net income or net loss for the year. At this point in the accounting cycle, any errors in financial statement preparation are corrected. After the worksheet has been properly prepared, formal financial statements are easily prepared.

Learning Objectives After studying Chapter 4, your students should gain proficiency in the following: 1. Explain Adjustments and How to Record Them on a Worksheet.

2. Complete the Worksheet.

3. Prepare Financial Statements from the Worksheet.

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4-1

Chapter 4 Assignment Grid Level of Difficulty

1 1 1 1 1 1 1 1 3 3 1 1

5 5 5 5 5 5 5 5 5 5 10 5

Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Medium Easy

1 1 1 1 2 2, 3

5 10 10 10 15 15

Easy Easy Easy Easy Medium Medium

3 1 1 1, 2 3

5 10 10 20 20

Easy Easy Easy Medium Medium

3 1 1 1, 2 3

5 5 10 20 20

Easy Easy Easy Medium Medium

1 1,2 1, 2, 3 1, 2, 3

15 30 60 60

Easy Medium Medium Medium

1 1, 2 1, 2, 3 1, 2, 3

15 30 60 60

Easy Easy Medium Medium

Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Worksheet theory 2 Adjusting entry theory 3 Adjusting process 4 Adjusting entry theory 5 Asset depreciation theory 6 Asset depreciation theory 7 Asset depreciation theory 8 Accrued salaries 9 Financial statement theory 10 Financial statement theory 11 Accruals and the Pandemic 12 Ethics: adjusting entries Concept Checks 1 Adjustment for Supplies 2 Adjustment for Prepaid Rent 3 Adjustment for Depreciation 4 Adjustment for Accrued Salaries 5 Worksheet 6 Worksheet Exercises (Set A) 4A-1 Financial Stmt. Placement 4A-2 Adjusting Entries 4A-3 Adjusting Entries 4A-4 Adjusting Entries & Worksheet 4A-5 Worksheet completion Exercises (Set B) 4B-1 Financial Stmt. Placement 4B-2 Adjusting Entries 4B-3 Adjusting Entries 4B-4 Adjusting Entries & Worksheet 4B-5 Worksheet completion Problems (Set A) 4A-1 Adjusting Entries & Worksheet 4A-2 Adjusting Entries & Worksheet 4A-3 Adjustments, Worksheets, Financial Stmt.

4A-4 Adjustments, Worksheets, Financial Stmt.

Problems (Set B) 4B-1 Adjusting Entries & Worksheet 4B-2 Adjusting Entries & Worksheet 4B-3 Adjustments, Worksheets, Financial Stmt.

4B-4 Adjustments, Worksheets, Financial Stmt.

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Estimated Time in Minutes

4-2

Assignment Topic(s)

Learning Objective(s)

Time in Minutes

of Difficulty

1

20

Medium

1, 2, 3

45

Medium

Financial Report Problem Reading Amazon’s Annual Report/Internet Project Keeping It Real Suarez Digital Services

Chapter 4 The Accounting Cycle Continued Learning Unit 4-1: Explaining Adjustments and How to Record Them on a Worksheet Summary: An accountant uses a worksheet to organize and check data before preparing financial statements necessary to complete the accounting cycle. The accounts listed on the far left of the worksheet are taken from the ledger. The rest of the worksheet has five sections: the trial balance, adjustments, adjusted trial balance, income statement, and balance sheet. Each of these sections is divided into debit and credit columns. If additional accounts are needed, they can be added later. Adjusting Entries are necessary entries at the end of the year and cover a variety of necessary adjustments.

Adjusting entries involve specific accounts and bring those account balances up-to-date. The common adjustments affect office supplies, payroll, depreciation, and prepaid rent or prepaid insurance.

Key Concepts: Worksheet, adjusting, historical cost, depreciation, residual value, accumulated depreciation, book value, accrued salaries payable Lecture Outline: 1. Adjusting Entries are: a. necessary entries at the end of the year or the period b. to cover a variety of necessary adjustments c. to record transactions that have not been recorded d. To update balance of specific accounts 2. The common adjusting entries: a. Adjusting Computer Supplies – to adjust the asset balance to the amount of assets on hand and adjust the expense to the amount of supplies used during the year.

Dr. Computer supplies expense XX Cr. Computer Supplies XX b. Adjusting Prepaid Rent –to adjust the asset balance to the amount of prepaid rent remaining and adjust the expense to the rent utilized during the accounting period.

Dr. Rent expense Cr. Prepaid rent

.

XX XX

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c. Adjusting computer equipment account for depreciation. i.

Assets are recorded at their historical cost (the price paid for them). ii.

A contra asset is called accumulated depreciation to record the total depreciation taken over the life of the asset. iii.

Depreciation is the spreading of this cost over the usefulness of the asset and the spreading of this cost represents the wear and tear of the asset.

Dr. Depreciation expense Cr. Accumulated Depreciation

XX XX

iv.

The residual value is the estimated value of an asset after all allowable depreciation has been taken. v.

Straight line depreciation = (cost – residual value)/estimated years of usefulness. vi.

Book value = cost of equipment - accumulated depreciation. vii.

The carrying value of the asset is the difference between the historical cost of the asset and its accumulated depreciation. d. Adjusting the Salaries Accrued Account – to record the salaries owed to employees but not recorded as of the end of the year.

Dr. Office salaries expense Cr. Salaries payable

XX XX

Teaching Tips/Strategy: Figure 4-1 shows a flowchart of the of the accounting cycle with steps 5 and 6 the focus of this chapter. At the start of the first chapter 4 lecture, review Figure 4-1 to set the context of the chapter coverage.

Use the Discussion Questions 2, 3 and 4 to illustrate the importance of the adjusting entries in the business accounting cycle.

Provide examples of how an asset declines in value with usage or the periodic allocating of the asset cost to an expense account. Use the Demonstration Summary Problem to illustrate the concepts of cost, residual value, useful life, depreciation expense and accumulated depreciation. Explain to the students the differences between the annual depreciation expense account and the accumulated depreciation account. The depreciation expense is presented on the income statement and only includes the current (annual or monthly) amount reflecting the decline in value. The accumulated depreciation account, a contra-asset account, is presented on the balance sheet and “accumulates” the total asset depreciation since the acquisition date.

Use the Concept Checks 1 through 4 to illustrate and prepare adjusting entries. Summarize the adjusting entries impact on the revenues, expenses, assets, and liabilities accounts. Remind students that all adjusting procedures are completed at the end of the period. If you debit an expense account, the credited account is an asset (prepaid) or a liability (payable). Cash is NOT used on any adjusting entries. Use Exercises 4A-2 and 4A-3 as classwork or assigned work to practice the necessary adjusting entries.

Use the “Ten-Minute Quiz” questions 2, 3, 4, 5, 6, 7 and 8 to reinforce the Learning Objective 4-1 concept.

Learning Unit 4-2: The Worksheet (Step 5 of the Accounting Cycle) Summary: The Adjusted Trial Balance is the section after all adjustments are done in the worksheet.

.

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The balances presented in the adjusted trial balance are the result of adding or subtracting the adjustments posted in the adjustments columns to balance amounts in the unadjusted trial balance (first two columns of the worksheet). Accounts that were not adjusted or added below the trial balance have their balances carried over to the adjusted trial balance. Accounts that were adjusted will have their combined balances carried over to the adjusted trial balance. For example, Salaries Expense is adjusted by adding the debit balance.

All accounts in the adjusted trial balance that are income or expense accounts have their balances recorded in the appropriate income statement section in the debit or credit columns. The difference in the two columns is either net income or net loss. The balance sheet section is the next section of the worksheet and prepared by listing the assets, contra-assets, liabilities, capital, and withdrawals from the adjusted trial balance. The difference in the two columns is either the net income or net loss amount. Both net income (or net loss) amounts, from the income statement column and from the balance sheet columns, should match.

Key Concepts: None Lecture Outline: 1. Worksheet or Spreadsheet a. An informal columnar report used by accountants to aid in completing the accounting cycle. b. Purpose: to organize and check accounts before the preparation of the trial balance and financial statements. c. There are five sections of the worksheet and each section includes a debit and credit column i. Trial Balance ii. Adjustments iii. Adjusted Trial Balance iv. Income Statement v. Balance Sheet 2. The income statement columns are completed as follow: a. Transfer the accounts in the adjusted trial balance that are income or expense accounts b. The debits and credits are totaled in each column. i. If total credits > total debits, the result is net income ii. If total debits > total credits, the result is net loss c. Place the net income in the debit column or the net loss in the credit column. d. After adding this amount, the debit and credit columns will balance.

3. The balance sheet columns are the next section of the worksheet and are completed as follows: a. Transfer the balance from assets, contra-assets, liabilities, capital, and withdrawals from the adjusted trial balance. b. Total the debit and credit columns. c. Place the net income in the credit column or the net loss in the debit column. d. After adding this amount, the debit and credit columns will now balance.

4. The difference added to the income statement section and the difference added to the balance sheet section are the same in value although one is a debit balance and one is a credit balance. a. If the adjusting amount has a debit balance in the Income Statement side and a credit balance in the Balance Sheet side, the amount is equal to the amount of net income. b. If the adjusting amount has a credit balance in the Income Statement side and a debit balance in the Balance Sheet side, the amount is equal to the amount of net loss.

Teaching Tips/Strategy: Use Concept Check 5 to review worksheet placement. Use Exercise 4A-4 or 4B-4 as classwork or assigned work to practice completing a worksheet.

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Use the “Ten-Minute Quiz” question 9 to reinforce the Learning Objective 4-2 concept.

Learning Unit 4-3: The Financial Statements from the Worksheet (Step 6 of the Accounting Cycle) Summary: The formal financial statements can be prepared from the worksheet completed in Learning Unit 4-2. To ensure the accuracy of the amounts, we double-check that all entries are recorded correctly, the correct amounts are entered in the proper places, the addition is correct across the columns (i.e., from the trial balance to the adjusted trial balance to the financial statements), and the columns are added correctly. Once all accounts and numbers are verified, you can utilize the adjusted trial balance columns to prepare the financial statements.

Key Concepts: None Lecture Outline: 1. Check to make sure the entries on the worksheet are correct and in balance. a. Verify the following items: i.

Double-check that all entries are recorded in the appropriate column ii.

The correct amounts are entered in the proper places iii.

The addition is correct across the columns iv.

The columns are added correctly b. Prepare the income statement (Figure 4.13) i.

Every amount reported on the formal statement is on the worksheet. ii.

No debit or credit columns appear on the formal statement iii.

The inside column on financial statements is used for subtotaling iv.

Withdrawals do not go on the income statement. They go on the statement of owner’s equity. c. Preparing the statement of owner’s equity. (Figure 4.14) i.

Check the ledger account for the beginning capital amount. Having additional investments by owner usually signals the amount on the worksheet is not the beginning balance. ii.

Net income from the income statement is added to the balance in owner’s equity. iii.

Net losses from the income statement are subtracted from the balance in owner’s equity. iv.

Withdrawal amounts from the balance sheet column on the worksheet are subtracted from the balance in owner’s equity. v.

The new balance in owner’s equity is carried to the balance sheet. d. Preparing the balance sheet (Figure 4.15) i.

Column totals on the worksheet do not match the formal balance in the balance equation. (a) The balance sheet is formatted differently from the trial balance. (b) The numbers are grouped by category instead of the trial balance’s simple listing of balances. ii.

The owner’s equity amount is the same as ending capital balance on the statement of owner’s equity.

Teaching Tips/Strategy: Review the “Success Coach” LU 4-3 and its true/false questions to review the checks and procedures needed to utilize the worksheet to prepare the financial statements. Use Exercise 4A-5 or 4B-5 as classwork and/or homework to prepare financial statements using a worksheet.

Use the “Ten-Minute Quiz” question 10 to reinforce Learning Objective 4-3 concept.

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Teaching Tips/Strategy: Each chapter contains a “Try It!” at the end of each Learning Unit. The “Try its!” are intended as practice for students and/or as checking of student understanding. There is also a Demonstration Summary Problem with each chapter to provide an overview of all the chapter concepts. Students can study and review this problem to view how all the chapter concepts fit together.

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Name

Date

Section

CHAPTER 4 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which is the proper order of accounting cycle activities?

1 A trial balance is prepared 2 Business Transactions occur and analyzed 3 Financial Statements are prepared 4 Information from the journal is posted to the ledger 5 Journal entries are recorded in the general journal 6 The worksheet is completed a. b. c. d.

5, 2, 6, 1, 4, 3 1, 3, 6, 5, 4, 2 2, 5, 4, 1, 6, 3 2, 5, 1, 6, 3, 4

2.

The purpose of adjusting entries is to: a. record revenues in the period in which they are earned b. record expenses in the period in which they are incurred c. the balances on the income statement and balance sheet are correct d. all of the above

3.

Which of the following accounts is not commonly adjusted in an adjusting entry? a. cash - adjusted to match the bank statement b. office supplies - adjusted to record supplies used during the period c. prepaid rent - adjusted to record rent expense d. equipment - adjusted to record depreciation

4.

At the end of its fiscal year, the company had only $100 of office supplies on hand but the supplies account listed $550. What is the year end adjusting journal entry? a. debit supplies and credit supplies expense for $100 b. debit supplies expense and credit supplies for $100 c. debit supplies and credit supplies expense for $450 d. debit supplies expense and credit supplies for $450

5.

On March 1, Babko Company paid $1,500 for 6 months rent. What is the adjusting entry for the fiscal year ending June 30? a. debit rent expense and credit prepaid rent for $750 b. debit prepaid rent and credit rent expense for $750 c. debit rent expense and credit prepaid rent for $1,000 d. debit prepaid rent and credit rent expense for $1,000

6.

Annual equipment depreciation is calculated as $5,000. What is the adjusting journal entry? a. debit equipment and credit depreciation expense for $5,000 b. debit depreciation expense and credit accumulated depreciation for $5,000 c. debit accumulated depreciation and credit equipment for $5,000 d. debit accumulated depreciation and credit depreciation expense for $5,000

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7.

Employees are paid every two weeks. On December 31, employees are owed $2,500 in salaries since the last payday on December 22. What is the adjusting journal entry? a. debit cash and credit salaries expense b. debit salaries expense and credit cash c. debit salaries payable and credit salaries expense d. debit salaries expense and credit salaries payable

8.

Adjustments for prepaid expenses: a. decrease revenues and increase assets b. decrease assets and increase expenses c. decrease assets and increase revenues d. decrease expenses and increase assets

9.

Which is correct concerning the adjusted trial balance? a. An adjusted trial balance lists all ledger account balances separated by assets and liabilities. b. An adjusted trial balance is a method used to prove the accounting to date has been posted properly. c. An adjusted trial balance is prepared after adjusting entries have been journalized and posted. d. The balance sheet accounts in the adjusted trial balance have the proper financial statement amounts.

10.

In a worksheet, the debit and credit columns listed in the Balance Sheet and Income Statement area: a. do not have debits equal credits, and the difference is the net income or net loss b. prove that debits equal credits c. prove the balance in owner's equity d. are formal financial statements

Answer Key to Chapter 4 Quiz 1. c 2. d 3. a 4. d 5. c 6. b 7. d 8. b 9. c 10. a

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Appendix for Chapter 4 The Accounting Cycle Continued Appendix for Chapter 4 Summary: Assets such as computer equipment benefit a company for more than one year or one accounting cycle. To account for these assets, we must recognize a portion of the cost of these assets used up during the accounting period. Two accounts are used in the calculation and accounting for depreciation: Depreciation Expense (Income Statement account) and Accumulated Depreciation (Balance Sheet account).

Two key accounting principles are the basis for the calculation and reporting of depreciation. One is the Historical Cost Principle which requires the Depreciation Expense and the asset amount to be based on the original cost of the asset such as computer equipment. The other is the Matching Principle which requires that the asset’s cost be allocated to Depreciation Expense over the life of the asset. Reporting the asset’s cost on an allocated basis accomplishes the matching of the asset’s cost with each period in which the asset is used.

There are two general depreciation methods used for recording financial statement depreciation: Straightline Depreciation and Accelerated Depreciation.

Lecture Outline: 1. Depreciation adjusting entries: a. Basic depreciation guidelines: i.

Assets are recorded at their historical cost (the price paid for them). ii.

A contra asset is called accumulated depreciation to record the total depreciation taken over the life of the asset. iii.

Depreciation is the spreading of this cost over the usefulness of the asset and the spreading of this cost represents the wear and tear of the asset.

Dr. Depreciation expense XX Cr. Accumulated Depreciation XX iv.

The residual value is the estimated value of an asset after all allowable depreciation has been taken. v.

Straight-line method is: Depreciation Expense = (cost of the asset – residual value or salvage value)/useful life of the asset vi.

Accelerated method of Double Declining Balance (DDB) is: Cost of Asset – Accumulated Depreciation – Book Value X Depreciation Rate (%) = Depreciation Expense

vii. viii.

i. For DDB, residual value is not a factor until the last year of useful life ii. “Back into” the amount of depreciation expense in last year so that book value equals residual value.

Book value = cost of equipment - accumulated depreciation.

The carrying value of the asset is the difference between the historical cost of the asset and its accumulated depreciation.

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ix.

Depreciation expense is also a factor in calculating taxable income and there are some differences from financial reporting. i. Tax depreciation is covered in IRS Publication 946, How to Depreciate Property.

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Chapter 5 The Accounting Cycle Completed Chapter Overview This chapter begins with a review of the entire accounting cycle while concentrating on journalizing and posting adjusting entries. Once adjusting journal entries are completed and posted, certain accounts in the general ledger are closed for the accounting period. Closing entries are used to return the balances of temporary accounts (revenue, expenses, withdrawals) to zero. These accounts begin the next accounting period with a zero balance and can accurately measure the total activity in each account for the year.

Closing entries are also used to modify the balance in the owner’s equity account to reflect the income, loss, and withdrawals that occurred during the year.

Four closing entries are generally needed: 1) Revenue is closed into the temporary account called “Income Summary”.

2) Expenses are closed into the temporary account called “Income Summary”.

3) Income Summary is closed into Capital.

4) Withdrawals for the year are closed into Capital.

After the closing entries are prepared and posted, a post-closing trial balance is prepared. This trial balance consists solely of balance sheet accounts since all other accounts have a zero balance at this point in time.

This trial balance assures that the closing entries were completed properly and that the balances are ready for recording in the new accounting period.

Learning Objectives After studying Chapter 5, your students should gain proficiency in the following: 1. Journalize and Post Adjusting Entries.

2. Journalize and Post Closing Entries.

3. Prepare a Post-Closing Trial Balance.

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Chapter 5 Assignment Grid Assignment Topic(s)

Learning Objective(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Worksheet completion 1 2 Adjusting Entries 1 3 Closing Entries 2 4 Temporary/Permanent Accounts 2 5 Closing Process 2 6 Closing Process 2 7 Income Summary Account 2 8 Worksheet and Closing Entries 2 9 Post-Closing Trial Balance 3 10 Closing Entries 2 11 Adapting to a Pandemic 1,2,3 12 Ethics, conflict of interest 1,2,3 Concept Checks 1 Journalizing and Posting Adjusting Entries 1 2 Steps of Closing & Journalizing Closing Entries 2 3 Journalizing Closing Entries 2 4 Posting to Income Summary 2 5 Posting to Capital 2 Exercises (Set A) 5A-1 Adjusting Journal Entries 1 5A-2 Permanent and Temporary Accounts 1, 2 5A-3 Closing Entries 2 5A-4 Closing Entries 2 5A-5 Post-Closing Trial Balance 3 Exercises (Set B) 5B-1 Adjusting Journal Entries 1 5B-2 Permanent and Temporary Accounts 1, 2 5B-3 Closing Entries 2 5B-4 Closing Entries 2 5B-5 Post-Closing Trial Balance 3 Problems (Set A) 5A-1 Worksheet, Adjusting and Closing Entries 1, 2 5A-2 Accounting Cycle 1, 2, 3 5A-3 Accounting Cycle 1, 2, 3 Problems (Set B) 5B-1 Worksheet, Adjusting and Closing Entries 1, 2 5B-2 Accounting Cycle 1, 2 5B-3 Accounting Cycle 1, 2, 3

Assignment Topic(s)

Learning Objective(s)

Copyright © 2023Pearson Education, Inc.

Estimated Time in Minutes

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5-2

Financial Report Problem Reading Amazon’s Annual Report/Internet Project

3

15

Easy

Keeping It Real Suarez Digital Services

1, 2, 3

60

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Mini Practice Set Sherman Realty (Reviewing the Accounting Cycle)

1, 2, 3

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Chapter 5 The Accounting Cycle Completed Introduction Summary: In Chapters 3 & 4, we completed the following steps of a manual accounting systems: 1) Business transactions occurred and generated source documents.

2) Business transactions were analyzed and recorded into a journal.

3) Information was posted or transferred from journal to ledger.

4) A trial balance was prepared.

5) A worksheet was completed.

6) Financial statements were prepared.

Chapter 5 covers the following steps needed to complete the accounting cycle: 7) Journalizing and posting adjusting entries.

8) Journalizing and posting closing entries 9) Preparing a post-closing trial balance.

Learning Unit 5-1: Adjusting Entries (Step 7 of the Accounting Cycle) Summary: Adjusting journal entries are journal entries needed to update ledger accounts so they can reflect the correct balances at the end of an accounting period. The information in the worksheet is up-todate, but the worksheet is an informal report. The information concerning the adjustments has not been placed into the journal or posted to the ledger account yet, which means that the books are not up-to-date and ready for the next accounting cycle to begin. The person preparing the accounts must use the adjustment columns of the worksheet as a basis for bringing the ledger up-to-date. To update the ledger, the entries are journalized and posted to the ledger. (Figures 5.1 and 5.2).

Key Concepts: Adjusting journal entries Lecture Outline: 1) Adjusting journal entries: a) are needed to update specific ledger accounts to reflect correct balances at the end of an accounting period. b) show debits and credits in the adjustment columns of the worksheet, (See Fig 5.1) c) are recorded in the general journal, (See Fig. 5.2) and d) then posted to the general ledger.

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Teaching Tips/Strategy: Exercises 5A-1 and 5B-1 are excellent for illustrating basic adjusting entries.

Use the “Ten-Minute Quiz” questions 1 and 4 to reinforce Learning Objective 5-1 concepts.

Learning Unit 5-2: Closing Entries (Step 8 of the Accounting Cycle) Summary: Permanent (real) accounts are accounts whose balances are carried over to the next accounting period. The balances that do not change when a new accounting period begins are assets, liabilities, and capital accounts. Temporary (nominal) accounts are those accounts whose balances are not carried over to the next accounting period. These accounts help summarize the total activity for an accounting period as well as help summarize a new or ending balance for Capital to begin the next accounting period. Income Summary is also a temporary account. Closing journal entries are those entries that reduce the temporary accounts to a zero balance and update the Capital account to reflect the changes that occurred during the year. There are four types of closing entries: close revenue, close expenses, close income summary and close withdrawals. All closing entries are journalized and posted to the ledger to update all related balances.

Key Concepts: Permanent (real) accounts, temporary (nominal) accounts, closing journal entries, income summary Lecture Outline: 1) Permanent v. temporary accounts a) Permanent (real) accounts: i) have balances that are carried over to the next accounting period. ii) balances do not change when a new accounting period begins. iii) balances are located on the balance sheet. iv) examples are assets, liabilities, and capital accounts. b) Temporary (nominal) accounts: i) have balances not carried over to the next accounting period. ii) help summarize the total activity for an accounting period. iii) are located on the income statement and statement of owner’s equity. iv) summarize a new or ending balance for Capital. v) examples are revenue, expenses, withdrawals, and Income Summary.

2) Closing process: a) totals the revenue and expense accounts for the accounting period. b) computes the net income or net loss. c) sets the temporary (nominal) accounts to have zero balances at the beginning of the accounting period so new amounts in the new year can be accumulated. d) reports the total withdrawals for the year.

3) Closing journal entries: a) are entries that reset the temporary accounts to a zero balance. b) update the Capital account to reflect the changes that occurred during the year.

4) Four types of closing entries: a) Step 1: Close Revenues (see Figure 5.5) i) Revenue accounts are individually closed into Income Summary. ii) Revenues have a credit balance. Closing entries debit the revenue accounts.

Dr. Revenue XX Cr. Income Summary XX b) Step 2: Close Expenses (see Figure 5.6)

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i) Expense accounts are individually closed into Income summary. ii) Expense accounts have a debit balance. Closing entries credit the expense accounts.

Dr. Income Summary Cr. Expenses

XX XX

c) Step 3: Close Income Summary i) Income Summary is used to determine if you have a net income or net loss. ii) Income summary is closed into the Capital account. iii) If there is net income: (See Figure 5.7) Dr. Income Summary XX (amount = Net Income) CR. Capital XX (amount =Net Income) iv) If there is net loss: Dr. Capital XX (amount = Net loss) CR. Income Summary XX (amount =Net loss) d) Step 4: Closing withdrawals: (See Figure 5.8) i) Withdrawals account is closed into the Capital account.

Dr. Capital CR. Withdrawals

XX XX

e) The closing entries are posted to the general ledger. i) Revenues, expenses, withdrawals, and Income Summary account balances should equal zero after posting closing entries. ii) Balance sheet accounts will have their balances carry forward to become the opening balances for the next accounting period.

Teaching Tips/Strategy: Differentiate between temporary and permanent accounts. Utilize Exercise 5A-2 to indicate the correct category for each account. Use the “Success Coach” LU 5-2 to review and explain the concept of closing entries. Demonstrate the closing process with the Concept Checks 2, 3, 4 and 5. They will review the proper closing sequence which includes journalizing and posting of the closing entries.

Immediately after the “Success Coach” section of the chapter, there is an image called the “Blueprint for Success: The Closing Process”. That image provides a useful visual explanation of the closing of accounts.

Use the “Ten-Minute Quiz” questions 2, 3, 5, 6, 7, 8 and 10 to reinforce the Learning Objective 5-2 concepts.

Learning Unit 5-3: The Post-Closing Trial Balance (Step 9 of the Accounting Cycle) Summary: After adjusting and closing entries have been posted, the balances from the permanent accounts are used to create the post-closing trial balance. These post-closing balances are the opening balances for the new accounting period.

Key Concepts: Post-closing trial balance Lecture Outline: 1) Post-closing trial balance:

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a) b) c) d)

contains only permanent accounts. is one where all temporary accounts have been closed. is one where all temporary accounts are summarized in the capital account. is one where, the structure should look as follows: Assets ........................ Dr. Contra-Assets ............ Cr. Liabilities .................. Cr. Ending Capital .......... Cr. e) Only assets, liabilities, and the ending capital should be presented.

Teaching Tips/Strategy: Use the “Success Coach” LU5-3 to review and apply critical thinking skills related to the post-closing trial balance. Exercises 5A-5 and 5B-5 are excellent for classwork to evaluate student understanding of the objective.

Use the “Ten-Minute Quiz” question 9 to reinforce the Learning Objective 5-3 concepts.

Teaching Tips/Strategy: Each chapter contains a “Try It!” at the end of each Learning Unit. The ”Try its!” are intended as practice for students and/or as checking of student understanding. There is also a Demonstration Summary Problem with each chapter to provide an overview of all the chapter concepts.

Students can study and review this problem to view how all the chapter concepts fit together. At the end of Chapter 5 there is a Mini Practice Set (Sherman Realty). This is a comprehensive review problem requiring students to complete the accounting cycle twice. This Mini Practice Set is an excellent review for students.

Copyright © 2023Pearson Education, Inc.

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Name

Date

Section

CHAPTER 5 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which of the following is not an adjusting entry? a. The supplies used during the period. b. The cash payment on a note from the bank. c. The depreciation of equipment. d. The salaries owed but not yet paid.

2.

Which of the following accounts is a permanent account? a. Cash b. Salary expense c. Interest income d. Revenue

3.

Which of the following accounts is a temporary account? a. Cash b. Accounts Payable c. Capital d. Revenue

4.

Which of the following is an adjusting entry? a. Accounts receivable is closed to reflect the amounts paid during the year. b. Depreciation on automobiles is $1,000 for the year. c. Revenues are closed to reflect the revenue earned but not yet received. d. Capital is closed to reflect the withdrawals during the year.

5.

Which of the following accounts is a closing entry? a. Accounts receivable is closed to reflect the amounts paid during the year. b. Salary expense is closed to reflect the salaries owed but not yet paid. c. Revenues are closed to allow an accurate account of annual revenue. d. Capital is closed to reflect the withdrawals during the year.

6.

What is the correct way to close expenses? a. Debit expenses and credit Capital. b. Debit Capital and credit expenses. c. Debit expenses and credit Income Summary. d. Debit Income Summary and credit expenses.

7.

What is the correct way to close withdrawals? a. Debit withdrawals and credit Capital. b. Debit Capital and credit withdrawals. c. Debit withdrawals and credit Income Summary. d. Debit Income Summary and credit withdrawals.

8.

The entry to close Income Summary a. depends on the total amount of revenues and total amount of expenses. b. is always a debit to Income Summary and a credit to Capital.

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c. is always a debit to Capital and a credit to Income Summary. d. never occurs.

9.

A post-closing trial balance a. only reflects the balance sheet accounts. b. only reflects the changes during the year. c. shows every account has a zero balance d. does not show total debits equal total credits.

10.

Which of the following is not true? a. All information from closing can be obtained from the worksheet or ledger. b. Closing entries are usually done only at year-end. c. Assets, liabilities, and capital are temporary accounts. d. When closing is complete, all revenue accounts will have a zero balance.

Answer Key to Chapter 5 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

b a d b c d b a a c

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Chapter 6 Banking Procedures and Control of Cash Chapter Overview This chapter focuses on cash and the internal control of cash. The chapter begins with an explanation of setting up and using a checking account. All cash received should be deposited in the entity’s bank account at the end of each day; and, except for petty cash disbursements, all cash payments should be made using the business’s checking account. At the end of each month, the cash balance shown in the general ledger should be reconciled with the cash balance reported by the bank. On the date of the bank statement, the bank is unaware of deposits in transit and outstanding checks while the business may not be aware of bank charges and non-sufficient funds check. The business makes journal entries to adjust the business records for transactions of which it was not aware.

While most of a firm’s cash disbursements should be made by check, a petty cash fund is used for small payments when writing a check is not convenient. The petty cash fund is an account in which the general ledger balance will always equal the total balance in the petty cash box plus receipts in the box. When the petty cash fund is low on cash and at the end of the year, the petty cash fund is reimbursed with cash; and the receipt for the expenses paid is recorded as expenses.

Learning Objectives After studying Chapter 6, your students should gain proficiency in the following: 1. Explain Banking Procedures and Checking Accounts.

2. Explain Bank Reconciliation.

3. Explain Petty Cash and Change Funds.

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Chapter 6 Assignment Grid Learning Assignment Topic(s) Objective(s) Discussion Questions and Critical Thinking/Ethical Case 1 Smartphone Apps 1 2 Online Banking 1 3 Endorsements 1 4 Parts of a Check 1 5 Writing Checks 1 6 Bank Statements 2 7 Bank Reconciliation 2 8 Outstanding Checks 2 9 NSF Checks 2 10 Bank Reconciliation Entries 2 11 EFT 2 12 Online Banking 2 13 Check Truncation 2 14 Petty Cash 3 15 Auxiliary Petty Cash 3 16 Petty Cash Replenishment 3 17 Change Fund 3 18 Cash Short & Over 3 19 Ethical Case 2 Concept Checks 1 Bank Reconciliation 2 2 Bank Reconciliation Journal Entries 2 3 Bank Reconciliation 2 4 Petty Cash 3 5 Petty Cash Replenishment 3 6 Increasing Petty Cash 3 Exercises (Set A) 6A-1 Bank Reconciliation Journal Entries 2 6A-2 Petty Cash Entries 3 6A-3 Replenish Petty Cash 3 6A-4 Replenish Petty Cash 3 6A-5 Cash Short & Over 3 Exercises (Set B) 6B-1 Bank Reconciliation Journal Entries 2 6B-2 Petty Cash Entries 3 6B-3 Replenish Petty Cash 3 6B-4 Replenish Petty Cash 3 6B-5 Cash Short & Over 3 Problems (Set A) 6A-1 Bank Reconciliation and Journal Entries 2 6A-2 Bank Reconciliation and Journal Entries 2 6A-3 Petty Cash Journal Entries 3 6A-4 Petty Cash Journal Entries 3

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Financial Report Problem Reading Amazon’s Annual Report/Internet Project

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Keeping It Real Suarez Digital Services

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Assignment Topic(s) Problems (Set B) 6B-1 Bank Reconciliation and Journal Entries 6B-2 Bank Reconciliation and Journal Entries 6B-3 Petty Cash Journal Entries 6B-4 Petty Cash Journal Entries

Learning Unit 6-1: Banking Procedures and Checking Accounts Summary: Internal control systems help safeguard the business assets, especially cash. Cash is the asset that is most easily stolen, lost, or mishandled. Some internal control procedures are: employee’s responsibilities and duties are divided, cash receipts are deposited the same day, cash payments will be made by check, employees are rotated, only one/two owners sign all checks and authorize payments, all supporting invoices or documents are stamped paid at the time of payment, all checks are prenumbered, and monthly bank statements are reconciled.

Key Concepts: Internal control system, signature card, deposit slip, endorsement, check, drawer, drawee, payee, cancelled check Lecture Outline: 1. Strong internal control procedures are necessary for a business to protect its assets. While cash is the easiest asset to be stolen, lost, or mishandled. All of the business’s assets need to be protected through internal control procedures. These procedures help the business: a. Encourage employees to adhere to company policies. b. Maintain a reliable management information system. c. Provide tools for management to operate the business more efficiently and effectively.

2. Internal control procedures include: a. Separating the duties of employees. b. Depositing cash receipts in the bank the same day the cash arrives. c. Issuing checks for all cash payments except for those using the petty cash account. d. Rotating duties among employees. e. Sign checks after receiving authorization to pay. f. Indicating, on the day of payment, on all supporting invoices the date and number of check issued. g. Prenumbering all checks and periodically accounting for each check. h. Reconciling of all bank statements by someone other than the employees who handle, record, or deposit the cash.

Opening a checking account: 1. Signature card - verify the signature of authorized employees 2. Deposit slip - bank form used to deposit funds:

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3.

4.

5.

6.

7.

8.

9.

a. When completing the form, the depositor lists all checks, coins, and other currency separately. b. When listing checks, include each check along with its American Bankers Association Code (ABA). c. Keep a copy of the deposit slip as a source document for the deposit as well as proof of transaction.

Automated Teller Machines (ATM): machines that accept cards as a form of identifying a specific bank account and are used to deposit, withdraw, or transfer funds.

Check endorsements: the signing or stamping of an authorized name on the back of the check.

Endorsing a check transfers the right for the stated amount of cash to someone else – usually the bank. There are 3 types of endorsements: a. A blank endorsement does not specify who can deposit the check, and the bank will pay the last person who signs the check. b. A full endorsement restricts who can deposit the check to the stated person or firm listed. Only the person or company named in the endorsement can transfer the check to someone else. c. A restrictive endorsement limits the use of the check so it must be deposited in the person or firm’s account.

Debit Cards: allow funds to be taken directly from the checking account to pay for purchases anywhere VISA or MasterCard is accepted.

Payment Processors such as PayPal are an online payment option that can be used to make payments.

Checks are written orders signed by a drawer (the person who writes the check) instructing the drawee (the person or entity that pays the check) to pay a specific sum of money to the payee (the person or entity to whom the check is payable) a. Figure 6.5 shows the various elements of a check and a check stub. b. Check stub is the portion of the check kept by the drawer and records beginning cash balance, any deposits, the balance in the account before issuing the check, the amount of the check, and the ending cash balance.

Bank Statement: Monthly statements sent to the owner of the checking account that reflect all the activity for a period. The statement begins with the beginning balance and lists the deposits received and checks cashed.

Cancelled Checks: checks that have been cashed or paid by the bank.

Teaching Tips/Strategy: Discussion Questions 2 through 5 are excellent to introduce the banking terms and key terminology included on this unit.

Use the “Ten-Minute Quiz” questions 1 and 2 to reinforce Learning Objective 6-1 concepts.

Learning Unit 6-2: The Bank Reconciliation Process Summary: Bank reconciliation is the process of reconciling the bank balance on the bank statement versus the company’s checkbook balance. Bank reconciliations involve several steps, including determining the deposits in transit and the outstanding checks. The cash balance in the business’s records and the cash balance in the bank statement must be reconciled. Typically, the reconciling items are timing differences between when the check was written by the drawer and cashed by the payee or when deposited by the payee and received by the bank. When reconciling the two statements, these timing differences must be identified.

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Key Concepts: Bank reconciliation, bank statement, deposits in transit, outstanding checks, NSF (nonsufficient funds), debit memorandum, credit memorandum, electronic funds transfer (EFT), ATM (automatic teller machine), phishing, check truncation (safekeeping) Lecture Outline: Bank reconciliation items: 1. Deposits in transit are determined by analyzing the bank statement to determine if last month’s deposits in transit were cleared by the bank and which of this month’s deposits were not cleared by the bank. Deposits in Transit are: a. deposits made by the business b. added to the business’s cash balance c. not processed by the bank before the bank statement was prepared.

2. Outstanding checks are: a. the checks written by the business b. are subtracted from the business’s cash balance c. not processed by the bank before the preparation of the bank statement.

3. Service charges are charges from the bank in exchange for the bank performing specific tasks.

The bank reduces these charges from the cash balance while the business does not usually record these charges until it receives notice in the bank statement.

4. Nonsufficient funds (NSF) are checks returned because the account did not have enough money in the account to pay for the check.

5. Other information provided by the bank statement: a. Credit memorandum shows an increase in the depositor’s balance b. Debit memorandum shows a decrease in the depositor’s balance 6. Online banking and computer software have made the bank reconciliation process efficient.

Bank statement reconciliation steps: 1. Prepare a list of deposits in transit.

2. Prepare a list of outstanding checks.

3. Record any bank charges or credits.

4. Compute the cash balance per your books.

5. Enter the bank balance on the reconciliation.

6. Total the deposits in transit.

7. Total the outstanding checks.

8. Compute the balance per the reconciliation. a. The reconciled cash balance per books and reconciled cash balance per bank should equal each other.

Banking Trends: 1. Electronic funds transfers (EFT): cash transfers without the use of paper checks.

2. ATM Machines: use a personal identification number (PIN) to match the card and user in order to authorize transactions from a specified bank account.

3. Mobile Remote Deposit capture (RDC) allows checking account customer to take a picture of a check with a mobile device for transfer to a bank for posting and clearing.

4. Online banking advantages: a. Convenience – never close. b. Availability – available anywhere. c. Transaction speed – is as quick as or faster than ATM processing speeds. d. Efficiency – can access and manage all of your bank accounts from one secure site. e. Effectiveness – tools available to help manage all your assets effectively.

5. The disadvantages to online banking are :

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a. Start-up time – may take time as individuals and businesses need to register for the online program. b. Learning curve – may be slow at first to navigate the banking site. c. Bank site changes – bank site may be updated and add new features in unfamiliar places. d. Trust – learning to trust that the transaction is properly executed.

6. Common banking scams: a. Phishing: customers receive fake emails pretending to be from the bank and attempt to obtain information about the business or the account. b. Skimming: theft of credit card information. Skimming at ATMs can be damaging because of the number of accounts and the amount of money that can be accessed. Tips to help avoid being a skimming victim: i. Keep your PIN safe and do not give it to anyone ii. Watch out for strangers who try to “help” at an ATM. iii. Trust yourself. It the ATM does not look right, do not use it. iv. If the ATM has unusual signage, do not use it. v. If your card is not returned after the transaction or after pressing cancel, immediately contact the institution that issued the card. vi. Check your statement to be sure no unusual withdrawals appear on it.

7. Check Truncation (also called: Safekeeping) – banks do not return cancelled checks to the depositor but instead use a procedure called check truncation. The bank holds a cancelled check for a specific period of time (usually 90 days) and then keeps a microfilm copy handy and destroys the original check.

Teaching Tips/Strategy: Relate the lecture topic with students’ experience with their personal checking accounts. Ask students what the benefits of reconciling are and having an updated balance of the cash account. Discuss challenges while preparing the banking reconciliation such as errors, NSF checks, and outstanding checks. Concept Checks 1, 2 and 3 are excellent to introduce the bank reconciliation concepts and develop steps to complete the bank reconciliation. Finally, explain the importance of reconciling bank accounts. Illustrate the preparation of a bank reconciliation with Exercise 6A-1, Problems 6A-1 and 6A-2. The chapter includes a “Blueprint for Success: A Bank Reconciliation” that provides a list of adjustments made during a bank reconciliation to the checkbook balance and the bank balance.

Use the “Ten-Minute Quiz” question 3, 4 and 5 (bank reconciliation) and 6 and 7 (banking scams) to reinforce the Learning Objective 6-2 concepts.

Learning Unit 6-3: The Establishment of Petty Cash and Change Funds Summary: Sometimes a business needs to make a purchase, and it is not practical or feasible to have a check written. A petty cash fund is a source of cash that allows a business to make these purchases without writing a check.

A change fund is a fund made up of various denominations that is used to make change for customers. This fund is placed in the cash register drawer and used to make change for customers who pay cash.

When the amount of change received or given out is not the proper amount, the amount of cash in the drawer is not the correct amount. The account Cash Short and Over is the account used to reconcile the cash account to the amount in the cash drawer when recording sales for the day.

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Key Concepts: Petty cash fund, petty cash voucher, auxiliary petty cash record, change fund, cash short and over.

Lecture Outline: Petty Cash Fund 1. Petty Cash is an asset reported on the balance sheet. a. Its purpose: To be used for small cash transactions such as postage and small supply purchases.

2. Setting up the petty cash fund: a. Custodian is the person responsible for administering the funds, b. Fund is established by writing a check to the company custodian, having it cashed, and storing the cash in a separate place. c. The journal entry is: debit (Dr.) Petty Cash and credit (Cr.) Cash.

3. Making payments from the petty cash fund (petty cash reimbursement): d. The custodian needs a completed petty cash voucher form when paying petty cash for a specific purpose. e. The petty cash voucher requires certain information: i. voucher number (to ensure all vouchers are accounted for) ii. date iii. person or organization to whom the payment was made iv. reason for the payment v. signature of the person who approved the payment vi. signature of the person who received the payment from petty cash vii. account to which the expense will be charged f. The petty cash vouchers are put into the petty cash box, and the total of cash and amount listed on the vouchers should equal the amount of cash approved for the fund.

4. An auxiliary petty cash record records the voucher information and aids the understanding of petty cash expenditures by keeping track of the amounts spent and why they were spent.

5. Petty cash reimbursement: g. When the amount of cash in the petty cash fund is reduced to a point where it needs to be replenished, a check is written. h. Journal Entry: debit (Dr.) the accounts listed on the petty cash vouchers and credit (Cr.) Cash. i. Cash is added to the petty cash box and the vouchers removed and stamped to indicate that they have been processed.

6. Increase/Decrease petty cash fund: After establishing the account, the account petty cash is not debited or credited unless the balance is increased or decreased.

Change Fund 1. The change fund: a. consists of various denominations of coin and paper currency b. is placed in the cash register drawer c. used to make change for customers who pay cash. d. The journal entry is: debit (Dr.) Change Fund and (Cr.) credit Cash. e. The formula is: Beg. change fund + Cash register total = Cash should have on hand − Counted cash = Shortage or overage of cash

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Cash Short and Over 1. Cash Short and Over: a. is debited when there is a shortage of cash b. cash over occurs when sales amount is smaller than the cash received. c. cash over or credit ending balance is considered other income d. is credited when there is an overage of cash. e. cash short occurs when sales are higher than the cash received. f. cash short or debit ending balance is recorded as miscellaneous expense.

Teaching Tips/Strategy: Discuss a petty cash system and explain how it works. Ask students what their experience has been with petty cash and how internal controls are implemented on the petty cash system.

Review the “petty cash and change fund” with the “Success Coach” LU 6-3 to reinforce the basic unit concepts.

Petty Cash Activity: a group-based activity imitating a “real-life” petty cash management includes a plastic box (petty cash box), “play dollars”, and receipts. The rules are: groups must establish, reconcile, replenish, and manage the petty cash.

Exercises 6A-2, 6A-3, 6A-4, and 6A-5 are excellent for class demos, practice, or homework assignments.

Use the “Ten-Minute Quiz” question 8 and 9 to reinforce the petty cash concepts.

A “change fund group activity” might be beneficial to have a hands-on approach to the concept. Items needed are a “cashier drawer” (box or play register), sales tape, and “play cash”. Replicate the process of reconciling the closing of the drawer and depositing the funds. Leave the cash on hand ending balance in the “change fund drawer”. Supporting documents with sales amounts, cash received, cash shortage/overages, reconciliation, and final journal entries are required.

Use the “Ten-Minute Quiz” question 10 to reinforce the change fund concepts.

Teaching Tips/Strategy: Each chapter contains a “Try It!” at the end of each Learning Unit. The “Try its!” are intended as practice for students and/or as checking of student understanding. There is also a Demonstration Summary Problem with each chapter to provide an overview of all the chapter concepts.

Students can study and review this problem to view how all the chapter concepts fit together.

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Name

Date

Section

CHAPTER 6 TEN-MINUTE QUIZ Circle the letter of the best response.

1. Which endorsement indicates the name of the company or the person to whom the check is to be paid? a. blank endorsement b. full endorsement c. restrictive endorsement d. special endorsement 2. A check is a written order to pay a specific amount to the a. drawer b. drawee c. payee d. supplier 3. Which of the following should not be included in the bank reconciliation? a. outstanding checks at year end b. deposits in transit c. nonsufficient funds d. petty cash receipts 4. When preparing a bank reconciliation, which of the following will not result in a journal entry for the business? a. Deposit in transit b. Bank service charge previously recognized by the business c. Error made by the bank in recording the amount of a check deposited d. Error made by the business in recording the amount of a check deposited 5. When preparing a bank reconciliation, bank service charges are a. added to the balance per bank statement b. deducted from the balance per bank statement c. deducted from the balance per book d. added to the balance per book 6. Which of the following is not an advantage of online banking? a. efficiency b. learning curve c. transaction speed d. availability 7. Emails that pretend to be from the bank and attempt to obtain information is a type of fraud called a. spam b. email fraud c. phishing d. truncation 8. Journal entries using the petty cash fund account a. occur when the vouchers are totaled

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b. occur when the fund is established and the balance changed c. occur each month d. never occur 9. When the petty cash fund is replenished, a. the expenses as described in the vouchers are debited b. cash per checking account is credited c. both a and b d. neither a nor b 10. When the cash drawer is short at the end of the day, a. Cash Short and Over is debited and sales is credited b. Cash Short and Over is debited and cash is credited c. Sales is debited and Cash Short and Over is credited d. Cash is debited and Cash Short and Over is credited

Answer Key to Chapter 6 Quiz 1.

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b c d a c b c b c a

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Chapter 7 Calculating Pay and Recording Payroll Taxes: The Beginning of the Payroll Process Chapter Overview This chapter examines the process of calculating employee pay and payroll taxes. The employees’ pay depends on their status as hourly or salary. Hourly employees need to have their pay computed at their hourly rate plus additional pay for overtime (if applicable), while for salaried employees it is usually a set pay per period. Each employee actually receives net pay or the amount after withholdings for federal income tax, state income tax, and social security tax have been subtracted from their gross earnings. The federal income withholding depends on several factors, most importantly the number of allowances the employee listed on his or her W-4 form. The social security tax actually consists of two parts with different rates. The FICA-OASDI has a rate of 6.2% of the first $142,000 (2021) earned by the employee while the FICA-Medicare has a tax rate of 1.45% for all wages.

The employer maintains all current payroll information in the employee payroll register. The employer also maintains a summary of each employee’s earnings, withholding taxes, net pay, and cumulative earnings during each calendar year in the employee earnings record. In addition to recording information about the employee and the taxes withheld, the employer must pay payroll taxes. The employee and the employer both pay the same amount of FICA taxes, but the employer also pays unemployment taxes.

Learning Objectives After studying Chapter 7, your students should gain proficiency in the following: 1. Calculate Gross Pay, Employee Payroll Tax Deductions for Federal Income Tax Withholding, State Income Tax Withholding, FICA (OASDI, Medicare), and Net Pay. 2. Prepare a Payroll Register and Maintain an Employee Earnings Record.

3. Calculate Employer Taxes for FICA (OASDI, Medicare), FUTA, SUTA, and Workers’ Compensation Insurance.

4. Journalize the Payroll Register, Employer Tax Liability, and Workers’ Compensation Insurance.

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Chapter 7 Assignment Grid Learning Assignment Topic(s) Objective(s) Discussion Questions and Critical Thinking/Ethical Case 1 Fair Labor Standards Act 1 2 Overtime Pay 1 3 W-4 Form 1 4 W-4 Form 1 5 FIT and SIT Withholdings 1 6 Payroll Register 2 7 Taxable Income 1 8 FICA Taxes 1 9 Social Security (OASDI) and Medicare Taxes 1 10 Employer Taxes 3 11 Employee Earnings Record 2 12 Payroll Records 1, 2, 3, 4 13 Social Security (OASDI) and Medicare Taxes 1 14 FUTA 3 15 SUTA 3 16 Workers’ Compensation Insurance 3 17 Ethical Question 1 18 Employer Taxes 3 19 Calendar Year 1 20 Calendar Year 1 Concept Checks 1 Calculating Gross Earnings 1 2 FIT and FICA 1 3 Net Pay 1 4 Payroll Register 2 5 Employer and Employee Taxes 2, 3 6 Account Classifications 4 Exercises (Set A) 7A-1 Gross Wages 1 7A-2 Net Pay 1 7A-3 Employer Tax 3 7A-4 Employer Tax 3 7A-5 Employer Tax 3 7A-6 Employer Tax 3, 4 7A-7 Employer Tax 3, 4 7A-8 Workers’ Compensation 4 Exercises (Set B) 7B-1 Gross Wages 1 7B-2 Net Pay 1 7B-3 Employer Tax 3 7B-4 Employer Tax 3 7B-5 Employer Tax 3 7B-6 Employer Tax 3, 4 7B-7 Employer Tax 3, 4 7B-8 Workers’ Compensation 4 .

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Financial Report Problem Reading the Amazon’s Annual Report/Internet Project

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Keeping It Real Suarez Digital Services

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Assignment Topic(s) Problems (Set A) 7A-1 Gross Earnings 7A-2 Net Pay 7A-3 Payroll Register 7A-4 Payroll Register and Payroll Taxes Problems (Set B) 7B-1 Gross Earnings 7B-2 Net Pay 7B-3 Payroll Register 7B-4 Payroll Register and Payroll Taxes

Learning Unit 7-1: Gross Pay, Employee Payroll Tax Deductions for Federal Income Tax Withholding, State Income Tax Withholding, FICA (OASDI, Medicare), and Net Pay Summary: Businesses need the ability to pay their employees and pay the associated payroll taxes. The accounting process used in payroll is the same for all businesses regardless of size. The accountant that calculates and records each payroll for the company and the following are especially important: • Accountants must be accurate in everything. Any mistake made in working with the payroll may affect both the employee and the company.

• Accountants need to be on time when working on the company’s payroll so that employees get their paychecks as expected and the government receives payroll taxes when due.

• Accountants must at all times obey the appropriate federal, state, and local laws governing payroll matters.

• Accountants should always keep employee data confidential since they are in possession of personal employee information such as pay rates and marital status.

To begin the payroll process, employees are classified as “hourly” or “salaried”. If an employee is an hourly employee, that employee only will be paid for the hours he or she worked. Employees classified as salaried employees receive a fixed dollar amount for the time period worked. Pay periods are defined as daily, weekly, biweekly (every two weeks), semimonthly (twice each month), monthly, quarterly, or annually. A pay period can start on any day of the week and must end after the specified period of time has passed. Gross earnings are calculated by adding the regular earnings for an employee for the period to any overtime earnings the employee has earned for that period. Overtime earnings (one and a half times every hour over 40 worked hours) must be computed according to the Fair Labor Standards Act (Federal Wage and Hour Law). An employer must follow the Fair Labor Standards Act if it is .

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involved in interstate commerce, which is doing business in more than one state. A workweek, according to the law, is a 7-day (or 168-hour) period.

Federal Income Tax Withholdings are taxes that are also called payroll taxes and must be paid by the employees. Employees pay these amounts by having them taken out, or withheld, from their paychecks.

The employer then sends them to the Internal Revenue Service (IRS), state governments, and maybe even local governments so they count against the amount of federal, state, and possible local income taxes that the employees will owe for the year. The amount to withhold is determined by the IRS Form W-4, Employee’s Withholding Allowance Certificate. It is completed by every employee and provides information that will be used to determine the amount of federal income tax (FIT) withholdings.

(Figure 7.1) The W-4 indicates marital status and total number of allowances that the employee claims for federal income tax purposes. The amount of federal income tax that needs to be withheld is listed in a wage bracket table that can be found in the IRS publication called Circular E, or The Employer’s Tax Guide, also known as Publication 15.

Most states also charge their residents an income tax based on the amount of money they earn from their employers. In those states a state income tax (SIT) withholding is necessary. FICA (Federal Insurance Contribution Act) requires employers to withhold tax amounts from employees’ pay and turn them over to the federal government. This tax is divided into two taxes, Social Security (OASDI or The Old Age, Survivors, and Disability Insurance) and Medicare (HI).

Employees have additional amounts withheld from their paychecks such as medical insurance, union dues, retirement plan contributions, or life insurance premiums. The Net Pay is the amount that the employees receive on their paycheck after all these taxes and withholdings have been subtracted from the employee’s gross pay.

Key Concepts: Fair Labor Standards Act (Federal Wage and Hour Law), interstate commerce, pay or payroll period, gross earnings (gross pay), workweek, Form W-4 (Employee’s Withholding Allowance Certificate), allowances (also called exemptions), federal income tax (FIT) withholding, wage bracket table, Circular E, state income tax (SIT) withholding, FICA (Federal Insurance Contributions Act), taxable earnings, calendar year, medical insurance, net pay Lecture Outline: 1. Gross Earnings: a. Employee classification: i. “hourly” where employees are paid based on the number of hours worked. ii. “salary” where employees are paid a fixed dollar amount for the time period.

2. Pay periods: lengths of time by an employer to calculate the amount of an employee’s earnings. a. daily, b. weekly, c. biweekly (every two weeks), d. semimonthly (twice a month), e. monthly, f. quarterly, g. annually.

3. Gross earnings: a. The total amount earned by an employee BEFORE any deductions are applied to reduce the amount that employee finally receives.

4. Fair Labor Standards Act (FLSA): When the company is involved in interstate commerce, then the FLSA is the Federal Wage and Hour Law that a. contains rules stating the minimum hourly rate of pay, .

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b. is the law of overtime (maximum number of hours a worker will work before being paid time and a half), i. Hourly employee should be paid at least one and a half times their regular pay for the hours worked over 40 hours in one workweek – a 7-day or 168-hour period. ii. Workweek can begin on any given day but must end seven days later. c. Has other rules and regulations employers must follow for payroll purposes. d. The amount of pay for an hourly employee can be computed: i. Regular pay + overtime pay, where 1. Regular pay = regular rate × regular hours 2. Overtime pay = regular rate × 1.5 × regular hours. e. Or an alternative computation: i. Extra pay rate = regular rate × .5 ii. Amount of pay = all hours worked × regular rate + (overtime hours worked × extra pay rate) Employee payroll taxes and deductions: a. Federal income tax withholding (FIT): i. amount of income tax the employer withholds from the employee’s gross pay. ii. based on the employee’s gross pay, number of pay periods in the year, and the number of allowances claimed on the employee’s W-4 Form. iii. W-4 is a form filled out by employees which includes: 1. number of allowances claimed, 2. the marital status, etc. b. Circular E is an IRS tax publication of tax tables and is used to determine the amount of FIT to withhold. Employers refer to the wage bracket table (See Fig. 7.2).

State income tax withholdings (SIT): a. amount of state income tax withheld by the employer from the employee’s gross pay. b. states’ withholding amounts are based on the same information that is listed on the employee’s W-4.

Other withholdings can be for: a. county taxes, b. city taxes, c. medical insurance, d. others.

FICA (Federal Insurance Contributions Act of 1935): a. Social Security – OASDI (Old Age, Survivors, and Disability Insurance) i. Social Security (OASDI) rate is 6.2% of the first $142,800 (2021) b. Medicare – HI (Hospital Insurance) i. Medicare (HI) is 1.45% of all earnings (no ceiling) Net Pay: a. Employee’s net pay is the gross pay less the total of FIT, SIT, FICA, and other withholdings.

Teaching Tips/Strategy: Indicate to students that the earning limit and percentages may change on an annual basis. Assist students in researching the new regulations and the annual updates at the Social Security website (www.ssa.gov ) and the Internal Revenue Service website (www.irs.gov) Present the payroll information and discuss all available resources for payroll preparers such as: IRS Circular E (www.irs.gov), Federal Department of Labor (www.dol.gov ), Social Security Administration (www.ssa.gov), and related state regulations. To assess the overtime topic, use Concept Check 1, Exercise 7A-1, and Problem 7A-1. To clarify and apply the FICA and other withholdings, use Concept Checks 2 and 3, Exercise 7A-2, and Problem 7A-2.

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Use the “Ten-Minute Quiz” questions 1, 2, 3, 4 5, 7 and 8 to reinforce the Learning Unit 1 concept.

Learning Unit 7-2: Preparing a Payroll Register and Maintaining an Employee Earnings Record Summary: The register includes each employee’s gross earnings, employee withholdings, net pay, taxable earnings, cumulative earnings, and the accounts charged for the salary and wage expense for that pay period. (See Figure 7.4) After preparing the payroll register for the period, and in order to comply with all applicable employment laws and regulations, a payroll record known as the individual employee earnings record is required. This record provides a summary of each employee’s earnings, withholdings, net pay, and cumulative earnings during each calendar year. (See Figure 7.5) Key Concepts: Payroll register, individual employee earnings record Lecture Outline: 1. The payroll register includes: a. employee names, b. pay period (daily, weekly, biweekly, semimonthly, monthly, quarterly, annually), c. each employee’s gross earnings, d. employee withholding taxes, e. net pay, f. taxable earnings, g. cumulative earnings, h. and the expense accounts to be charged, i. separate hourly and salaried personnel registers, and j. example. (See Figure 7.4) 2. Individual employee earnings record: a. Prepared after the payroll register is completed and is required by law, b. Summarizes the total amount of wages paid, c. Summarizes the deductions per employee for the calendar year, d. Aids in preparing governmental reports. (Quarterly, annually, W-2, etc.), e. Records all earnings and deductions on an annual basis (new record every year), f. Provides a summary of each employee’s earnings, withholding taxes, net pay, and cumulative earnings during each calendar year. (See Figure 7.5) Teaching Tips/Strategy: Review the basic elements of the payroll register and the individual earnings record. Use the Success Coach LU 7-2 to clarify the payroll register and employee earnings record concepts.

As part of the lecture, prepare a full payroll register (Problem 7A-3) and explain the necessary steps to successfully complete a payroll register. To assess the topic, use the Problem 7B-3 as an assessment tool to verify that the concept was learned and retained.

Learning Unit 7-3: Employer Taxes for FICA (OASDI, Medicare), FUTA, SUTA, and Workers’ Compensation Insurance .

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Summary: Employers pay exactly the same amount of Social Security taxes (OASDI and Medicare) for each employee as the employee pays. The employee’s and employer’s OASDI rate is 6.2% each.

Employers also pay unemployment taxes (SUTA and FUTA) that are used to provide unemployed workers with benefits while they are looking for work. Unemployment taxes are paid by employers based on wages paid to employees. Federal Unemployment Tax Act (FUTA) taxes pay the costs of administering the federal and state programs but do not pay benefits to employees. State Unemployment Tax Act (SUTA) taxes pay the benefits to unemployed persons. Employers normally pay FUTA tax at a rate of 6% on wages earned by each employee up to a wage base limit of $7,000 with a tax credit for SUTA tax against this tax up to a maximum credit of 5.4%. That leaves only .6 % (6.0%-5.4%=.6%).

Workers’ compensation insures employees against losses they may incur due to work-caused injury or death while on the job. In most states, this tax is paid completely by the employer, not the employee.

Key Concepts: Federal Unemployment Tax Act (FUTA), State Unemployment Tax Act (SUTA), workers’ compensation insurance, experience, or merit rating Lecture Outline: 1. Employers’ taxes: a. FICA (Federal Insurance Contributions Act of 1937): i. Social Security – OASDI (Old Age. Survivors, and Disability Insurance) and FICA Medicare . ii. Employers’ amount is the same amount as the employees. iii. Deposited every payroll or quarterly. b. FUTA – Federal Unemployment Tax Act (1935): i. Law that requires employer payments for the unemployment insurance portion. ii. FUTA tax rate is 6.0% on gross wages up to a wage base limit of $7,000. iii. Federal government gives a credit for some or all the SUTA paid. iv. Rate is 6.0% for FUTA with a 5.4% normal SUTA tax credit leaving a net FUTA tax rate of .6%. v. FUTA is taxed on employers and not withheld from employees. vi. Paid once a year. c. SUTA – State Unemployment Tax: i. A tax levied by every state to provide income for unemployed workers. ii. Wage base limits vary from state to state but have at least a base rate of $7,000. iii. The wage rate may vary from state to state. iv. Payment frequency depends on the state. d. Workers’ Compensation Insurance: i. Insurance required by the employers to protect their employees against losses due to injury or death incurred while on the job. ii. This insurance is completely paid by the employer (in most states). iii. The rate varies from state to state and business to business based on the type of work employees perform and the amount or extent of on-the-job injuries experienced. iv. The amount is adjusted at the end of the year. v. The premium is based on total estimated payroll. vi. The rate is calculated for each $100 of weekly payroll. vii. It is a prepaid insurance.

Teaching Tips/Strategy: The employer tax responsibilities are a complex subject and difficult for the students to understand. Try using Concept Check 5 and Exercise 7A-3 to explain the employer’s tax .

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liabilities. Encourage the student to share their experiences and opinion on this topic. Explore the different for your state, city, or county in regard to payroll taxes. Request, as an assignment, research on local and federal regulations related to unemployment, union dues, retirement plans, cafeteria plans, and any other employer-sponsored activities. These activities will help the learner relate the chapter to their future or current employment.

Use the Success Coach LU 7-3 and the “Ten-Minute Quiz” questions 6 and 9 to review these concepts.

Learning Unit 7-4: The Payroll Register, Employer Tax Liability, and Workers’ Compensation Insurance Summary: At this point in the payroll process, the accountant has calculated gross earnings, deductions for employee withholdings, and net pay for each of the organization’s employees. The accountant enters these amounts into two accounting records called the payroll register and the employee earnings record.

The accountant also computes the amount of payroll taxes that the employer must pay. The accountant must record these payroll amounts in the accounts of the organization by making journal entries in the general journal and posting these entries to accounts in the general ledger. By entering these amounts into the employer’s accounting system, the organization’s financial statements will include these payroll transactions. All information needed to make these journal entries comes from the hourly and salaried payroll registers. (See Figure 7-4) Workers’ compensation insurance is the insurance paid in advance by an employer to protect its employees against loss due to accidental death or injury incurred during employment. The premium for workers’ compensation insurance is paid at the beginning of the year based on estimated gross payroll for the year.

Key Concepts: Payroll tax expense Lecture Outline: Recording the Payroll - The first journal entry will record the employees’ payroll liability. It uses the payroll register to determine: 1. The gross pay for each payroll expense category (hourly, salary, departmental, etc.)

2. The amounts of deductions owed for payroll taxes: a. FIT Payable b. SIT Payable c. FICA OASDI Payable d. FICA Medicare Payable e. Other various liabilities f. And Wages and Salaries Payable The Journal Entry to record the payroll expense (employee’s payroll or paycheck details) is: Dr. Specific Departmental Expense XXX Cr. FIT Payable XXX Cr. SIT Payable XXX Cr. FICA OASDI Payable XXX Cr. FICA Medicare Payable XXX Cr. Other withholdings payable XXX Cr. Wages and Salaries Payable XXX

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3. The payroll taxes are liabilities from the time the employee earns the salaries and the time the taxes are paid to the taxing authority. These items are the employer’s responsibility and, in most states ONLY the employer pays for those expenses.

4. Recording Payroll Tax Expense: Payroll Tax Expense is the general ledger account that records the total of the employer’s FICA-OASDI, FICA-Medicare, FUTA, and SUTA taxes. a. The employer’s payroll taxes are an added expense for the company and are not part of the payroll expense that records the employee payroll and the employee withholding. b. Tax liabilities are placed in separate liability accounts; because, for the most part, they are paid to different taxing authorities on separate checks.

The journal entry to record the payroll (employer’s ONLY) is: Dr. Payroll Tax Expense XXX Cr. FICA OASDI Payable XXX Cr. FICA Medicare Payable XXX Cr. FUTA Payable XXX Cr. SUTA Payable XXX Teaching Tips/Strategy: Students need to realize that these amounts are liabilities at this point in time.

The salaries payable is a liability from the time the employee earns the salary and the time when they are paid the salary. The student also needs to understand that FIT, SIT, and the employee’s portion of FICA are not expenses to the company.

Differentiate between the employee’s payroll entry and the employer’s tax journal entry. Use excerpts from Problem 7A-4 as examples. Assign students to complete Problem 7B-4.

Use the “Ten-Minute Quiz” questions 6 and 10 to reinforce the Learning Unit 4 concepts.

Teaching Tips/Strategy: Each chapter contains a Try It! at the end of each Learning Unit. The Try its! are intended as practice for students and/or as checking of student understanding. There is also a Demonstration Summary Problem with each chapter to provide an overview of all the chapter concepts.

Students can study and review this problem to view how all the chapter concepts fit together.

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Name

Date

Section

CHAPTER 7 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Tim earns $16 per hour. He worked 47 hours this pay period and receives time-and-a-half for any hours worked over 40 hours per week. His gross pay is: a. $640 b. $752 c. $808 d. $1,128 2.

Employers determine the amount of federal income tax withholdings based on the number of allowances an employee has indicated on form: a. W-2 b. W-3 c. W-4 d. Circular E

3.

Employers determine the amount of withholdings based on the employee's designation of allowances, the number of pay periods, the amount of pay per this pay period, and: a. W-2 b. W-3 c. Form 941 d. IRS Publication 15-T

4

Generally, employers are required to withhold a portion of an employee's wages for all except: a. Federal unemployment tax b. FICA c. Federal income tax d. State income tax

5

Employers may withhold all of the following except: a. Union dues b. FICA c. FUTA d. SIT

6.

Employers incur payroll tax expense for which of the following tax(es)? a. State income tax on employee earnings b. Federal income tax on employee earnings c. Medical insurance tax d. FICA (employer portion)

7.

Which of the following payroll taxes does not have maximum wage base? a. FICA – OASDI b. FICA - Medicare c. FUTA d. SUTA

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8.

Hallie's earnings for the pay period are $5,200. Prior to this, she has earned a total of $125,400.

If the FICA-OASDI rate is 6.2% for the first $142,800 ( 2021 wage base) and the FICAMedicare rate is 1.45%, how much FICA tax should be withheld for this pay period? a. $187.00 b. $397.80 c. $137.70 d. $286.20

9.

Ken's earnings for the pay period are $5,200. Prior to this, he has earned a total of $3,000. If the state unemployment tax is 5.4% of the first $7,000 and the federal unemployment tax is 0.6%, how much is the employer's liability for federal unemployment tax? a. $0 b. $24 c. $32 d. $248

10.

Employers record each employee's gross earnings, employee withholding taxes, net pay, and taxable earnings in: a. The payroll register b. The payroll tax return c. The social security return d. The federal income tax return

Answer Key to Chapter 7 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

c c d a c d b b b a

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Chapter 8 Paying the Payroll, Depositing Payroll Taxes, and Filing the Required Quarterly and Annual Tax Forms: The Conclusion of the Payroll Process Chapter Overview This chapter examines the paying of the payroll, depositing of the payroll taxes, and the filing of the required tax forms. Payroll tax expense is recorded when the employee earns the pay. Payroll tax is debited and wages payable is credited along with the payroll tax liabilities for the employee’s withholdings. These withholdings need to be deposited with an authorized depository or a Federal Reserve Bank. The business must file a Form 941, the Employer’s Quarterly Federal Tax Return, each quarter. At the end of each year, the employer must provide the employee and other agencies a copy of a Form W-2 showing the employee’s annual wages and withholdings at the federal, state, and local level. The employer must also file a Form 940, Employer’s Annual Federal Unemployment Tax Return. This chapter illustrates several forms to familiarize the students with the filing process.

Learning Objectives After studying Chapter 8, your students should gain proficiency in the following: 1. Pay Payroll and Depositing Taxes.

2. Prepare Quarterly Reports for Federal and State Governments.

3. Prepare Annual Reports, Forms W-2, and W-3.

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Chapter 8 Assignment Grid Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Payroll Cash Account 2 Payroll Cash Account 3 Payroll Account 4 Form 941 5 Form 941 6 Form 941 7 W-2 8 Form 940 9 FUTA 10 FUTA 11 W-2 and W-3 12 W-2 and W-3 13 Ethics Concept Checks 1 Journalizing Employer Payroll Taxes 2 Journalizing Employer Payroll Taxes 3 Journalizing Employer Payroll Taxes 4 Employer Payroll Obligations 5 Payroll Account Exercises (Set A) 8A-1 Transfer of Funds to Payroll Account 8A-2 Form 941 8A-3 Form 941 and Payroll Tax Deposits 8A-4 Form 940 8A-5 Form 940 8A-6 W-3 8A-7 Payroll Tax Deposits Exercises (Set B) 8B-1 Transfer of Funds to Payroll Account 8B-2 Form 941 8B-3 Form 941and Payroll Tax Deposits 8B-4 Form 940 8B-5 Form 940 8B-6 W-3 8B-7 Payroll Tax Deposits

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Assignment Topic(s) Problems (Set A) 8A-1 Recording Payroll 8A-2 Form 941 8A-3 Recording Payroll and Form 941 8A-4 Form 940 Problems (Set B) 8B-1 Recording Payroll 8B-2 Form 941 8B-3 Recording Payroll and Form 941 8B-4 Form 940 Financial Report Problem Reading the Amazon’s Annual Report/Internet Project Keeping It Real Suarez Digital Services

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Learning Unit 8-1: Payroll and Depositing Taxes Summary: Most organizations use a special checking account for paying its payroll. This account is called Cash – Payroll Checking and only paychecks are written from this account. A company with a substantial number of employees might want to use an extra account just for payroll for a number of reasons. First, having a separate account just for paychecks provides much better internal control over the funds deposited to pay employees. Also, because only payroll checks are written from this account, it is easier to reconcile it to the bank statement each month and determine whether someone has not cashed his or her paycheck for some reason. Finally, the business can still manage its cash effectively even with this extra bank account. The business simply deposits the total net pay amount in this account and thus has enough money to pay every paycheck without leaving extra in the account that could be used for other purposes. The paychecks from most companies are attached to pay stubs that show the employee’s gross earnings, deductions for employee withholding taxes, and net pay or the amount of pay that they actually receive. Employers withhold these amounts, report them and the related earnings to federal, state, and sometimes local governments, and then turn them over to those levels of government.

For any organization, the process began when the business opened. Every employer must get an Employer Identification Number (EIN) which is like a Social Security Number for businesses. The EIN identifies businesses to the government and is used by an employer when recording and paying payroll and income taxes. To get an EIN, an employer fills out Form SS-4. The form is sent to the IRS which assigns the required number to the business.

As required by law, all employers withhold federal income tax from employees’ paychecks, along with Social Security (OASDI) and Medicare taxes as established by the Federal Insurance Contributions Act (FICA). The Federal Unemployment Tax Act (FUTA) tax is the unemployment tax paid and reported separately that employers pay to the federal government. An organization reports the FIT (Federal Income Tax) and FICA (Federal Insurance Contributions Act) taxes to the federal government on a quarterly basis. For example, the last calendar quarter of the year, which covers October, November, and December is reported by January of the following year.

To comply with federal law, businesses do two things. First, the business must determine when FIT and FICA taxes need to be paid to the federal government and make this payment on time. Second, the business must report these taxes on Form 941, the Employer’s Quarterly Federal Tax Return (Figure 8.4). To determine when payroll taxes are due, for payroll tax deposit purposes, employers are usually classified as either monthly or semiweekly depositors. Though it is rare for a company to owe less than $2,500 in total taxes for the quarter. However, if that does happen, the taxes may be deposited quarterly. A monthly depositor is an employer who has to deposit Form 941 taxes (federal income tax withholdings, OASDI, and Medicare) on the 15th day of the month following the payday(s).

Semiweekly depositors must deposit their Form 941 taxes once or twice each week, depending on when payroll is paid. These classifications last for an entire calendar year, and employers are reevaluated every year. Employers are classified according to the dollar amount of the Form 941 taxes that they have paid in the past.

A banking day is any day that a bank is open to the public for business. Generally, a banking day will end at 2:00 or 3:00 P.M. local time. Banking business transacted after this time is usually considered to be the next day’s business. Saturdays, Sundays, and federal holidays are usually not considered banking days.

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Key Concepts: Employer identification number (EIN), Form SS-4, Form 941 taxes, monthly depositor, semiweekly depositor Lecture Outline: 1. A special payroll checking account is used by most businesses because: a. Checks with a special format and pay stub for payroll information are used. b. It is easier to reconcile the account c. It is used for effective cash management 2. The journal entry to record the payment of payroll is: Dr. Wages & Salaries Payable XXX Cr. Cash – Payroll Checking XXX 3. Paying Taxes: FIT, OASDI, and Medicare are also Form 941 taxes because that is the form used to report these taxes.

4. FICA (Federal Insurance Contributions Act) is part of the Social Security law that requires employees and employers to pay OASDI taxes and Medicare taxes.

5. The business will be classified into one of the following types of payroll tax depositors.

1) Monthly Depositors – a. Makes its payroll tax deposits only once each month for the amount of Form 941 taxes due from the prior month. b. Taxes must be deposited by the 15th day of the month unless that day falls on a Saturday, Sunday, or bank holiday under which case the deposit is made on the next business day.

2) Semi-weekly depositors – a. Business classified as semi-weekly has three banking days to make its payroll tax deposit and can make up to two deposits in one week. b. IRS begins each week on Wednesday and ends each week the following Tuesday.

3) If a business’s payday is Wednesday, Thursday, or Friday, the payroll tax deposit is due the third banking day after Friday (usually the following Wednesday). If the business’s payday is Saturday, Sunday, Monday, or Tuesday, the payroll tax deposit is due on the third banking day after Tuesday (usually Friday).

6. The IRS requires that businesses submit all tax payments via the electronic Funds Tax Payment System (EFTPS).

Teaching Tips/Strategy: Use as classroom discussion the Discussion Questions 3, 4, and 5. Use the Accounting Coach LU 8-1 to assess understanding of payroll deposit requirements. Exercise 8A-2 can be used to illustrate payroll tax deposit due dates.

Use the “Ten-Minute Quiz” questions 2, 5, and 6 to reinforce the Learning Objective 1 concept.

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Learning Unit 8-2: Quarterly Reports for Federal and State Governments Summary: To comply with federal law, businesses do two things. First, the business must determine when FIT and FICA taxes need to be paid to the federal government and make this payment on time.

Second, the business must report these taxes on Form 941, the Employer’s Quarterly Federal Tax Return. (See Figure 8.4) When taxes total more than $1,000 for a calendar year, then employers must complete Form 941, Employer’s Quarterly Federal Tax Return, and submit it to the IRS for every quarter in a calendar year.

State Unemployment Tax Act (SUTA) taxes are paid to the government of the state in which a business is located and are typically due by the end of the month following each calendar quarter.

Employers also usually are required to complete a state unemployment tax report, much like they complete Form 940.

If the total FUTA tax owed for the calendar year is less than $500, an employer must pay the tax to the IRS by the end of January of the next year. If the total amount owed is more than $500, then it is due by the end of the month following the end of the calendar quarter. If the employer is required to make Form 941 tax payments by EFTPS, then it must also deposit FUTA tax by this method. By the end of the year, any of the business employees earning more than the $7,000 wage base limit will require the employer to pay FUTA tax into the federal government. For example, a business with 6 employees will have total FUTA tax calculated as follows: 6 employees × $7,000 FUTA taxable earnings × 0.6% FUTA tax rate = $252.

Key Concepts: Form 941 (Employer’s Quarterly Federal Tax Return), calendar quarter.

Lecture Outline: 1. Completing the Employer’s Quarterly Federal Tax Return, Form 941 1) The business must complete Form 941 for every quarter in the calendar year to report FIT and FICA taxes to the federal government.

2) Forms can be found on www.irs.gov 2. Paying SUTA Taxes. This tax is usually paid only by employers to the state for employee unemployment insurance.

1) The Experience/merit rating is a percentage rate assigned to a business by the state to calculate the unemployment taxes.

2) This rate is based on the employment record of the employer and the amount of contributions paid into the state unemployment fund. The lower the rating, the less tax that must be paid.

3) The tax is paid to the state in which the business is located and is due by the end of the month following the quarter.

3. Paying Federal Unemployment Tax (FUTA) 1) Tax is 0.6% on the first $7,000 of earnings after the normal FUTA tax credit is applied.

2) Federal rate is actually 6.2%, but a credit of 5.4% is normally given to employers who pay their state unemployment tax (SUTA).

3) If the amount owed is less than $500, the tax must be paid by the end of January of the next year.

4) If the amount owed is more than $500, the tax must be paid by the end of the month following the end of the calendar quarter.

5) If the employer is required to make Form 941 tax payments by EFTPS, it must also deposit FUTA tax through the same method.

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Teaching Tips/Strategy: Use Exercise 8A-3 to illustrate completion of Form 941. In addition, you may wish to use Problem 8A-1 as a comprehensive demonstration for Learning Objectives 1 and 2. Then you can assign the students to complete Problem 8B-1.

Use the “Ten-Minute Quiz” questions 1, 2, and 10 to reinforce the Learning Objective 2 concept.

Learning Unit 8-3: Annual Reports, Forms W-2, and W-3 Summary: Businesses must complete Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return, by January 31 of the following year. However, if all taxes owed for the year were deposited by January 31, then the business has until February 10 to file its return. To make sure that corporations make its FUTA deposits on time, the accountant keeps track of the amount of FUTA tax owed. The accountant prepares the worksheet to determine the amount of FUTA taxes that the organization owes for the first quarter of the year.

The Internal Revenue Service requires that each calendar year employers complete a Form W-2, Wage and Tax Statement, a multipart form. The IRS requires every employer to give or mail copies of the Form W-2 to each person who worked for the company in the past year. These forms must be distributed by January 31 of the following year. Employees use the amount on the W-2 form to prepare their income tax returns and calculate the amounts of income tax they owe. They must attach one copy of the form to their federal income tax return, and other copies are attached to any state or local income tax returns that they may be required to file. Note that OASDI wages and taxes are shown separately from the amounts reported for Medicare wages and taxes because of the wage base limit for the OASDI tax that does not apply to the Medicare tax. If an employee stops working for an employer during the year, he or she may ask for a W-2 before the year ends. The employer must provide the W-2 within 30 days of the last paycheck or the date of the request, whichever is later. The employer must also give copies of the W-2s for all employees to the Social Security Administration, state, and local governments, and keep a copy for its own records.

The IRS also require employers to prepare its Form W-3, Transmittal of Wage and Tax Statements, and send this form to the Social Security Administration along with copies of the W-2s for all employees (See Figure 8.6). The Form W-3 reports the total amounts of wages, tips, and compensation paid to employees, the total OASDI and Medicare taxes withheld, and some other information. The information used to complete Form W-3 came from a summary of the individual employee earnings records that the payroll accountant prepared soon after the year ended.

Key Concepts: Form 940 (Employer’s Annual Federal Unemployment Tax Return), Form W-2 (Wage, and Tax Statement), Form W-3 (Transmittal of Wage and Tax Statements).

Lecture Outline: 1. Completing the Employer’s Annual Federal Unemployment (FUTA) Tax Return, Form 940: 1) One version of the form is used by employers at the end of the calendar year to report the amount of unemployment tax due for the year. Generally, an employer with workers in more than one state uses this version of the form. If more than $500 is cumulatively owed in a quarter, it should be paid quarterly, one month after the end of the quarter. Normally, the report is due January 31 after the calendar year, or February 10 if an employer has already made deposits.

2. Form W-2: Wage and Tax Statement (See Figure 8.5).

1) Form is completed by the employer at the end of each calendar year to provide a summary of gross earnings and deductions to each employee.

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2) At least three copies go to the employee, one copy to the IRS, one copy to any state where employee’s income taxes have been withheld, one copy to the Social Security Administration, and one copy into the records of the business.

3. Form W-3: Transmittal of Income and Tax Statements (See Figure 8.6).

1) Form is completed by the employer to verify the number of W-2s and amounts withheld as shown on them.

2) Form is sent to the Social Security Administration data processing center along with copies of each employee’s W-2 forms.

Teaching Tips/Strategy: Use Exercise 8A-5 to illustrate completion of Form 940. Then you can assign the students to complete Exercises 8B-5. This chapter’s “Blueprint for Success” shows an example of a completed IRS Form 941: Employer’s Quarterly Federal Tax Return.

Teaching Tips/Strategy: Each chapter contains a Try It! at the end of each Learning Unit. The Try its! are intended as practice for students and/or as checking of student understanding. There is also a Demonstration Summary Problem with each chapter to provide an overview of all the chapter concepts.

Students can study and review this problem to view how all the chapter concepts fit together.

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Name

Date

Section

CHAPTER 8 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

The Employer's Annual Federal Unemployment Tax Return is called a. Form W-2 b. Form W-3 c. Form W-4 d. Form 940 2.

Form 941 requires the reporting of the following taxes? a. FUTA and FICA b. FICA and FIT c. FICA, FIT, and FUTA d. FICA

3.

The employer becomes liable for payroll taxes when a. the employee earns the wages b. the employee is paid the wages c. the federal tax return is filed d. the payroll tax return is filed

4.

Payroll tax expense is debited to record a. the employee’s FIT b. the employee's portion of FICA c. the employer's portion of FICA d. the employee's FUTA

5.

The total amount of FICA taxes due must be deposited in a. the business's bank account b. with the state social security office c. with the IRS d. an authorized depository

6.

The IRS requires businesses to submit a. all tax payments via the Electronic Funds Tax Payment System b. all tax payments once a year c. some payroll tax payments once a year and others monthly d. submit all tax payments via check using a special voucher

7.

An insurance program that provides benefits to workers who are injured on the job is called a. federal unemployment insurance b. state unemployment insurance c. workers' compensation insurance d. social security

8.

The Employer's Annual Federal Unemployment Tax Return. This shows the annual amount of FUTA tax the employer owes for the year. a. Form 940

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b. Form 941 c. Form W-4 d. Form W-2 9.

The annual report by an employer to each employee showing the employee's wages subject to FICA and federal income taxes along with withholdings for various taxes. a. Form 940 b. Form 941 c. Form W-4 d. Form W-2

10.

The rating assigned to an employer by a state based on the employer's record of employment and unemployment. a. tax rating b. merit rating c. FUTA tax credit d. SUTA tax credit

Answer Key to Chapter 8 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

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d b a c d a c a d b

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Chapter 9 Sales and Cash Receipts in a Perpetual Inventory System Chapter Overview Chapter 9 discusses merchandising companies and their operations. When recording sales, a business credits sales for the total amount and debits either cash or accounts receivable depending on the sale.

Some businesses offer incentives in order to collect the account receivable quickly. A common discount term is 2/10, n/30 which indicates that a customer may take a 2% discount if they pay within 10 days. If the business doesn’t pay within 10 days, it must pay the full amount within 30 days. When making the sale, the business records the sale in the sales journal and posts to the general ledger and the accounts receivable subsidiary ledger. The subsidiary ledger records each individual customer’s accounts receivable, and a schedule of each customer balance, totaled, equals the amount in the controlling account – the accounts receivable balance in the general ledger. The business uses this information to issue a monthly statement to each customer informing the customer of the amount they owe.

In addition to recording sales and sales discounts, businesses also need to collect sales tax. The sales tax collected is paid by the customer and passed from the business to the taxing agency so the tax collected is a liability.

Learning Objectives After studying Chapter 9, your students should gain proficiency in the following: 1. Explain and Journalize Entries for Sales, Sales Discounts, and Sales Returns and Allowances for Transactions for a Perpetual Inventory System.

2. Record to Subsidiary Ledgers and Post to General Ledger Sales Transactions and Returns.

3. Record and Post Cash Receipt Transactions and Prepare a Schedule of Accounts Receivable.

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Chapter 9 Assignment Grid Estimated Time in Minutes

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Discussion Questions and Critical Thinking/Ethical Case 1 Contra-Account 2 Sales Discount Account 3 Contra-Revenue Accounts 4 Discount Period & Credit Period 5 Payment Terms 6 Sales Discount 7 Cost of Goods Sold 8 Recording Discounts 9 Ethical Problem 10 Accounts Receivable & Subsidiary Ledger 11 Accounts Receivable & Subsidiary Ledger 12 Posting Reference 13 Invoice 14 Sales Tax 15 Sales Tax & Sales Discounts 16 Credit Memorandum 17 Ethical Problem Concept Checks 1 Perpetual Inventory 2 Perpetual Inventory Discount 3 Perpetual Inventory Return 4 Perpetual Inventory Freight 5 General Journal 6 Credit Memorandum 7 Journalize Transactions 8 Schedule of Accounts Receivable Exercises (Set A) 9A-1 Perpetual Inventory Transactions 9A-2 Record & Post 9A-3 Perpetual Inventory Transactions 9A-4 Perpetual Inventory Transactions 9A-5 Entries, Postings, Schedule of A/R 9A-6 Sales Tax and Return Exercises (Set B) 9B-1 Perpetual Inventory Transactions 9B-2 Record & Post 9B-3 Perpetual Inventory Transactions 9B-4 Perpetual Inventory Transactions 9B-5 Entries, Postings, Schedule of A/R 9B-6 Sales Tax and Return Problems (Set A) 9A-1 Entries, Postings, Schedule of A/R 9A-2 Entries, Postings, Schedule of A/R 9A-3 Entries, Postings, Schedule of A/R 9A-4 Entries, Postings, Schedule of A/R

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Problems (Set B) 9B-1 Entries, Postings, Schedule of A/R 9B-2 Entries, Postings, Schedule of A/R 9B-3 Entries, Postings, Schedule of A/R 9B-4 Entries, Postings, Schedule of A/R

Assignment Topic(s) Financial Report Problem Reading Amazon’s Annual Report/Internet Project Keeping It Real Suarez Digital Services

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Learning Unit 9-1: Journalizing Transactions for a Perpetual Inventory System Summary: A perpetual inventory system is an inventory system that continually monitors its levels of inventory. The system employs recording units on hand at the beginning of each accounting period, units purchased and sold, and the current balance after each sale or purchase. The Gross Sales are the total amount earned from the cash or credit sale of merchandise to customers. A sales invoice is the bill sent to customers reflecting a credit sale. The sales returns and allowances accounts is a contra-revenue account that records sales price adjustments and allowances granted on merchandise that is defective or has been returned. The sales discounts (2/10, n/30 = 2% discount if paid within 10 days, net or full amount due in 30 days) are price reductions granted to customers for payments made within a specific period of time. The sales discount account is a contra-revenue account that records cash discounts granted to customers for payments made within a specific period of time. Note that the discount period is the time when a discount is granted. The discount period is less time than the credit period, which is the length of time allowed to pay the amount owed on the invoice. Net sales are gross sales less sales returns and allowances and less sales discounts.

The Sales Tax Payable is an account in the general ledger that accumulates the amount of sales tax owed, and the account has a normal credit balance. A Controlling Account-Accounts Receivable is the accounts receivable account in the general ledger after postings are complete. The control account for receivables shows the balance owed to the firm by its customers. This balance of the control account is detailed in the accounts receivable subsidiary ledger which contains the balances owed by each customers to whom the firm has granted credit payment terms. A subsidiary ledger account is opened for each customer, and the customer accounts are arranged, alphabetically, in the accounts receivable subsidiary ledger. Each time an accounts receivable related transaction occurs - such as a sale on credit, a return of goods sold on credit, and payments received from credit customers, the accounts receivable subledger is brought up-to-date.

Key Concepts: Perpetual inventory system, merchandise (inventory), cost of goods sold, discount period, credit period, sales discount account, sales tax payable account.

Lecture Outline: 1. Purchase transactions: a. The entry to purchase inventory on open account:

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Dr. Merchandise Inventory Cr. Accounts Payable b. The entry to purchase equipment on open account: Dr. Equipment Cr. Accounts Payable c. The entry to record purchase discounts on inventory: Dr. Accounts Payable Cr. Merchandise Inventory

XX XX

XX XX XX XX

d. The entry to record cost of freight for purchased inventory: Dr. Merchandise Inventory XX Cr. Cash 2. Sales transactions: a. The entries to record sales on credit and cost of goods sold: Dr. Cash

XX

XX Cr. Sales

Dr. Cost of Goods Sold Cr. Merchandise Inventory

XX XX \XX

b. Sales Returns and Allowances: A contra-revenue account that record returns and defective merchandise. i. The entry to record a return or allowance for merchandise sold on credit: Dr. Sales Returns and Allowances Cr. Accounts Receivable

XX

Dr. Merchandise Inventory Cr. Cost of Goods Sold

XX

XX

XX

c. Sales Discounts are price reductions granted to customers for payments made within a specific period of time. i. The term of the sale, 2/10, n/30, indicates: 1. 2% discount if paid within 10 days (the discount period) of the invoice date, 2. Or the full (net) amount must be paid within 30 days (the credit period). ii. The term n/10, EOM indicates: 1. There is no discount, 2. And the full (net) amount must be paid within 10 days after the End of the Month (the credit period). iii. The journal entry for cash sales with a discount: Dr. Cash (sales less discount taken) Dr. Sales Discount Cr. Sales Revenue

XX XX XX

d. Sales Tax Payable is a liability account to record the sales tax collected that needs to be paid to the state, city, or locality.

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i. State and City sales tax vary from state to state and city to city. In some locations only certain items may be taxed and in other locations there may not be a sales tax at all ii. The sales tax is computed by multiplying the sales tax percentage times the sales price of the item being taxed. iii. The journal entry for sales transactions with sales tax: Dr. Cash or Accounts Receivable XX Cr. Sales Tax Payable (tax rate X sales $ amount) Cr. Sales

XX XX

Teaching Tips/Strategy: Students are comfortable with a merchandising industry. Relate the terminology with a known merchandising businesses (or stores) such as Walmart or Target that your students have visited. For the lecture, use discussion questions 1 through 9. This set of questions will allow the class to start understanding the many types of merchandising terms. You can assign each question to a group, and let the groups present their opinion and response to the class. Concept Checks 1through 4 are excellent for demonstration and practice.

Use the “Ten-Minute Quiz” questions 1, 2, 3, 5, and 6 to reinforce these concepts.

Learning Unit 9-2: Subsidiary Ledgers and General Ledger Sales Transactions and Returns Summary: Merchandise companies are divided in two categories: retailers or wholesalers. The retailers are merchants who buy goods from wholesalers for resale to customers. Wholesales companies are merchants that buy from the manufacturing or supplier and sell inventory to retailers.

A sales invoice is a bill sent to customers indicating the total amount due the company for the sale(s) on credit (See Fig 9.14). The invoice also indicates: the invoice number, the customer’s name and address, the date of the sale, and the credit terms allowed to the customer.

Credit sales are recorded in the general journal and posted to the general ledger. The credit sale amount is also posted to the individual customer’s account in the Accounts Receivable Subsidiary Ledger.

Key Concepts: Wholesalers, sales invoice, accounts receivable subsidiary ledger, subsidiary ledger, controlling account-accounts receivable, credit memorandum.

Lecture Outline: 1. Accounts Receivable Subsidiary Ledgers: a. General ledger balance is supported by a list (subsidiary ledger) of customers owing money. b. A manual system would not be manageable if the business had 1,000 credit customers however, computerized systems such as QuickBooks makes the management and maintenance of subsidiary ledgers easy and efficient. c. A Subsidiary ledger contains a single type of account, such as credit customers. An account is opened for each customer, and the accounts are arranged alphabetically.

2. To clarify the difference in updating the general ledger versus the subsidiary ledger: a. You will post to the general ledger and record to the subsidiary ledger. b. The word post refers to information that is moved from the general journal to the general ledger.

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c. The word record refers to information that is transferred from the general journal into the individual customer’s account in the subsidiary ledger. d. Accounts receivable subsidiary ledger (or any other subsidiary ledger): i. The subsidiary ledger can be in the form of a hardcopy book or file setup. The subsidiary ledger may be part of accounting software such as QuickBooks with the customer accounts stored on either the computer’s hard drive or in the Cloud. ii. The subsidiary ledger can be organized alphabetically based on customers’ names. New customers can be added and inactive customers deleted. iii. The account title Accounts Receivable in the general ledger is called the controlling account—Accounts Receivable because it summarizes or controls the accounts receivable subsidiary ledger. iv. At the end of the month the total of the individual accounts in the accounts receivable ledger will equal the ending balance in Accounts Receivable control account in the general ledger.

3. A credit memorandum is prepared by the seller and: a. Notifies a customer that the amount of the goods returned or the amount allowed for damaged goods has been subtracted (credited) from the customer’s ongoing account with the company. b. The journal entry to record the credit memorandum debits Sales Returns and Allowances and credits Accounts Receivable (in the customer’s subsidiary ledger account).

Teaching Tips/Strategy: Use the Concept Check 6 regarding a credit memorandum. Exercise 9A-5 can be used to demonstrate concepts of this unit.

Use the “Ten-Minute Quiz” questions 4, 8, 9, and 10 to reinforce the Learning Objective 2 concepts.

Learning Unit 9-3: Cash Receipt Transactions and Preparation of Schedule of Accounts Receivable Summary: The schedule of accounts receivable is an alphabetical list of the companies that have an outstanding balance in the accounts receivable subsidiary ledger. This total should be equal to the balance of the Accounts Receivable controlling account in the general ledger at the end of the month.

Key Concepts: Schedule of accounts receivable Lecture Outline: 1. There are only a few transactions where the company receives cash.

Journal Entries are: 1. Owner investment in the business: Dr. Cash Cr. Owner, Capital

XX XX

2. Cash merchandise sale in a perpetual inventory system: Dr. Cash XX Cr. Sales XX Dr. Cost of Goods Sold Cr. Inventory

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XX XX

3. Collection of accounts receivable from prior credit sale (with a sales discount. If there is no discount, the journal entry omits the sales discount account.): Dr. Cash Dr. Sales Discount Cr. Accounts Receivable

XX XX XX

4. Cash sales with of assets other than inventory (for example, equipment): Dr. Cash Cr. Store Equipment

XX XX

Teaching Tips/Strategy: As a classroom demonstration, complete all required journal entries using Exercise 9A-5. Use Problems 9A-2, 9A-3, and 9A-4 to assess the understanding of the required entries.

Teaching Tips/Strategy: Each chapter contains a Try It! at the end of each Learning Unit. The Try its! are intended as practice for students and/or as checking of student understanding. There is also a Demonstration Summary Problem with each chapter to provide an overview of all the chapter concepts.

Students can study and review this problem to view how all the chapter concepts fit together.

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Name

Date

Section

CHAPTER 9 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Sales Discounts is a: a. Revenue account b. Expense account c. Contra-Revenue account d. Contra-Expense account 2.

A business sells goods for $400 with terms 2/10, n/30 on July 15. How much cash will the business receive if they receive payment on July 24? a. $268 b. $368 c. $392 d. $400

3.

A business sells goods for $500 with terms 2/10, n/30 on July 5. What is the sales discount if they receive payment on July 25? a. $0 b. $5 c. $25 d. $30

4.

If a business sells merchandise for $230 and later issues the customer a credit memorandum for $33 dollars, the customer's account receivable balance is: a. $33 b. $197 c. $230 d. $263

5.

A company collects sales tax of 5% on cash sales of $300, the journal entry is: a. Cash $300 Sales $300 b. Cash $300 Sales $285 Sales Tax Payable $15 c. Cash Sales

$315 $315

d. Cash $315 Sales $300 Sales Tax Payable $15 6.

The amount of sales tax collected is a: a. liability to the business collecting the tax b. expense to the business collecting the tax c. revenue to the business collecting the tax

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d. profit to the business collecting the tax 7.

A business makes a sale on account and the customer returns the item. When recording the return, the business issues a: a. sales invoice b. sales credit c. credit memorandum d. debit memorandum

8.

The total of the accounts receivable subsidiary ledger should equal: a. the sales on account for the month less the cash received from the credit customers b. the sales on account less the sales discounts taken c. the sales on account less the sales returns and allowances d. the sales on account less the discounts and returns and allowances taken less the cash received from the credit customers

9.

The entries in the sales journal must also be recorded separately to: a. the accounts receivable general ledger account b. the accounts receivable subsidiary ledger accounts c. the accounts receivable controlling account d. the sales account

10.

A single summarizing account in the general ledger, summarizing all the accounts in a subsidiary ledger such as accounts receivable, is referred to as a: a. summary account b. contra-account c. general account d. controlling account

Answer Key to Chapter 9 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

c c a b d a c d b d

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Chapter 10 Purchases and Cash Payments in a Perpetual Inventory System Chapter Overview This chapter looks at a buyer’s view of a merchandise company and pays special attention to the way transactions are recorded in a perpetual inventory system. In a perpetual inventory system, purchases of merchandise inventory are recorded by debiting merchandise inventory and crediting accounts payable. The purchaser records purchases at cost and uses merchandise inventory to record any returns or allowances for damaged or unacceptable goods. A debit memorandum is issued by the buyer to inform the seller that the purchaser has debited accounts payable to reduce the amount that it will pay the seller. The purchaser also uses the merchandise inventory account when paying for any goods within the discount period to record any discounts. When that inventory is sold, there are two entries: one to record the cost of goods sold and another one to recognize the sales revenue.

Businesses use the accounts payable subsidiary ledger in a manner similar to the accounts receivable subsidiary ledger. The subsidiary ledger is used to create a schedule of accounts payable and tie the total dollar amounts of the account balances in the accounts payable subsidiary ledger to the controlling account – accounts payable.

Learning Objectives After studying Chapter 10, your students should gain proficiency in the following: 1. Journalize, Record and Post Purchase Transactions Using the Perpetual Inventory Method.

2. Journalize, Record, and Post Cash Payments Transactions and Prepare a Schedule of Accounts Payable.

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Chapter 10 Assignment Grid Estimated Time in Minutes

Level of Difficulty

5 5 5 5 5 5 5 5 5 5 5 5 5 5

Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Medium Easy

10 10 10 10 10

Medium Easy Easy Easy Easy

15 15 20 10 10

Easy Easy Medium Easy Easy

Learning Objective(s) 1 1 2 2 1

Estimated Time in Minutes 15 15 20 10 10

Level of Difficulty Easy Easy Medium Easy Easy

1 1, 2 1, 2 1, 2

30 45 45 40

Medium Medium Medium Hard

Learning Assignment Topic(s) Objective(s) Discussion Questions and Critical Thinking/Ethical Case 1 F.O.B. 1 2 Merchandise Inventory 1 3 Cost of Goods Sold 1 4 F.O.B. 1 5 F.O.B. 1 6 Accounts Payable Subsidiary Ledger 2 7 Controlling for Accounts Payable 2 8 Purchase Requisition & Purchase Order 1 9 Invoice 1 10 Merchandise Inventory & Equipment 1 11 Debit Memorandum 1 12 Cost of Goods Sold 1 13 Purchase Discounts 1 14 Ethical Case 1 Concept Checks 1 Journalizing Transactions 1, 2 2 Schedule of Accounts Payable 2 3 Perpetual Inventory Discount 1 4 Perpetual Inventory Return 2 5 Perpetual Inventory Freight 2 Exercises (Set A) 10A-1 Record & Post Transactions 1 10A-2 Merchandise Return 1 10A-3 Purchase Discounts 2 10A-4 Schedule of Accounts Payable 2 10A-5 Purchase Merchandise 1 Exercises (Set B)

Assignment Topic(s) 10B-1 Record & Post Transactions 10B-2 Merchandise Return 10B-3 Purchase Discounts 10B-4 Schedule of Accounts Payable 10B-5 Purchase Merchandise Problems (Set A) 10A-1 Merchandising Transactions 10A-2 Merchandising Transactions 10A-3 Transactions, Schedule of A/P 10A-4 Merchandising Transactions Problems (Set B) .

10-2

10B-1 10B-2 10B-3 10B-4

Merchandising Transactions Merchandising Transactions Transactions, Schedule of A/P Merchandising Transactions

1 1, 2 1, 2 4

30 45 45 40

Medium Medium Medium Hard

Financial Report Problem Reading Amazon’s Annual Report/Internet Project

1

15

Medium

Keeping It Real Suarez Digital Services

1, 2

60

Hard

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Learning Unit 10-1: Journalize, Record, and Post Purchase Transactions Using the Perpetual Inventory Method Summary: If the seller is responsible for paying the shipping cost until the goods reach their destination, the freight charges are F.O.B. destination (F.O.B. stands for “free on board” the freight carrier). If goods are shipped by the seller F.O.B. destination, title will change when goods have reached their destination point. If the buyer is responsible for paying the shipping costs, the freight charges are F.O.B. shipping point. When the seller ships goods F.O.B. shipping point, the legal ownership (title) passes to the buyer when the goods are shipped. In this situation, the seller will sometimes prepay the freight charges as a matter of convenience and will add these freight charges to the invoice of the purchaser. Purchases discounts are not taken on freight.

A purchase requisition is a form used within a business by the requesting department asking the purchasing department of the business to buy specific goods. The purchase order (P.O.) is a form used in business to place an order for the buying of goods from a seller. The purchase invoice is the seller’s sales invoice, which is sent to the purchaser.

A receiving report is a business form used to notify the appropriate people of the ordered goods received along with the quantities and specific condition of the goods. The invoice approval form is used by the accounting department in checking the invoice, including comparing the purchase invoice to the purchase order, and finally approving purchase invoice for recording and payment.

Accounts payable is the controlling account in the general ledger. At the end of the month, the sum of the individual amounts owed to the creditors should equal the balance in accounts payable at the end of the month. An accounts payable subsidiary ledger is a book or file that contains, in alphabetical order, the name of the creditor and amount owed from purchases on open account.

A debit memorandum is a document issued by a customer (buyer to a seller.) It indicates that a return or allowance has occurred. The effect of a debit memo is to reduce accounts payable, while the affected accounts in the seller’s books accounts include sales returns and allowances and accounts receivable. A debit memorandum is a memo issued by a purchaser to a seller, indicating that some purchase returns and allowances have occurred; and, therefore, the purchaser now owes less money on account.

Key Concepts: F.O.B. destination, F.O.B. shipping point, purchase requisition, purchase order, purchase invoice, receiving report, invoice approval form, accounts payable subsidiary ledger, debit memorandum.

Lecture Outline: 1. Freight charges are a cost of purchasing inventory. Freight costs are recorded as a debit to merchandise inventory. a. F.O.B. (Free on Board) Destination indicates that the seller pays the freight, and ownership and the sale occurs when the goods are received by the buyer or the purchaser. b. F.O.B Shipping point indicates that the purchaser pays the freight, and ownership and the sale occurs when the goods are shipped. c. Purchase discounts are not taken by the purchaser on freight charges.

2. The purchasing process: a. Prepare a purchase requisition - a form used within a business by the requesting department asking the purchasing department of the business to buy specific goods. b. Purchasing Department prepares a purchase order - a form used in business to place an order for the buying of goods from a seller. (See Figure 10.2) c. Sales invoice prepared by the seller. This is called a purchase invoice to the purchaser. (See Figure 10.3) .

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d. Receive the goods and prepare a receiving report - a report used to notify the appropriate people of the ordered goods received along with the quantities and specific condition of the goods. e. Verify the numbers and approve invoice using an invoice approval form – a form used by the accounting department in checking the invoice including comparing the invoice to the purchase order, and finally approving it for recording and payment. (See Figure 10.4) f. Merchandise inventory account is used to record freight charges for merchandise. g. Purchases of merchandise inventory are almost always for credit and are recorded in the general journal and posted to the general ledger. The credit purchase amount is also recorded to the individual supplier’s account in the accounts payable subsidiary ledger. h. The accounts payable account balance in the general ledger is the controlling account because it has all of the individual supplier’s accounts payable balances included in its balance. i. The individual creditors have their own account within the accounts payable subsidiary ledger.

(See Figure 10.6) i. These accounts represent the amount the business owes to each creditor. ii. The accounts are listed in alphabetical order. iii. The total of the subsidiary ledger equals the balance in the controlling account in the general ledger. iv. Maintaining the subsidiary ledger requires proper posting and recording of purchase transactions. Check marks are placed in the post reference column to show the transactions have been posted to the subsidiary ledger. j. A debit memorandum is a piece of paper issued by a customer to a seller indicating a return or allowance has occurred. (See Figure 10.9) Teaching Tips/Strategy: Use the Success Coach LU 10-2 to clarify the concepts of purchases, purchases returns and other calculations involving merchandise inventory. Use discussion questions 1 through 5 and 8 through 11 to discuss critical terms related to merchandise inventory transactions. Demonstrate Exercise 10A-2 in class and assign Exercise 10A-2 to reinforce the concepts presented in the objectives.

Use the “Ten-Minute Quiz” questions 1 through 8 and 10 to reinforce objective concepts.

Learning Unit 10-2: Journalize, Record, and Post Cash Payments Transactions and Prepare a Schedule of Accounts Payable.

Summary: All payments for purchases of cash (check) are recorded in the general journal. At the end of the month, the schedule of accounts payable, a list of ending account balances owed to individual suppliers or creditors, should equal the ending balance in accounts payable, the controlling account in the general ledger.

Now let’s prove that the sum of the accounts payable subsidiary ledger at the end of the month is equal to the controlling account, accounts payable, at the end of the month. To do so, creditors with an ending balance in the accounts payable subsidiary ledger must be listed in the schedule of accounts payable (Figure 10.13). At the end of the month, the total owed in accounts payable, the controlling account in the general ledger, should equal the sum owed the individual creditors that are listed on the schedule of accounts payable. If it does not, the journalizing, posting, and recording must be checked to ensure that they are complete and accurate. Also, the balances of each creditor account should be checked.

Key Concepts: Controlling account

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Lecture Outline: 1. Controlling account is the account in the general ledger that summarizes or controls a subsidiary ledger. (Example: The accounts payable account in the general ledger is the controlling account for the total balances in the accounts payable subsidiary ledger.) a. After postings are complete, the controlling account equals the sum of all the totals in the related subsidiary ledger.

2. With cash payment transactions, cash will be credited. Any discount taken will also be credited while other accounts will be debited. (See Figure 10.12 for examples of cash payments transactions.)

Teaching Tips/Strategy: Use the Success Coach LU 10-2 to clarify the concepts involving cash payments transactions and schedules of accounts payable. Use discussion question 6 and 7 to discuss critical terms related to accounts payable and schedules of accounts payable. Use the Concept Checks 2 through 4 to practice, and assign Exercises 10A-3,10A-4, and 10A-5 to reinforce the concepts presented in the objective.

Use the “Ten-Minute Quiz” question 9 to reinforce objective concepts.

Teaching Tips/Strategy: Each chapter contains a Try It! at the end of each Learning Unit. The Try its! are intended as practice for students and/or as checking of student understanding. There is also a Demonstration Summary Problem with each chapter to provide an overview of all the chapter concepts. Students can study and review this problem to view how all the chapter concepts fit together.

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Name

Date

Section

CHAPTER 10 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

If a business buys goods for $350 and later issues a debit memorandum for $25, the amount it owes the seller is: a. $325 b. $350 c. $375 d. $400 2.

F.O.B. Shipping Point indicates: a. The buyer is paying for freight, and the sale takes place when the goods are delivered. b. The seller is paying for freight, and the sale takes place when the goods are shipped. c. The buyer is paying for freight, and the sale takes place when the goods are shipped. d. The seller is paying for freight, and the sale takes place when the goods are delivered.

3.

F.O.B. Destination indicates: a. The buyer is paying for freight, and the sale takes place when the goods are delivered. b. The seller is paying for freight, and the sale takes place when the goods are shipped. c. The buyer is paying for freight, and the sale takes place when the goods are shipped. d. The seller is paying for freight, and the sale takes place when the goods are delivered.

4.

A business form that indicates a departments' request to purchase supplies is: a. A purchase requisition b. A purchase order c. A receiving report d. A check request

5.

A business form that indicates a departments' approval to purchase supplies is: a. A purchase requisition b. A purchase order c. A receiving report d. A check request

6.

The account used to record the cost of freight by the purchaser on merchandise purchased is: a. Merchandise inventory b. Cost of goods sold c. Freight-in d. Freight-out

7.

A company purchased goods but found they were defective and returned them. The company would record the return as: a. A purchase return b. A purchase discount c. A sales return d. A sales discount

8.

Purchase discounts are calculated based on: .

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a. b. c. d.

Cost of purchase Cost of purchase less any returns and allowances Cost of purchases less returns and allowances plus freight-in Cost of purchases less freight-in

9.

When a business returns goods to the seller, they need to debit: a. The merchandise inventory account b. The subsidiary ledger for that supplier c. Accounts payable and the subsidiary ledger for that supplier d. The merchandise inventory account and the accounts payable account.

10.

Gross profit is calculated by: a. Revenue less operating income b. Operating income less cost of goods sold c. Cost of goods sold less freight-in d. Revenue less cost of goods sold

Answer Key to Chapter 10 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

a c d a b d a b c d

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Chapter 11 Preparing a Worksheet for a Merchandise Company Using the Perpetual Method Chapter Overview This chapter explains how to adjust the value of the inventory on hand to the value of the inventory on the balance sheet and prepare a worksheet for a merchandising company using a perpetual inventory system.

In a perpetual inventory system, the balance of inventory on hand is continually, or perpetually, updated every time that there is a transaction that affects the Merchandise Inventory account. A perpetual system keeps continual track of each type of inventory item by recording units on hand at the beginning, units sold, and the current balance after each purchase or sale.

The appendix at the end of the chapter 12 illustrates worksheets for a periodic inventory system. A periodic inventory system only adjusts inventory at the end of the accounting period and calculates the cost of the unsold goods on hand by taking the cost of each unit on hand times the number of units of each product on hand.

Learning Objectives After studying Chapter 11, your students should gain proficiency in the following: 1. Figuring Adjustments for Merchandise Inventory using the Perpetual Method, Unearned Rent, Supplies Used, Insurance Expired, Depreciation Expense, and Salaries Accrued.

2. Preparing a Worksheet for a Merchandise Company.

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Chapter 11 Assignment Grid Estimated Time in Minutes

Level of Difficulty

1 1 1 1 1 2 1

5 5 5 5 5 5 5

Easy Easy Easy Easy Easy Easy Easy

1 1 2 1

10 15 10 10

Easy Easy Easy Easy

1 1 1 2

10 15 10 20

Easy Easy Easy Medium

1 1 1 2

10 15 10 20

Easy Easy Easy Medium

1 1, 2 1, 2 1, 2

30 60 60 60

Medium Medium Medium Medium

1 1, 2 1, 2 1, 2

30 60 60 60

Medium Medium Medium Medium

Financial Report Problem Reading Amazon’s Annual Report/Internet Project

1

10

Easy

Keeping It Real Suarez Digital Services

1, 2

60

Hard

Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Merchandise Inventory 2 Perpetual Inventory 3 Periodic Inventory 4 Unearned Revenue 5 Inventory Physical Count 6 Unearned Revenue 7 Ethical Issue - Petty Cash Concept Checks 1 Adjustment for Merchandise Inventory 2 Adjustment for Unearned Fees 3 Worksheet 4 Merchandise Inventory Adjustment Exercises (Set A) 11A-1 Normal Account Balances 11A-2 Income Statement Computations 11A-3 Transaction Analysis 11A-5 Worksheet Preparation Exercises (Set B) 11B-1 Normal Account Balances 11B-2 Income Statement Computations 11B-3 Transaction Analysis 11B-5 Worksheet Preparation Problems (Set A) 11A-1 Income Statement Computations 11A-2 Worksheet 11A-3 Worksheet 11A-4 Worksheet Problems (Set B) 11B-1 Income Statement Computations 11B-2 Worksheet 11B-3 Worksheet 11B-4 Worksheet

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Learning Unit 11-1: Adjustments for Merchandise Inventory Using the Perpetual Method, Unearned Rent, Supplies Used, Insurance Expired, Depreciation Expense, and Salaries Accrued Summary: The Merchandise Inventory account shows the goods that a merchandise company has available to sell to customers. Companies have several ways to keep track of the cost of goods sold (the total cost of the goods sold to customers) and the quantity of inventory on hand. The two systems are the periodic inventory system and perpetual inventory system. The perpetual inventory system is an inventory system that keeps continual track of each type of inventory unit by recording units on hand at the beginning, units sold, and the current balance after each sale or purchase.

Key Concepts: Cost of goods sold, perpetual inventory system, beginning merchandise inventory (beginning inventory).

Lecture Outline: Adjustments for merchandise inventory: Businesses can choose either to track the cost of goods sold using a perpetual inventory system or a periodic inventory system: 1. Perpetual inventory system continually updates the balance of inventory on hand.

2. Adjusting entries to update the value of the inventory to the value of the inventory actually on hand: a. Adjusting journal entry for inventory shrinkage: Dr. Cost of Goods Sold XX Cr. Merchandise Inventory

XX

b. Adjusting journal entry to record more inventory on hand than in the Merchandise Inventory account: Dr. Merchandise Inventory XX Cr. Cost of Goods Sold

XX

3. Adjusting entries are required when rent is received in advance of earning the rent. Unearned Rent is a liability account which is used to record rent received in advance. When rent is earned, then the amount earned needs to be credited to Rent Revenue and debited to Unearned Rent.

Teaching Tips/Strategy: Use the Success Coach LU 11-1 to discuss the key concepts of this unit. For class demonstration use Concept Checks 1, 2, and 4, Exercises 11A-1, 11A-2, and 11A-3. To fully assess the understanding and mastery of this unit, assign Problem 11A-1.

Use the “10-Minute Quiz” questions 2 and 3 to reinforce concepts.

Learning Unit 11-2: Worksheets for Merchandise Companies Using the Perpetual Inventory Method Summary: In this unit we prepare a worksheet for Art’s Wholesale Clothing Company. For convenience, we reproduce the company’s chart of accounts in Figure 11.3, and Figure 11.4 which shows the trial

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balance that was prepared from Art’s Wholesale ledger. In looking at the trial balance, we see many new titles that did not appear in the trial balance which we completed for a service company in Chapter 5.

Examples are mortgage payable, interest expense, and unearned revenue. Mortgage Payable is a liability account that records the increases and decreases in the amount of debt owed on a mortgage.

Interest Expense is a non-operating expense categorized as Other Expense. Unearned Revenue is a liability account that records receipt of payment for goods and services in advance of delivery. Unearned rent is a particular example of this general type of account.

Key Concepts: Mortgage payable, interest expense, unearned revenue.

Lecture Outline: A worksheet similar to the one used for service businesses is completed.

1. The initial balances from the general ledger are entered into the columns of the trial balance section of the worksheet.

2. Similar to the adjusting entries for a service business, adjusting entries are calculated to represent the changes during the period. Common adjustments involve supplies, insurance, depreciation, accrued wages (and salaries) interest expense and unearned revenue. a. Interest expense – the cost of borrowing money. Businesses making loan payments pay a portion of the amount borrowed (principal) and the interest charged by the institution from which they borrowed the funds.

The journal entry to record accrued interest is: Dr. Interest Expense XX Cr. Interest Payable

XX

b. Unearned revenue – a liability account that records the amount owed for goods and services received in advance of delivery of those services. When cash is received, cash is debited and the liability “unearned” is credited.

The journal entry when cash is received for rent paid in advance is: Dr. Cash Cr. Unearned Rent

XX XX

The journal adjusting entry for the portion of the rent earned during the year: Dr. Unearned Rent Cr. Rent Revenue (Earned)

XX XX

c. The journal entry to adjust the supplies account ending balance to actual supplies on hand at the end of period is: Dr. Supplies expense XX Cr. Supplies (asset account)

XX

d. The journal entry needed when insurance expires during the year is: Dr. Insurance expense XX Cr. Prepaid insurance

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XX

e. The adjusting entry to reflect the depreciation expense for the accounting period is: Dr. Depreciation expense XX Cr. Accumulated depreciation f.

XX

The adjusting entry for salaries accrued (employees work earned but not paid) since the last payment of salaries is: Dr. Salaries expense XX Cr. Salaries payable

XX

The next step in the worksheet is to fill out the balance sheet and income statement columns. After adjusting the merchandise inventory accounts, the ending inventory balance is carried to the balance sheet column in the worksheet.

Teaching Tips/Strategy: Use the Success Coach LU 11-2 to discuss the key concepts regarding the worksheet. As a group-based activity, assign Exercises 11A-4 and 11B-4. Then regroup students to grade or peer review each other’s worksheet. The peer review will consist of a list of the items completed correctly and common items with which the students have challenges.

Use the “Ten-Minute Quiz” questions 1, 4, 5, 6, 7, 8, 9 and 10 to reinforce the concepts.

The “Blueprint for Success” shows how the amounts in the Adjusted Trial Balance columns of a worksheet for a merchandise company are added to the Income Statement column and the Balance Sheet columns.

Name

Date

Section

CHAPTER 11 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

If supplies of $800 are showing as the balance in the supplies account and $300 of supplies have been used during the period, what is the adjusting entry? a. debit supplies and credit supplies expense for $300 b. debit supplies expense and credit supplies for $300 c. debit supplies and credit supplies expense for $500 d. debit supplies expense and credit supplies for $500 2.

The adjusting entry to record inventory shrinkage: a. debits merchandise inventory and credits cost of goods sold b. debits cost of goods sold and credits merchandise inventory c. debits merchandise inventory and credits sales

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d. debits sales and credits merchandise inventory 3.

The adjusting entry to increases in inventory value when actual inventory on hand is greater than inventory on balance sheet: a. debits merchandise inventory and credits cost of goods sold b. debits cost of goods sold and credits merchandise inventory c. debits merchandise inventory and credits sales d. debits sales and credits merchandise inventory

4.

If supplies of $800 are showing as the balance in the supplies account and the physical count of supplies shows $300 on hand, what is the adjusting entry? a. debit supplies and credit supplies expense for $300 b. debit supplies expense and credit supplies for $300 c. debit supplies and credit supplies expense for $500 d. debit supplies expense and credit supplies for $500

5.

If 6 months of rent totaling $6,000 was received 4 months ago, what is the adjusting entry? a. debit unearned rent and credit rent revenue for $2,000 b. debit rent revenue and credit unearned rent for $2,000 c. debit unearned rent and credit rent revenue for $4,000 d. debit rent revenue and credit unearned rent for $4,000

6.

If $5,300 of insurance was prepaid and $2,700 has expired, what is the adjusting entry? a. debit insurance expense and credit prepaid insurance for $2,600 b. debit prepaid insurance and credit insurance expense for $2,600 c. debit insurance expense and credit prepaid insurance for $2,700 d. debit prepaid insurance and credit insurance expense for $2,700

7.

What is the entry to record $1,300 of depreciation for the year? a. debit depreciation expense and credit prepaid depreciation b. debit depreciation expense and credit accumulated depreciation c. debit prepaid depreciation and credit depreciation expense d. debit accumulated depreciation and credit prepaid depreciation

8.

What is the adjusting entry to record salaries accrued of $770? a. debit salaries payable and credit salaries expense b. debit salaries payable and credit accrued salaries c. debit salaries expense and credit prepaid salaries d. debit salaries expense and credit salaries payable

9.

When completing the worksheet: a. ending inventory is carried to the balance sheet columns b. ending inventory is carried to the income statement columns c. beginning inventory is carried to the balance sheet columns d. beginning inventory is carried to the income statement columns

10.

When completing the worksheet: a. net income is added to the debit column of the balance sheet b. net income is added to the credit column of the balance sheet c. net income does not appear on the worksheet d. net income is added to the credit column of the income statement

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11-6

Answer Key to Chapter 11 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

b b a d c c b d a b

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11-7

Chapter 12 Completion of the Accounting Cycle for a Merchandise Company Using the Perpetual Inventory Method Chapter Overview This chapter contains a review of the worksheet and how it is used to prepare financial statements for a merchandising company. The income statement for a merchandising company is expanded to include: cost of goods sold, gross profit, operating expenses, and other income and/or expenses in arriving at net income. The amount of net income or loss is carried to the statement of owner’s equity and the ending balance in owner’s equity is carried to the balance sheet. The balance sheet is also expanded to include several classifications: current assets, plant and equipment, and current liabilities.

Similar to service organizations, the worksheet is prepared, adjusting journal entries are completed and posted, and certain accounts in the general ledger are closed for the accounting period. After the closing entries are prepared and posted, a post-closing trial balance is prepared.

Some businesses use reversing entries as a way of handling adjusting entries. Reversing entries help to reduce errors and simplify the recordkeeping process by allowing for routine entries to be made throughout the year instead of being concerned with the adjusting entry made in the prior year.

Learning Objectives After studying Chapter 12, your students should gain proficiency in the following: 1. Prepare Financial Statements for a Merchandise Company Using the Perpetual Inventory Method.

2. Complete Adjusting Entries, Closing Entries, and a Post-Closing Trial Balance for a Merchandise Company.

3. Complete Reversing Entries.

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12-1

Chapter 12 Assignment Grid Estimated Time in Minutes

Level of Difficulty

1 1 1 1 1 2 2 2 3 1

5 5 5 5 5 5 5 5 5 10

Easy Easy Easy Easy Easy Easy Easy Easy Easy Medium

1 1 1 3

5 10 15 10

Easy Easy Easy Easy

1 2 1 2, 3

10 10 15 30

Easy Easy Easy Medium

1 2 1 2, 3

10 10 15 30

Easy Easy Easy Medium

40 90 90

Medium Medium Medium

150

Hard

40 40 90

Medium Medium Medium

150

Hard

5

Easy

Learning Objective(s)

Assignment Topic(s)

Discussion, Questions and Critical Thinking/Ethical Case 1 Worksheet 2 Net Sales 3 Operating Expense Categories 4 Asset Classification 5 Operating Cycle 6 Adjusting Entries 7 Closing Steps - Merchandiser 8 Temporary Accounts 9 Reversing Entries 10 Ethics Concept Checks 1 Calculate Net Sales 2 Calculate Gross Profit & Net Income 3 Classification of Accounts 4 Reversing Entries Exercises (Set A) 12A-1 Account Classification 12A-2 Closing Entries 12A-3 Classified Balance Sheet 12A-4 Adjusting/Reversing Entries Exercises (Set B) 12B-1 Account Classification 12B-2 Closing Entries 12B-3 Classified Balance Sheet 12B-4 Adjusting/Reversing Entries

Problems (Set A) 12A-1 Income Statement 1 12A-2 Statement of Owners’ Equity/Balance Sheet 1 12A-3 Worksheet & Financial Statements 1, 2 12A-4 Worksheet, Financial Statements, & Reversing Entries 1, 2, 3 Problems (Set B) 12B-1 Income Statement 1 12B-2 Statement of Owners’ Equity/Balance Sheet 1 12B-3 Worksheet & Financial Statements 1, 2 12B-4 Worksheet, Financial Statements, & Reversing Entries 1, 2, 3

Financial Report Problem Reading Amazon’s Annual Report/Internet Project

.

12-2

1

Keeping It Real Suarez Digital Services r

1, 2

60

Medium

Mini Practice Set (Reviewing the Accounting Cycle) The Fantastic Dress Shop: Practice Set: accounting cycle; merchandising company

Learning Unit 12-1: Financial Statements for Merchandise Companies Using the Perpetual Inventory Method Summary: The income statement (Figure 12.1) is prepared from the income statement columns of the worksheet. On the formal income statement, the inside columns in financial reports are used for subtotaling, not for debit and credit. The income statement is broken down into several sections: revenue, cost of goods sold, gross profit, operating expenses, other income, and other expenses. Net sales are the gross amount received less sales returns and allowances and sales discounts. The Cost of goods sold amount represents the cost of those goods (inventory) that were sold in the period. Gross profit is the portion of the net sales left after deducting the cost of the goods sold in the accounting period.

Operating expenses are expenses broken down into those directly related to the selling activity of the company (selling expenses) and those related to administrative or office activity (administrative expenses or general expenses). The other income/other revenue section includes revenue earned or expenses incurred from other than operating activities. (These are not sales or operating expenses.)

Statement of owner’s equity is based on the balance sheet column of the worksheet. The capital account in the ledger should be checked to see whether any additional investments occurred. You add the net income from the income statement and deduct the withdrawals to calculate the ending balance for capital.

This ending capital amount is carried over to the balance sheet. A classified balance sheet classifies assets as current assets or plant and equipment, and groups liabilities as current or long-term liabilities.

The operating cycle is the average time it takes to buy and sell merchandise and then collect accounts receivable. The categories on the classified balance sheet are as follows: current assets, plant and equipment, current liabilities, long-term liabilities, and equity. The current assets are assets that can be converted into cash or used within one year or within the normal operating cycle of the business, whichever is longer. The plant and equipment are long-lived assets such as equipment, buildings, or land that are used in the production or sale of goods or services.

Key Concepts: Selling expenses, administrative expenses (general expenses), other income, other expenses, classified balance sheet, current assets, operating cycle, capital assets, current liabilities, longterm liabilities.

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12-3

Lecture Outline: 1. The income statement is prepared from information included on the worksheet. The format for the income statement is: Net Sales - Less: Cost of Goods Sold = Equals: Gross Profit - Less: Operating Expenses = Equals Net Income from Operations + Plus: Other Income - Less: Other Expenses = Equals: Net Income a. Revenues: Gross sales less sales returns and allowances and less sales discounts equals Net Sales. b. Cost of Goods Sold c. Gross Profit: Net Sales - Cost of Goods Sold = Gross Profit d. Operating Expenses: Many businesses break expenses down into those directly related to the selling activity of the business (selling expenses) and those related to administrative or office activity (administrative expenses or general expenses). i.

Some examples of operating expenses are: a) Sales salaries expense b) Delivery expense c) Advertising expense d) Depreciation expense, store equipment e) Insurance expense ii.

Some examples of administrative or general expenses are: a) Rent expense b) Office salaries expense c) Utilities expense d) Supplies expense e) Depreciation expense, office equipment e. Other Income (or Other Revenue): i.

Revenue other than revenue from sales or services and appears in a separate section on the income statement ii.

Examples are: rental income, storage fees, or interest income f. Other Expenses: i.

Any expense that does not relate to the main operating activities of the business and appears in a separate section on the income statement ii.

Example: interest expense (interest owed on money borrowed by the company) g. Net Income is carried over to the statement of owner’s equity.

2. Statement of Owner’s Equity is prepared from information on the worksheet and the income statement. The ending balance is carried to the balance sheet. The statement format is: Beginning Balance + Plus: Net Income for the Year - Less: Withdrawals for the Year = Ending Balance 3. The Balance Sheet: The classified balance sheet is a balance sheet that categorizes assets as current or plant and equipment, and groups liabilities as current or long-term. a. Current Assets are:

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12-4

i.

b.

c.

d.

e.

cash and other assets that will be converted into cash or used up during a normal operating cycle (generally, one year) ii. listed in the order of liquidity or the ability to be converted to cash iii.

Examples are: cash, accounts receivable, merchandise inventory, supplies, and prepaid insurance Capital Assets (long-term assets): i. long-lived assets such as buildings or land that are used in the production or sale of goods or service ii. net book value of these long-lived assets: cost - accumulated depreciation = book value iii. accumulated depreciation is a contra-asset account whose value is the cumulative total of depreciation expense taken to date on that asset iv. plant and equipment are listed in order of useful life Current Liabilities: i. obligations or debts that will come due within one year or within the operating cycle, whichever is longer ii.

Examples are: current portions of long-term debt (such as the portion of a mortgage payable which must be paid in the next year), accounts payable, and accrued liabilities that will come due within one year or within the operating cycle, whichever is longer iii. listed first and the remaining liabilities are listed in order as to how soon they will come due Long-Term Liabilities: i. obligations (debts) that are not due or payable for more than one operating cycle or a year whichever is longer ii. listed in the order the debt was incurred and includes the long-term portion of long-term debt iii.

Examples: long-term notes payable, long-term portion of a mortgage payable Owner’s Equity (on the balance sheet) is the ending balance carried from the statement of owner’s equity

Teaching Tips/Strategy: Ask students to provide examples of merchandising businesses that are familiar to them. Use the Success Coach LU 12-1 to reinforce the concept. The Concept Checks 1, 2, and 3 are useful for class demonstration to practice section calculations. Practice account classification and financial statement placement utilizing Exercises 12A-1 or 12B-1. As a final review, assign Problem 12A1 or 12B-1 to assess the understanding of the income statement preparation. Assign Problem 12A-2 or 12B-2 for preparation of the statement of owner’s equity and classified balance sheet.

Use the “Ten-Minute Quiz” questions 1, 2, 3, 4, 5, and 7 to reinforce learning these concepts.

Learning Unit 12-2: Journalizing and Posting Adjusting and Closing Entries: Preparing the Post-Closing Trial Balance Summary: Closing entries are prepared to clear all temporary accounts in the ledger to zero and to update capital in the ledger to its latest balance. The company uses the worksheet to complete the closing process. Close all balances on the income statement credit column of the worksheet, by debits. Close all balances on the income statement debit column of the worksheet, by credits. Transfer (or close) the balance of the Income Summary Account to the Capital account. Transfer (or close) the balance of the Owner’s Withdrawals account to the Capital account. After the closing process is completed, it is necessary to post the closing journal entries to the general ledger; and then all temporary accounts should have zero balances in the ledger.

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12-5

The post-closing trial balance (Figure 12.7) is prepared from the general ledger after all adjusting and closing entries are posted. All temporary accounts have been closed and are not shown, and the capital account has been adjusted to the updated balance as of the end of the period.

Key Concepts: Journalizing adjusting entries, posting adjusting entries, completion of worksheet, closing entries, preparation of post-closing trial balance.

Lecture Outline: 1. The goals of closing are the same for a merchandise company as they are for a service company.

The goals are a. to clear all temporary accounts in the ledger to zero b. to update capital in the ledger to its latest balance c. The closing steps are: a) Close all balances on the income statement credit column (revenues) of the worksheet The journal entry to record the closing is: Dr. Revenues XX Cr. Income Summary XX (Remember to list ALL the revenue accounts separately) b) Close all balances on the income statement debit (expenses) column of the worksheet The journal entry to record the closing is: Dr. Income Summary XX Cr. Expenses XX (Remember to list ALL the expense accounts separately) c) The ending balance of income summary is transferred to the capital account.

The journal entry is: ( Use when revenues > expenses = net income or the income summary has a credit balance) Dr. Income Summary Cr. Capital

XX XX

(Use when revenues < expenses = net loss or the income summary has a debit balance) Dr. Capital Cr. Income Summary

XX XX

d) The balance of the withdrawals is transferred to the capital account The journal entry is:

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12-6

Dr. Capital XX Cr. Withdrawals or Drawings

XX

2. After all the adjusting entries (Figure 12.5) and closing entries (Figure 12.6) are journalized and posted: a. All temporary accounts (revenues, expenses, and withdrawals) will have zero balances in the ledger b. Capital account will be updated with a new balance 3. Post-closing trial balance: a. Is prepared from the general ledger b. Contains no temporary accounts since they have been closed c. Shows an ending inventory balance which becomes the beginning inventory amount for the following year Teaching Tips/Strategy: After the class discussion, utilize the Accounting Coach LU 12-2 to assess the level of retention of the material presented in this section. Explain the reasons why all entries presented on the worksheet are not “official” until journalizing and posting has occurred. Clarify why the net income from the worksheet might not match the financial statements unless you journalize and post all required adjustments.

Use the “Ten-Minute Quiz” questions 6 and 8 to reinforce learning these concepts.

Learning Unit 12-3: Reversing Entries (Optional Section) Summary: Reversing entries are an optional bookkeeping technique in which certain adjusting entries are reversed or switched on the first day of the new accounting period so that transactions in the new period can be recorded without referring back to prior adjusting entries. Reversing entries are general journal entries that are the opposite of adjusting entries. Reversing entries help reduce potential errors and simplify the recordkeeping process.

Key Concepts: Reversing entries Lecture Outline: 1. Reversing entries: a. adjusting journal entries are reversed, on the first day of the new accounting period, so that transactions in the new period can be recorded without referring back to prior adjusting entries b. reversing journal entries are general journal entries that are the opposite of adjusting entries c. Comparison of the system without the entries i. Journal entries for the accrual of salaries without using a reversing entry: If the December entry was: Salaries Expense (December portion) XX Salaries Payable XX Income Summary Salaries Expense

XX XX

The January reversing entry is not used (See Fig. 12.9) Salaries Payable XX

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12-7

Salaries Expense (January portion) Cash

XX XX

ii. Journal entries for the accrual of salaries with reversing entries: If the December entry was: Salaries Expense (December portion) XX Salaries Payable XX Income Summary Salaries Expense Reversing Entry: (See Fig. 12.10) Salaries Payable Salaries Expense

XX XX

XX XX

January entry to record entire salary expense for the time period: Salaries Expense XX Cash XX Teaching Tips/Strategy: Explain to students that reversing entries are optional. The purpose of reversing entries is to simplify the adjustment and recording process. To introduce the students to this topic, use the Concept Checks #4 as a demonstration exercise. At the end of the chapter, you can assign either problem 12A-4 or 12B-4 that covers and details all the chapter’s objectives.

Use the “Ten-Minute Quiz” questions 9 and 10 to reinforce the concepts.

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12-8

Name

Date

Section

CHAPTER 12 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Current assets include all of the following except: a. cash b. c. land d.

2.

3.

accounts receivable merchandise inventory

Gross profit less operating expenses equals a. cost of goods available for sale c. gross profit

b. d.

net income net income from operations

Net sales less cost of goods sold equals a. cost of goods available for sale c. gross profit

b. d.

net income net income from operations

4.

A company breaks expenses into selling expenses and administrative expenses. Which of the following is not a selling expense? a. advertising expenses b. delivery expense c. depreciation expense, office equipment d. commission expense

5.

A company's net sales is $120,000; cost of goods sold is $37,000; selling expenses are $25,000; administrative expenses are $29,000; and interest income is $3,000. How much is net income? a. $29,000 b. $32,000 c. $83,000 d. $123,000

6.

Closing entries are prepared to a. reduce all permanent account balances to zero b. reduce all temporary account balances to zero c. reduce all permanent and temporary account balances to zero d. reduce net income to zero

7.

A company's net sales is $120,000; cost of goods sold is $37,000; selling expenses are $25,000; administrative expenses are $29,000; and interest income is $3,000. How much is net income from operations? a. $29,000 b. $32,000 c. $83,000 d. $123,000

8.

A post-closing trial balance is best prepared from a. the general ledger b. c. the financial statements d.

9.

the general journal the worksheet

If an adjusting entry was made to record the December unpaid portion of salaries expense of $770, the reversing entry would be a. debit salaries expense and credit salaries payable b. debit salaries expense and credit income summary c. debit salaries payable and credit salaries expense d. debit income summary and credit salaries expense

.

12-9

10.

A reversing entry could be used for a. adjusting entries for salaries payable c. adjusting entries for unrecorded revenue

Answer Key to Chapter 12 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

c d c c b b a a c a

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12-10

b. d.

adjusting entries for prepaid insurance adjusting entries for unearned revenue

Appendix for Chapter 12 Accounting For Merchandise Inventory Using The Periodic Method Of Inventory Valuation Chapter Overview This chapter contains accounts, transactions, and worksheet usage related to use of the Periodic Inventory System for a merchandising company. The worksheet is prepared, adjusting journal entries are completed, and posted, and certain accounts in the general ledger are closed for the accounting period. After the closing entries are prepared and posted, a post-closing trial balance is prepared.

Learning Objectives After studying Chapter 12A, your students should gain proficiency in the following: 1. Discounts, and Sales Returns and Allowances.

2. Purchases Transactions, Including Freight.

3. Journalizing and Recording Transactions and Posting to the General Ledger Along with a Debit Memorandum.

4. Cash Payments Transactions and Schedules of Accounts Payable.

5. Adjustments for Merchandise Inventory, Unearned Rent, Supplies Used, Insurance Expired, Depreciation Expense, and Accrued Salaries.

6. Worksheets for Merchandise Companies Using the Periodic Inventory Method.

7. Completion of the Accounting Cycle for a Merchandise Company Using the Periodic Method of Inventory Valuation.

8. Adjusting and Closing Entries and the Post-Closing Trial Balance for a Merchandise Company Using the Periodic Method.

9. Journalizing and Posting Closing Entries.

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12A-1

Chapter 12A Assignment Grid Estimated Time in Minutes

Level of Difficulty

1 2 5 6, 7

10 20 10 15

Easy Easy Easy Medium

1 3 6

40 30

Medium Medium Medium

5, 6, 7

6

Hard

3, 4

150

Hard

Learning Objective(s)

Assignment Topic(s)

Exercises (Set A) 12A-1 Journalizing, Recording, & Posting 12A-2 Journalizing, Recording, & Posting 12A-3 Transaction Analysis 12A-4 Closing Entries Problems (Set A) 12A-1 Journalizing, Posting, A/R Schedule 12A-2 Journalizing & Posting 12A-3 Worksheet 12A-4 Worksheet, Financial Statements, & Adjusting & Closing Entries 12A-5 Journalizing, Special Journals, Subsidiary Ledgers, A/R & A/P Schedules

Learning Unit 12-1: Discounts, and Sales Returns and Allowances Summary: Retailers are merchants who buy goods from wholesalers for resale to customers. Gross Sales are the total amount earned from the cash or credit sale of merchandise to customers. A sales invoice is the bill sent to customers reflecting a credit sale. The sales returns and allowances account is a contra-revenue account that records price adjustments and allowances granted on merchandise that is defective or has been returned. The sales discounts (2/10, n/30 = 2% if paid within 10 days, net or full amount due in 30 days) are price reductions granted to customers for payments made within a specific period of time. The sales discount account is a contra-revenue account that records cash discounts granted to customers for payments made within a specific period of time. Note that the discount period is the time when a discount is granted. The discount period is less time than the credit period, which is the length of time allowed to pay the amount owed on the invoice. Net sales are gross sales less sales returns and allowances and less sales discounts.

Sales Tax Payable is an account in the general ledger that accumulates the amount of sales tax owed, and the account has a normal credit balance.

Key Concepts: Retailers, merchandise, sales returns and allowances (SRA) account, sales discount, discount period, credit period, sales discount account, net sales, gross sales, sales tax payable account.

Lecture Outline: 1. Gross Sales: total amount earned from the cash or credit sales to customers. a. The entry to record the day’s cash sales: Dr. Cash (total day’s cash sales) Cr. Sales (total day’s Sales)

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12A-2

XX XX

b. The entry to record the day’s sale on credit: Dr. Accounts Receivable (days’ sales on account) Cr. Sales (total day’s Sales)

XX XX

2. Sales Returns and Allowances: A contra-revenue account that record returns and defective merchandise. a. The entry to record a return or allowance of merchandise sold on credit: Dr. Sales Returns and Allowances Cr. Accounts Receivable

XX XX

b. The entry to record a return or allowance of merchandise sold for cash: Dr. Sales Returns and Allowances XX Cr. Cash XX 3. Sales Discounts are price reductions granted to customers for payments made within a specific period of time. a. The term 2/10, n/30 indicates: i. 2% discount if paid within 10 days (the discount period) of the invoice date, ii. Or the full (net) amount must be paid within 30 days (the credit period). b. The term n/10, EOM indicates: i. There is no discount, ii. And the full (net) amount must be paid within 10 days after the end of the month (the credit period). c. The journal entry for payment of invoice within the discount period: Dr. Cash (sales less discount taken) Dr. Sales Discount Cr. Accounts Receivable (gross sales)

XX XX XX

4. Sales Tax Payable is a liability account to record the sales tax collected that needs to be paid to the state, city, or locality. a. State and City sales tax vary from state to state and city to city. In some locations only certain items may be taxed and in other locations there may not be a sales tax at all. b. The sales tax is computed by multiplying the sales tax percentage times the sales price of the item being taxed. c. The journal entry for sales transactions with sales tax: Dr. Cash or Accounts Receivable (depending on type of sale) XX Cr. Sales Tax Payable (tax rate X sales) XX Cr. Sales XX Teaching Tips/Strategy: Students are comfortable with a merchandising industry. Relate the terminology with a known merchandising business (or store) that your students have visited.

Learning Unit 12-2: Purchases Transactions, Including Freight Summary: The Purchases account records all merchandise bought for sales. It records the cost of the merchandise and represents costs that are directly related to bringing merchandise into the store for resale to customers. All purchases are recorded individually in the accounts payable subsidiary ledger to

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12A-3

properly identify the merchandise and the merchant. Merchandise received as defective results in a notification to the manufacturer being issued, and the manufacturer issues a credit memorandum indicating a reduction from the original selling price.

The account that records a decrease to a buyer’s cost is a contra-cost account called Purchases Returns and Allowances. The account that records the discount is called Purchases Discount. This account is a contra-cost account because it lowers the cost of purchases, and the normal balance is a credit. Freight charges are not taken into consideration in calculating net purchases.

If the seller is responsible for paying the shipping cost until the goods reach their destination, the freight charges are F.O.B. destination (F.O.B. stands for “free on board” the carrier). If goods are shipped by the seller F.O.B. destination, title will change when goods have reached their destination point. If the buyer is responsible for paying the shipping costs, the freight charges are F.O.B. shipping point. When the seller ships goods F.O.B. shipping point, the legal ownership (title) passes to the buyer when the goods are shipped. In this situation, the seller will sometimes prepay the freight charges as a matter of convenience and will add it to the invoice of the purchaser. Purchases discounts are not taken on freight.

Key Concepts: Purchases, purchases returns and allowances, purchases discount, F.O.B. destination, F.O.B. shipping point.

Lecture Outline: 1. The Purchases account records the cost of inventory purchased for resale. Purchases is a cost and follows the same rules as expenses The journal entry to record a purchase is: Dr. Purchases XX Cr. Accounts Payable, supplier

XX

2. Seller records returns and allowances through the Sales Returns and Allowances Account.

3. The purchaser makes similar entries through the Purchases Returns and Allowances Account for the amount of defective or unacceptable merchandise.

4. Purchases Returns and Allowances is a contra-cost account. a. The purchaser issues a debit memorandum to the seller indicating that it debited Accounts Payable to reduce the amount it owes the seller. b. The journal entry to record the return of merchandise or an allowance provided by seller: Dr. Accounts Payable, supplier XX Cr. Purchases Returns and Allowances

XX

5. Purchases Discounts is a contra-cost account in the general ledger that records cash discounts offered by suppliers of merchandise for payment within the discount period. a. The term 2/10, n/30 indicates: i. A 2% discount ii. IF paid within 10 days (the discount period) of the date of the invoice, iii. OR the full (net) amount must be paid within 30 days (the credit period). b. The term n/10, EOM indicates: i. There is no discount, ii. AND the full (net) amount must be paid within 10 days after the End of the Month (the credit period). c. The journal entry for cash payment with a discount:

.

12A-4

Dr. Accounts Payable XX Dr. Purchases Discount XX Cr. Cash (sales less discount taken) XX 6. Net purchases = gross purchases less purchases returns and allowances and less purchases discounts.

7. Freight charges are a cost of purchasing inventory, but they are not included when computing net purchases. The business that pays for the freight owns the merchandise. a. F.O.B. (Free on Board) destination indicates that the seller pays the freight, and legal ownership (title) passes when the goods reach their destination. b. F.O.B Shipping point indicates that the purchaser pays the freight, and legal ownership (title) passes when the goods are shipped. c. Purchases discounts are not taken on freight charges.

Teaching Tips/Strategy: Start the class discussion by differentiating between a seller and a purchaser.

Compare the journal entries and records necessary from the seller’s and the purchaser’s point of view.

Assign Problems12A-1 and 12A-2 to reinforce the concepts presented on the objective.

Learning Unit 12-3: Journalizing and Recording Transactions and Posting to the General Ledger Along with a Debit Memorandum Summary: Accounts payable is the controlling account in the ledger and at the end of the month the sum of the individual amount owed to the creditors should equal the balance in accounts payable at the end of the month. An accounts payable subsidiary ledger is a book or file that contains, in alphabetical order, the name of creditors and amounts owed from purchases on account.

A debit memorandum is a piece of paper issued by a customer to a seller. It indicates that a return or allowance has occurred. Result of debit memo: debits or reduces accounts payable, while the seller’s ledger accounts affected would include sales returns and allowances and accounts receivable. A debit memorandum is a memo issued by a purchaser to a seller, indicating that some purchases returns and allowances have occurred; and, therefore, the purchaser now owes less money on account.

Key Concepts: Debit memorandum.

Lecture Outline: 1. Journal entry for merchandise purchase plus freight cost: Dr. Purchases XX Dr. Freight-in XX Cr. Accounts Payable XX 2. Post general ledger accounts to the general ledger by recording the general journal abbreviation and page number. Record the account number in the PR column of the general journal. When the subsidiary ledger is updated, a check mark is placed in the PR column of the general journal.

3. Debit memorandum – piece of paper issued by a customer to a seller indicating that a return or allowance has occurred.

4. Journal entry for debit memorandum of merchandise returned: Dr. Accounts Payable XX Cr. Purchases Returns and Allowances XX

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12A-5

Teaching Tips/Strategy: Assign Exercise 12A-2 to reinforce the concepts presented in the objective.

Learning Unit 12-4: Cash Payments Transactions and Schedules of Accounts Payable Summary: All payments of cash (check) are recorded in the general journal. At the end of the month, the schedule of accounts payable, a list of ending amounts owed individual creditors, should equal the ending balance in accounts payable, the controlling account in the general ledger.

Now let’s prove that the sum of the accounts payable subsidiary ledger at the end of the month is equal to the controlling account, accounts payable, at the end of the month. To do so, creditors with an ending balance in the accounts payable subsidiary ledger must be listed in the schedule of accounts payable (Figure 12A.13). At the end of the month, the total owed in accounts payable, the controlling account in the general ledger, should equal the sum owed the individual creditors that are listed on the schedule of accounts payable. If it does not, the journalizing, posting, and recording must be checked to ensure that they are complete. Also, the balances of each title should be checked.

Key Concepts: Controlling account Lecture Outline: 1. Controlling account is the account in the general ledger that summarizes or controls a subsidiary ledger. (Example: The accounts payable account in the general ledger is the controlling account for the accounts payable subsidiary ledger.) a. After postings are complete, the controlling account equals the sum of all the totals in the related subsidiary ledger.

2. With cash payment transactions, cash will be credited. Any discount taken will also be credited while other accounts will be debited. (See Figure 12A.13 for examples of cash payments transactions.)

Teaching Tips/Strategy: Assign Problem 12A-5 to reinforce the concepts presented in this and prior objectives.

Learning Unit 12-5: Adjustments for Merchandise Inventory, Unearned Rent, Supplies Used, Insurance Expired, Depreciation Expense, and Accrued Salaries Summary: The Merchandise Inventory account shows the goods that a merchandise company has available to sell to customers. Companies have several ways to keep track of the cost of goods sold (the total cost of the goods sold to customers) and the quantity of inventory on hand. The two systems are periodic inventory system and perpetual inventory system. The perpetual inventory system is an inventory system that keeps continual track of each type of inventory by recording units on hand at the beginning, units sold, and the current balance after each sale or purchase.

This chapter appendix discusses the periodic inventory system, in which the balance in inventory is updated only at the end of the accounting period. This system is used by companies which sell a variety of merchandise with low unit prices. The amount of inventory that the organization starts the year with is called beginning merchandise inventory or simply beginning inventory. The balance of beginning

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inventory in the merchandise inventory account never changes during the accounting period. Any purchases of merchandise are recorded in a separate account, the Purchases account. At the end of the period, the company takes a physical count of the merchandise in stock. This amount is called ending merchandise inventory or simply ending inventory. The ending merchandise inventory (ending inventory) is the cost of goods that remain unsold at the end of the accounting period. It is an asset on the new balance sheet. The ending inventory for this period will become the beginning inventory for the next period. When the income statement is prepared, the cost of goods sold section requires two distinct numbers for inventory. The beginning inventory adds to the cost of goods sold, and the ending inventory is subtracted from the cost of goods sold. Remember that the two amounts for beginning and ending inventory were calculated months apart. Thus, combining these amounts to come up with one inventory balance would not be accurate.

Freight-In is a cost of goods sold account that records the shipping cost to the buyer. Note that net sales (gross sales less sales returns and allowances and sales discounts) less cost of goods sold equals gross profit. Subtracting operating expenses from gross profits equals net income. Remember that under accrual accounting, revenue is recognized when it is earned, whether payment is received then or not. If payment is received for rent before the revenue is earned or not yet performed, a liability called Unearned Rent is the result. As an example, the company may have the cash, but the rental income is not recorded until it is earned.

Key Concepts: Cost of goods sold, periodic inventory system, beginning merchandise inventory (beginning inventory), ending merchandise inventory (ending inventory), freight-in, gross profit.

Lecture Outline: Adjustments for merchandise inventory: Businesses can choose either to track the cost of goods sold using a perpetual inventory system or a periodic inventory system: 1. Perpetual inventory system continually updates the balance of inventory on hand.

2. Periodic inventory system updates the balance of inventory on hand only at the end of the accounting period: Cost of goods sold computation: Beginning Inventory + Net Purchases + Freight-In - Ending Inventory Cost of Goods Sold Gross Profit computation: Net Sales (Gross Sales - Sales Discounts and Sales Returns and Allowances) - Cost of Goods Sold Gross Profit 3. Closing entries (Periodic inventory system): a. Remove the value of inventory on hand at the beginning of the period (beginning inventory) and transfer it to income summary.

Adjusting journal entry: Dr. Income Summary XX (beginning inventory amount) Cr. Merchandise Inventory XX (beginning inventory amount) b. Enter the value of inventory on hand at the end of the period (ending inventory) and record it in income summary.

Adjusting journal entry:

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Dr. Merchandise Inventory XX (ending inventory amount) Cr. Income Summary XX (ending inventory amount)

Learning Unit 12-6: Worksheets for Merchandise Companies Using the Periodic Inventory Method Summary: In this unit we prepare a worksheet for Art’s Wholesale Clothing Company. For convenience, we reproduce the company’s chart of accounts in Figure 12A.17, and Figure 12A.18 shows the trial balance from Art’s Wholesale ledger. In looking at the trial balance, there are many new titles that did not appear in the trial balance which was completed for a service company previously. Examples are mortgage payable, interest expense, and unearned revenue. Mortgage Payable is a liability account that records the increases and decreases in the amount of debt owed on a mortgage. Interest Expense is a non-operating expense categorized as Other Expense. Unearned Revenue is a liability account that records receipt of payment for goods and services in advance of delivery. Unearned rent is a particular example of this general type of account.

Key Concepts: Mortgage payable, interest expense, unearned revenue.

Lecture Outline: A worksheet similar to the one used for service businesses is completed.

1. The initial balances from the general ledger are added to the worksheet.

2. Similar to the adjusting entries for a service business, adjusting entries are computed to represent the changes during the period. a. Mortgage payable – a liability account showing the amount owed on a mortgage. b. Interest expense – the cost of borrowing money. Businesses making loan payments pay a portion of the amount borrowed (principal) and the interest charged by the institution from which they borrowed the funds. c. Unearned revenue – a liability account that records the amount owed for goods and services in advance of delivery of those services. When cash is received, cash is debited and the liability “unearned” is credited.

The journal entry when cash is received for rent paid in advance is: Dr. Cash XX Cr. Unearned Rent XX The journal adjusting entry for the portion earned during the year: Dr. Unearned Rent XX Cr. Rent Revenue (Earned) XX d. The journal entry to adjust supplies account ending balance to actual supplies on hand at end of period is: Dr. Supplies expense XX Cr. Supplies (asset account) XX e. The journal entry needed when insurance expires during the year is: Dr. Insurance expense XX Cr. Prepaid insurance XX

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f.

The adjusting entry to reflect the depreciation for the accounting period is: Dr. Depreciation expense XX Cr. Accumulated depreciation XX

g. The adjusting entry for salaries accrued (employees work earned but not paid) since the last payment of salaries is: Dr. Salaries expense XX Cr. Salaries payable XX The next step in the worksheet is to fill out the balance sheet and income statement columns. After adjusting the merchandise inventory accounts, the ending inventory balance is carried to the balance sheet column in the worksheet.

Learning Unit 12-7: Completion of the Accounting Cycle for a Merchandise Company Using the Periodic Method of Inventory Valuation Summary: The income statement (Figure 12A.20) is prepared from the income statement columns of the worksheet. On the formal income statement, the inside columns in financial reports are used for subtotaling, not for debit and credit. The income statement is broken down into several sections: revenue (Gross Sales and Net Sales), cost of goods sold, gross profit, operating sections, other income and other expenses. Gross sales are the gross amount received. You must deduct the sales discounts and the sales returns and allowances to arrive at the net sales amount. The Cost of goods sold amount represents the cost of those goods (inventory) that were sold in the period. Gross profit is the portion of the net sales left after subtracting the cost of the goods sold. Operating expenses are expenses broken down into those directly related to the selling activity of the company (selling expenses) and those related to administrative or office activity (administrative expenses or general expenses). The other income/other revenue section includes revenue earned or expenses incurred from other than operating activities. (These are not sales or operating expenses.)

Statement of owner’s equity is based on the balance sheet column of the worksheet. The capital account in the ledger should be checked to see whether any additional investments occurred. You add the net income from the income statement and deduct the withdrawals to calculate the ending amount of capital.

This ending capital amount is carried over to the balance sheet. A classified balance sheet classifies assets as current assets or plant and equipment, and groups liabilities as current or long-term liabilities.

The operating cycle is the average time it takes to buy and sell merchandise and then collect accounts receivable. The categories on the classified balance sheet are as follows: current assets, plant and equipment, current liabilities, long-term liabilities, and equity. The current assets are assets that can be converted into cash or used within one year or within the normal operating cycle of the business, whichever is longer. The plant and equipment are long-lived assets such as equipment, buildings, or land that are used in the production or sale of goods or services.

Key Concepts: Selling expenses, administrative expenses (general expenses), other income, other expenses, classified balance sheet, current assets, operating cycle, plant and equipment, current liabilities, long-term liabilities.

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Lecture Outline: 1. The income statement is prepared from information included on the worksheet. The format for the income statement is: Net Sales - Cost of Goods Sold = Gross Profit - Operating Expenses = Net Income from Operations + Other Income - Other Expenses = Net Income a. Revenues: Gross sales less sales returns and allowances and less sales discounts equals net sales. b. Cost of Goods Sold Section: Beginning Inventory + Net Purchases + Freight-in + Ending Inventory = Cost of Goods Sold c. Gross Profit: Net Sales - Cost of Goods Sold = Gross Profit d. Operating Expenses: Many businesses break expenses down into those directly related to the selling activity of the business (selling expenses) and those related to administrative or office activity (administrative expenses or general expenses). i.

Some examples of operating expenses are: a) Sales salaries expense b) Delivery expense c) Advertising expense d) Depreciation expense, store equipment e) Insurance expense ii.

Some examples of administrative or general expenses are: a) Rent expense b) Office salaries expense c) Utilities expense d) Supplies expense e) Depreciation expense, office equipment e. Other Income: i.

Revenue other than revenue from sales or services and appears in a separate section on the income statement ii.

Examples are: rental income, storage fees, or interest income f. Other Expenses: i.

Any expense that does not relate to the main operating activities of the business and appears in a separate section on the income statement ii.

Example: interest expense (interest owed on money borrowed by the company) g. Statement of Owner’s Equity: Net Income is carried over to the statement of owner’s equity.

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2. Statement of Owner’s Equity is prepared from information on the worksheet and the income statement. The ending balance is carried to the balance sheet. The statement format is: Beginning Balance + Net Income for the Year - Withdrawals for the Year = Ending Balance 3. The Balance Sheet: The classified balance sheet is a balance sheet that categorizes assets as current or plant and equipment, and groups liabilities as current or long-term. a. Current Assets are: i. cash and other assets that will be converted into cash or used up within one year or the normal operating cycle of the business, whichever is longer ii. listed in the order of liquidity or ability to be converted to cash iii.

Examples are: cash, accounts receivable, merchandise inventory, supplies, prepaid insurance, and prepaid rent b. Plant and equipment (long-term assets): i. long-lived assets such as buildings or land that are used in the production or sale of goods or services ii. net book value of the assets: cost - accumulated depreciation = net book value iii. accumulated depreciation is a contra-asset account whose value is the cumulative total of depreciation taken on that asset iv. plant and equipment are listed in order of useful life c. Current Liabilities: i. obligations or debts that will come due within one year or within the operating cycle, whichever is longer ii.

Examples are: current portions of long-term debt (such as mortgage payable), accounts payable, and accrued liabilities that will come due within the operating cycle iii. accounts payable are listed first and the remaining liabilities are listed in order as to how soon they will come due d. Long-Term Liabilities: i. obligations (debts) that are not due or payable for more than one operating cycle or a year ii. listed in the order the debt was incurred and includes the long-term portion of long-term debt iii.

Examples: long-term notes payable, mortgages payable (the long-term portion) e. Owner’s Equity (on the balance sheet) is the ending balance carried from the statement of owner’s equity Teaching Tips/Strategy: Ask students to provide examples of service businesses and merchandising businesses that are familiar to them.

Learning Unit 12-8: Adjusting and Closing Entries and the PostClosing Trial Balance for a Merchandise Company Using the Periodic Method Summary: The adjusting entries from the adjustments columns of the worksheet (See Figure 12A.23) need to recorded in the journal (See Figure 12A.24) and then posted to the ledger accounts.

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Key Concepts: None Lecture Outline: 1. The adjustments (adjusting entries) shown in the worksheet need to be recorded in the general journal and then posted to the general ledger accounts.

2. The adjusted trial balance amounts on the worksheet need to be transferred to either the balance sheet columns or the income statement columns depending upon the individual accounts.

Teaching Tips/Strategy: Explain the reasons why all entries presented on the worksheet are not “official” until journalizing and posting has occurred. Clarify why the net income from the worksheet might not match the financial statements unless you journalize and post all required adjustments.

Learning Unit 12-9: Journalizing and Posting Closing Entries Summary: Closing entries are prepared to clear all temporary accounts in the ledger to zero and to update capital in the ledger to its latest balance. The company uses the worksheet to complete the closing process. Close all balances on the income statement credit column of the worksheet, by debits. Close all balances on the income statement debit column of the worksheet, by credits. Transfer (or close) the balance of the Income Summary Account to the Capital account. Transfer (or close) the balance of the owner’s Withdrawals account to the Capital account. After the closing process is completed, it is necessary to the post the closing journal entries to the general ledger; and then all temporary accounts should have a zero balance.

The post-closing trial balance (Figure 12A.26) is prepared from the general ledger after all adjusting and closing entries are posted. All temporary accounts have been closed and are not shown, and the capital account has been adjusted to the updated balance as of the end of the period.

Key Concepts: None Lecture Outline: 3. The goals of closing are the same for a merchandise company. The goals are a. to clear all temporary accounts in the ledger to zero b. to update capital in the ledger to its latest balance c. The closing steps are: a) Close all balances on the income statement credit column (revenues) of the worksheet The journal entry to record the closing is: Dr. Revenues XX Cr. Income Summary XX (Remember to list ALL the revenue accounts separately) b) Close all balances on the income statement debit (expenses) column of the worksheet The journal entry to record the closing is: Dr. Income Summary Cr. Expenses

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XX XX

(Remember to list ALL the expense accounts separately) c) The ending balance of income summary is transferred to the capital account.

The journal entry is: (Use when revenues > expenses = net income or the income summary has a credit balance) Dr. Income Summary XX Cr. Capital XX (Use when revenues < expenses = net loss or the income summary has a debit balance) Dr. Capital Cr. Income Summary

XX XX

d) The balance of the withdrawals is transferred to the capital account The journal entry is: Dr. Capital XX Cr. Withdrawals or Drawings

XX

4. After the entries are journalized (Figure 12A.25) and posted: a. All temporary accounts (revenues, expenses, and withdrawals) will have zero balances in the ledger b. Capital account will be updated with a new balance 5. Post-closing trial balance (Figure 12A.26): a. Is prepared from the general ledger b. Contains no temporary accounts since they have been closed c. Shows an ending inventory balance which becomes the beginning inventory amount for the following year Teaching Tips/Strategy: Explain the reasons why all entries presented on the worksheet are not “official” until journalizing and posting has occurred. Clarify why the net income from the worksheet might not match the financial statements unless you journalize and post all required adjustments.

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Chapter 13 Accounting for Bad Debts Chapter Overview Handling bad debts is a necessary part of accounting and this chapter looks at how bad debts are handled in a business. It discusses how accounts receivable becomes uncollectible along with how these transactions are journalized. Accrual accounting matches earned revenue with expenses that occur in the same period. When a company has credit customers, one of the expenses incurred in earning the revenue is allowing for bad debts. The business accounts for bad debts in the period in which the sale was made, and this is done by one of two methods: the sales percentage method or the aging of accounts receivable method. The estimated bad debts are recorded as an expense and as a contra-asset account called allowance for doubtful accounts. This account offsets accounts receivable to show the net realizable amount of accounts receivable. If these bad debts are subsequently repaid, the first journal entry reinstates accounts receivable; and a second entry records the receipt of cash.

Learning Objectives After studying Chapter 13, your students should gain proficiency in the following: 1. Explain Accrual Accounting and Journalize Bad Debts Transactions.

2. Use the Allowance Method to Estimate Bad Debts and Prepare an Aging of Accounts Receivable.

3. Write Off and Recover Uncollectible Accounts by the Allowance and the Direct Methods.

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Chapter 13 Assignment Grid Estimated Level Learning Time in of Objective(s) Minutes Difficulty

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Matching Principle 1 2 Allowance for Doubtful Accounts 1 3 Net Realizable Value 1 4 Writing off Accounts 1 5 Allowance for Doubtful Accounts 1 6 Bad Debts Expense 1 7 Income Statement Approach 2 8 Comparison of both Approaches 2 9 Aging of Accounts Receivable 2 10 Writing off Accounts and Recoveries 3 11 Net Realizable Value 3 12 Direct Write-off Method 3 13 Bad Debts Recovered Account 3 14 Ethical Case 3 Concept Checks 1 Categorizing Accounts 3 2 Allowance Method 2 3 Journalize Adjusting Entries – Both Methods 2 4 Write-off Uncollectible Accounts/Reinstatement - Allowance Method 3 5 Write-off Uncollectible Accounts and Reinstatement – Direct Write-off Method 3 Exercises (Set A) 13A-1 Partial Balance Sheet 1 13A-2 Adjusting Entry 2 13A-3 Adjusting Entry 2 13A-4 Adjusting and Write-off Entries 2, 3 13A-5 Entries under Various Methods 2 Exercises (Set B) 13B-1 Partial Balance Sheet 1 13B-2 Adjusting Entry 2 13B-3 Adjusting Entry 2 13B-4 Adjusting and Write-off Entries 2, 3 13B-5 Entries under Various Methods 2 Problems (Set A) 13A-1 Journal Entries 1, 2, 3 13A-2 Adjusting Entries, Partial Balance Sheet 1, 2 13A-3 Journal Entries 3 13A-4 Entries, Posting, Partial Balance Sheet 1, 2, 3 Problems (Set B) 13B-1 Journal Entries 1, 2, 3 13B-2 Adjusting Entries, Partial Balance Sheet 1, 2 13B-3 Journal Entries 3

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5 5 5 5 5 5 5 5 5 5 5 5 5

Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Medium Easy Easy Medium

5 10 15

Easy Easy Medium

15

Medium

15

Medium

20 20 20 20 20

Medium Medium Medium Medium Medium

20 20 20 20 20

Medium Medium Medium Medium Medium

25 30 25 60

Medium Medium Medium Hard

25 30 25

Medium Medium Medium

13B-4

Entries, Posting, Partial Balance Sheet

1, 2, 3

60

Hard

Estimated Level Learning Time in of Objective(s) Minutes Difficulty

Assignment Topic(s) Financial Report Problem Reading Amazon’s Annual Report/Internet Project Keeping It Real Suarez Digital Services

2

10

Medium

1, 2, 3

15

Easy

Learning Unit 13-1: Accrual Accounting and Journalizing Bad Debts Transactions Summary: Generally accepted accounting principles (GAAP) require use of the allowance method, a method that estimates the amount of losses or unpaid receivables at the same time (month) that the sales (revenue) occur. At the time of the sales, it is extremely difficult to determine which customer will default. Therefore, we estimate, based on prior experience, a group or an amount that will not make payments by the end of the period. Bad Debts Expense is an expense account whose normal balance is a debit. It is a temporary account that is closed to Income Summary at year’s end. The bad debts expense account is the operating expense that estimates the amount of credit sales that will probably not be collectible in a given accounting period when the allowance method is used. The Allowance for Doubtful Accounts is a contraasset account to the accounts receivable account and is listed with the assets in the balance sheet.

This account is permanent, functions opposite (increase by credit, decrease by debit) of assets, and is subtracted from the accounts receivable account to calculate the net realizable value of the receivables. The Net-realizable value is the amount (Accounts Receivable – Allowance for Doubtful Accounts) that is expected to be collected. Under the allowance method, you can utilize one of two ways of calculating the estimate: the percentage-of-sales (income statement method) or the percentage of receivables (balance sheet method).

Key Concepts: Bad debts expense, allowance for doubtful accounts, net realizable value.

Lecture Outline: 1. Accrual accounting matches revenues earned and expenses incurred in the same period.

Therefore, accrual accounting requires that as revenues are recognized for an accounting period an approximate estimate amount that might be deemed uncollectible must also be recorded: Journal entry to record the estimate of bad debts: Dr. Bad Debt Expense Cr. Allowance for Doubtful Accounts

XX XX

a. Bad debts expense is an operating expense account that estimates the amount of credit sales that will probably not be collected for that given time period.

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b. Allowance for doubtful accounts: (i) is a contra-asset that accumulates the expected future amount of bad debts as of a given date. (ii) It normally has a credit balance and offsets the accounts receivable account. c. Net-realizable value: (i) is the amount of receivables a company expects to collect. (ii) calculated by subtracting allowance for doubtful accounts from accounts receivable. d. Write-off under the allowance method: (i) When it becomes clear that a specific account is deemed uncollectible, it can no longer be considered an account receivable and needs to be removed from the ledger.

Journal entry: Dr. Allowance for Doubtful Accounts XX Cr. Accounts Receivable, customer

XX

(ii) This entry reduces the allowance account because the estimate of FUTURE uncollectible accounts has been reduced. (iii) Bad debts expense is not used because the estimate of bad debts was made earlier and bad debts expense was debited at that time.

Teaching Tips/Strategy: While discussing the chapter it is critical to explain the reasoning of estimating the bad debts at the time of the sales, not at the time of default to apply the matching principle. Since the journal entries tend to confuse students, explain that under the allowance method the journal entries are similar; and the amount is what varies. Take some time to explain the concept of the allowance account and how estimates are calculated. Use the Discussion Questions 1 through 5 to start the class discussion over these topics.

Use the “Ten-Minute Quiz” questions 1, 2 3, and 7 to reinforce the learning objective.

Learning Unit 13-2: The Allowance Method Summary: The allowance method is used to estimate the amount of bad debts for the current period. This estimate can be determined by the following methods: the income statement or the balance sheet approach. The income statement approach (or percent-of-sales method) is a method that estimates the amount of bad debts expense that will result based on a percentage of net credit sales for the period. It is based on experience where the company estimates what percentage of credit sales will be uncollectible. Bad debts expense is calculated as the estimated uncollectible percentage x net credit sales for the period. The amount of the expected bad debts is added to the existing balance of allowance for doubtful accounts.

The balance sheet approach bases the new total allowance for doubtful accounts on the current accounts receivable on the balance sheet. Thus, the adjustment is reduced by the old balance in allowance for doubtful accounts. When the adjustment is credited, the new balance will reflect the state of accounts receivable. This approach focuses on the aging of accounts receivable. This report lists all invoices based on their “age” or the time that the bills have been due waiting for payment. The longer a bill has been due and not paid, the more likely it is that it is not going to be paid. Therefore, one way of estimating the amount of bad debts for the past year is to look at

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accounts receivable and analyze it according to how many days past due the accounts are based on an analysis of all the accounts receivable pending and evaluating the amount that might be considered uncollectible or bad debts.

The aging of accounts receivable lists the name of the customer and the total balance due for that customer based on the number of days that the invoice is outstanding or unpaid. The report has additional columns to allocate the balance due for that customer as: not yet due, 1 - 30 days past due, 31 - 60 days past due, 61 - 90 days past due, and over 90 days past due. The company estimates, based on prior records, to determine the percentage of bad debts that arise from each of these columns. The total amount deemed uncollected per column is added to calculate the final uncollectible expense or bad debts expense for the overall receivables. The journal entry is for the amount necessary to adjust the allowance for doubtful accounts to equal the required balance as determined necessary per the aging schedule.

The amount calculated is the estimated bad debts expense for the period. This amount is used in the adjusting entry. The resulting allowance account ending balance rarely would equal the bad debts expense because the allowance account was not likely to be zero prior to adjustment.

Key Concepts: Income statement approach, balance sheet approach, aging of accounts receivable.

Lecture Outline: Methods of estimating how many accounts will become uncollectible.

1. Income statement approach: a. This approach is a method that estimates the amount of bad debts expense that will result based on a percentage of net credit sales for the year. b. This amount is calculated by multiplying the dollar value of sales on account for the period times the percentage of net credit sales deemed uncollectible.

Journal entry to record the estimate of bad debt: Dr. Bad Debts Expense XX (amount is the % x net credit sales) Cr. Allowance for Doubtful Accounts XX (amount is the % x net credit sales) 2

Balance sheet approach: a. This approach is a method used to calculate the amount required in the allowance for doubtful accounts. b. This method is based on the accounts receivable aging process. c. Because some account receivables can exceed the operating cycle, this approach has to consider the current balance in the allowance for doubtful accounts, or the same receivable could be counted twice.

Journal entry to record the estimate of future bad debt based on this year’s sales is: Dr. Bad Debts Expense XX (The bad debts amount debited is the balance from the aging of Accounts Receivable schedule - balance in the allowance for doubtful accounts provided the new estimate is greater than the current balance in the allowance account.)

Cr. Allowance for Doubtful Accounts XX

3. The aging of accounts receivable (See Table 13.1 as an example of an aging schedule):

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a) lists the name of the customer. b) the total balance due for that customer based on the number of days that the invoice is outstanding or unpaid. c) report has additional columns to allocate the balance due for that customer as: not yet due as well as columns for brackets of days past due. d) is based on company estimates and on prior records to determine the percentage of bad debts that arise from each of these columns. e) total amount deemed uncollected per column is added to calculate the final uncollectible expense or bad debts expense for the overall receivables. f) journal entry is the amount necessary to adjust the allowance for doubtful accounts to equal the required balance as determined necessary per the aging schedule.

Journal entry to record the estimate of future bad debt (based on the aging of accounts receivable) Dr. Bad Debts Expense XX Cr. Allowance for Doubtful Accounts XX Teaching Tips/Strategy: For class demonstration use the Concept Checks 2 and 3, Exercises 13A-2, 13A-3, 13A-4, and 13A-5. Assign Problems 13A-3 and 13A-4. The Exercises will cover the critical topics necessary for the completion of the required journal entries in the assignment. It is helpful to the students to compare and contrast the two approaches for adjusting the allowance account and recording bad debts expense. Students often conflate or confuse the two approaches, Figure 13.4 provides a summary of the two approaches: Income Statement approach (% of net credit sales) and Balance Sheet approach (adjustment as a result of aging of accounts receivable).

Use the “Ten-Minute Quiz” questions 4, 5, 6, and 8 to reinforce the concepts.

Learning Unit 13-3: Writing Off and Recovering Uncollectible Accounts Summary: When the organization determines that a specific customer is not able to pay the debt, the accounts receivable amount should no longer be considered an asset and should be written off.

The journal entry reduces the allowance for doubtful accounts and reduces the accounts receivable controlling account as well as the accounts receivable subsidiary ledger. This journal entry does not affect any expenses. Bad debts expense is not affected when an account is finally written off. The estimate for bad debts expense was recorded in the previous year before the bad debt actually occurred.

When a company cannot reasonably estimate its bad debts expense, it may use the direct writeoff method. Using this method, an account that is determined to be uncollectible would be directly written off to this year’s bad debts expense account without regard to when the original sale was made. In this method, the allowance for doubtful accounts is not used, because no adjustment is needed at the end of the year to estimate bad debts expense. The journal entry would be a debit to bad debts expense and a credit to accounts receivable. If the write-off account is collected, an account called a bad debts recovered is used. When an account receivable has been written off and is recovered, the bad debts recovered account (other revenue), is credited in the direct write-off method if the recovery is in a year following the write-off.

Key Concepts: Direct write-off method, bad debts recovered.

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Lecture Outline: 1. Write off an account using the allowance method: a) When an account is deemed uncollectible, it is no longer an asset. b) The account would be written off the company books so as to not overstate a company’s assets. c) No entry to expenses is necessary, because the expense was recorded earlier when the allowance for doubtful accounts account was adjusted. d) The net realizable value of accounts receivable does not change, because both the accounts receivable and the allowance for doubtful accounts is changed by the same dollar amount.

Write-off journal entry: Dr. Allowance for Doubtful Accounts XX Cr. Accounts Receivable, customer

XX

2. Bad debts recovery: a) Two journal entries need to be recorded if the bad debt is recovered in the future to reinstate the receivable and record the payment. (The reinstatement of the accounts receivable must be done before the cash is received from the customer.)

Reinstate the receivable journal entry (only for the amount that customer is paying) Dr. Accounts Receivable, customer XX Cr. Allowance for Doubtful Accounts

XX

Customer payment journal entry: Dr. Cash XX Cr. Accounts Receivable, customer

XX

3. Direct write-off method: a) This method does not use the matching principle or GAAP. a. Companies that must prepare GAAP-compliant financial statements must use the allowance method. b) With direct-write-off, the allowance for doubtful accounts is not used because there is no estimation bad debts matched against revenues for the accounting period. c) Bad debts expense is debited immediately when an account is deemed uncollectible.

Journal Entry Dr. Bad Debts Expense XX Cr. Accounts Receivable, customer

XX

4. When the bad debt is recovered in a future operating cycle: a) Bad debts recovered account is credited. b) The amount recovered is classified as other revenue. c) The bad debts recovered amount is included on the other revenue and expenses section of the income statement.

Journal entries: (reinstatement of the written-off accounts receivable)

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Dr. Accounts Receivable, customer XX Cr. Bad Debts Recovered Journal entries: (customer payment) Dr. Cash XX Cr. Accounts Receivable, customer

XX

XX

5. If the bad debt is recovered in the same operating cycle, the journal entries are: Journal entries: (reinstatement of the write-off accounts receivable) Dr. Accounts Receivable, customer XX Cr. Bad Debts Expense Journal entries: (customer payment) Dr. Cash XX Cr. Accounts Receivable, customer

XX

XX

Teaching Tips/Strategy: Use a comprehensive exercise that includes the allowance estimates, a write off, and the recovery journal entries. It might be lengthy, but it will cover the entire process presented on the chapter. Problem 13A-4 is excellent for class demonstration.

To compare and contrast both methods (Allowance and the direct write-off), use Concept Checks 4 and 5 to present both methods. For a group activity use the Exercise 13A-4, part b to present a step-by-step process for all required journal entries under the direct write-off method.

Use the “Ten-Minute Quiz” questions 9 and 10 to reinforce the learning objective.

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Name

Date

Section

CHAPTER 13 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Two methods of estimating uncollectible receivables are the: a. aging of receivables and direct write-off method b. aging of receivables and the percentage-of-sales method c. allowance for doubtful accounts method and the direct write-off method d. percentage-of-sales method and the direct write-off method 2.

Allowance for doubtful accounts is a: a. contra-asset account c. contra-revenue account

b. d.

contra-liability account contra-expense account

3.

Which account shows the amount of accounts receivable that a company does not expect to collect? a. Bad debts expense b.

Allowance for doubtful accounts c. Net realizable value d Allowance for net realizable value

4.

The percentage-of-sales method estimates bad debts: a. as a percentage of accounts receivable b. as a percentage of net credit sales c. as a percentage of each column in the aging of accounts receivable d as a percentage of net realizable value

5.

The aging of accounts receivable: a. does not consider the balance in the allowance for doubtful accounts b. does not consider the balance in bad debts expense c. considers the balance in the allowance for doubtful accounts d. considers the balance in Bad debts expense

6.

When writing off an uncollectible account: a. allowance for doubtful accounts does not change b. accounts receivable and net realizable value decrease c. bad debts expense increases d. net realizable value does not change

7.

Net-realizable value is: a. accounts receivable less bad debts expense b. accounts receivable c. accounts receivable less allowance for doubtful accounts d. bad debts expense

8.

If the balance in the allowance for doubtful accounts is a debit balance of $1,200 and the aging of accounts receivable estimates $2,500 for the amount of uncollectible accounts receivable. The bad debts expense is: a. credited for $1,300 b. debited for $1,300 c. credited for $3,700 d. debited for $3,700

.

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9.

When using the direct write-off method, the journal entry to estimate future bad debt: a. credits bad debts expense b. debits bad debts expense c. credits allowance for doubtful accounts d. does not exist

10.

A company that uses the direct write-off method records the bad debt: a. as a percentage of net credit sales during the year b. as an amount that is based on the aging of accounts receivable c. as an amount that is based on the aging of accounts receivable after considering the current balance in the allowance for doubtful accounts account. d. as the receivable is deemed worthless

Answer Key to Chapter 13 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

b a b b c d c d d d

.

13-10

Chapter 14 Notes Receivable and Notes Payable Chapter Overview This chapter discusses notes receivable and notes payable. It begins with the illustration of a promissory note and an understanding of the maker, the payee, the principal, and the maturity date. Interest is calculated by multiplying the principal by the interest rate and by a time factor (Formula: I = P x R x T). After explaining the fundamentals of notes, the chapter illustrates the journal entries involved in recording notes, dishonored notes, and notes given in exchange for assets purchased. The chapter also explains the steps involved in discounting a customers’ note: 1) find the maturity value of the note, 2) calculate the discount period, 3) calculate the bank discount; and 4) calculate the proceeds received.

Learning Objectives After studying Chapter 14, your students should gain proficiency in the following: 1. Determining Interest Calculations and Maturity Dates on Notes.

2. Journalizing Entries to Record Notes.

3. Journalize Entries to Discount a Note.

4. Journalize Adjustments for Interest Expense and Interest Income.

.

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Chapter 14 Assignment Grid Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Notes Payable and Accounts Payable 1 2 Promissory Note 1 3 Maturity Date 1 4 Notes Receivable 2 5 Subsidiary Ledger 2 6 Notes Receivable 2 7 Defaulting on a Note 3 8 Discounting a Note 3 9 Contingent Liability 3 10 Interest 3 11 Discount on Notes Payable 4 12 Effective Interest Rate 4 13 Discount on Notes Payable 4 14 Ethical Case 4 Concept Checks 1 Determining Maturity Date 1 2 Calculate Maturity Value 1 3 Journalizing Notes for Buyer and Seller 2 4 Discounting a Note 3 5 Four Steps in the Discounting Process 3 6 Journal Entry for Discounting 3 7 Defaulting 3 8 Discounting One’s Own Note 4 9 Adjusting the Discount 4 Exercises (Set A) 14A-1 Calculating Interest 1 14A-2 Determining the Maturity Date 1 14A-3 Days in a Year Table 1 14A-4 Discounting/Dishonoring Notes 2, 3 14A-5 Adjusting the Discount 4 Exercises (Set B) 14B-1 Calculating Interest 1 14B-2 Determining the Maturity Date 1 14B-3 Days in a Year Table 1 14B-4 Discounting/Dishonoring Notes 2, 3 14B-5 Adjusting the Discount 4 Problems (Set A) 14A-1 Buyer and Seller Entries 2 14A-2 Note Receivable Computations 3 14A-3 Journalizing Note Transactions 4 14A-4 Journalizing Note Transactions 1, 2, 3, 4

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Estimated Time in Minutes

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5 5 5 5 5 5 5 5 5 5 5 5 5 5

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Estimated Learning Objective(s)

Level Time in Minutes

of Difficulty

Problems (Set B) 14B-1 Buyer and Seller Entries 14B-2 Note Receivable Computations 14B-3 Journalizing Note Transactions 14B-4 Journalizing Note Transactions

2 3 4 1, 2, 3, 4

30 35 25 60

Medium Medium Easy Hard

Financial Report Problem Reading Amazon’s Annual Report/Internet Project

1

15

Easy

Keeping It Real Suarez Digital Services

1

20

Medium

Assignment Topic(s)

Chapter 14 Notes Receivable and Notes Payable Chapter Introduction Summary: Companies use notes instead of informal promises (such as accounts receivable, the subject of chapter 13) for many reasons, such as recording sales of high-cost items like farm machinery or construction equipment that have long-term credit periods (usually over 60 days). This can give additional time to settle past due accounts or allow borrowing money from a bank for a fee. The fee that is charged for the use of one’s money over a period of time is called interest. In addition, a note gives the seller or lender a stronger legal claim for collecting a past due account because the note acts as formal proof of the transaction.

Learning Unit 14-1: Interest Calculations and Determining Maturity Dates on Notes Summary: A promissory note (often called a “note”) is a written promise by a borrower to pay a certain sum of money to the lender at a fixed future date. The principal is the face amount of the promissory note or the amount that was borrowed. The payee is the person to whom a note is payable. The maker is the person promising to pay a note. The maturity date is the due date of the promissory note. The borrower calls this obligation a note payable. The payee views this note as an asset called a note receivable. The interest is the cost of using money for a period of time and the calculation is as follows: Principal x Interest Rate x Time = annual interest amount. The interest on a note is the amount of interest that the note accumulates while expecting payment.

Key Concepts: Promissory note, principal, payee, maturity date, maker, note payable, note receivable.

Lecture Outline: 1. Promissory notes: a) Formal written promise by a borrower to pay a certain sum at a fixed future date (See Figure 14.1) b) Notes include the following: i) Principal or the amount being borrowed ii) Length of time before the note is paid iii) Date the note was issued iv) Lender to whom the money is owed (payee) .

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v) Interest rate on the note vi) Due date (or Maturity Date) of the note vii) Maker of the note (who is promising to pay the note) 2. Interest: a) Interest Expense is recorded for the maker of the note. b) Interest Income is recorded for the payee on the note. c) Interest calculation: Principal x Rate x Time. (time could be stated in months or days based on a year) 3. Maturity date can be determined by: a) Exact days using a calendar or table of days in a year (Table 14.1) b) Number of months

Teaching Tips/Strategy: The Discussion Questions 1 through 4 are excellent for a pre-lecture preparation.

Concepts covered on the objective require prior knowledge of the topics before the exercises are completed.

For lecture demonstration you can utilize Concepts Checks 1 and 2 and Exercises 14A-1, 14A-2, and 14A3.

Use the “Ten-Minute Quiz” questions 1, 2, 3, and 4 to reinforce the learning concept.

Learning Unit 14-2: Journalizing Entries to Record Notes Summary: There are several types of transactions that can be used involving notes. An extension of time to pay on an accounts payable can be granted by the exchanging and signing of a notes payable for an accounts payable. Notes can be paid by maturity due date. It is possible that a note may be renewed at maturity to extend time when maker is unable to pay at maturity. A note may also be given in exchange for equipment or other asset.

Sometimes an organization accepts notes from customers and will not (or cannot) wait to receive its cash until the maturity date. Instead, it goes to a bank and exchanges the note for cash. This process is called discounting a note. The company will endorse the note and receive the maturity value of the note (principal plus interest) less what the bank charges for holding the note from the date of discounting until the maturity date. The discount period is the time period during which the bank holds the note (until maturity). The amount that the bank charges the company is called the bank discount. The note proceeds is the maturity value less bank discount. If the company fails to pay it at maturity, then the note is said to be a dishonored note or a note in default. A default is a failure of maker to pay the maturity value of a note when due. The dishonored note is a note that was not paid at maturity by the maker.

IT 14-2 Key Concepts: Dishonored note, default.

Lecture Outline: 1. Promissory note: a) Note receivable is a promissory note from the payee’s point of view. .

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b) Note payable is a promissory note from the maker’s point of view. c) Time Extension: i) Maker may request a time extension to gain additional time, ii) Or to settle past due accounts payable and convert the accounts payable to a note payable. iii) Payee may accept the time extension because a note is a formal written promise to pay, and interest is accumulated on the note (See Figure 14.3).

Seller’s (payee’s) journal entry: Dr. Notes Receivable XX Cr. Accounts Receivable Buyer’s (maker’s) journal entry: Dr. Accounts Payable XX Cr. Notes Payable

XX

XX

d) Interest is calculated on the maturity day of the note (See Figure 14.4) Seller’s journal entry: Dr. Cash XX Cr. Notes Receivable Cr. Interest Income

XX XX

Buyer’s journal entry: Dr. Notes Payable Dr. Interest Expense Cr. Cash

XX XX

XX

e) If the note is renewed at maturity (See Figure 14.5) i) Interest for the original note is recognized and recorded. ii) Original note principal + interest = principal of the new note.

Seller journal entry: Dr. Cash (if any) XX Dr. Notes Rec. (new) XX Cr. Notes Receivable (old) XX Cr. Interest Income XX Buyer journal entry: Dr. Notes Payable (old) Dr. Interest Expense Cr. Notes Payable (new) Cr. Cash (if any)

XX XX XX XX

f) A dishonored note: i) Note was not paid at maturity by the maker. ii) Maker is considered to have defaulted on the note. iii) Note principal + interest due are transferred to the customer’s accounts receivable and subsidiary ledger.

Seller’s journal entry: Dr. Accounts Receivable XX .

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Cr. Interest Income Cr. Notes Receivable

XX XX

Buyer’s journal entry: Dr. Notes Payable XX Dr. Interest Expense XX Cr. Accounts Payable

XX

g) If the note is repaid, the accounts receivable for the seller and the accounts payable for the buyer are paid and removed from the ledger accounts.

Seller journal entry: Dr. Cash XX Cr. Accounts Receivable

XX

Buyer journal entry: Dr. Accounts Payable Cr. Cash

XX

XX

h) If the note is given in exchange for equipment or other asset: Seller journal entry: Dr. Notes Receivable Cr. Sales

XX

Buyer journal entry: Dr. Store Equipment Cr. Notes Payable

XX

XX

XX

Teaching Tips/Strategy: For the demonstration lecture use the Problem 14A-1 as a step-by-step demonstration. Afterwards, let the students complete the Problem 14B-1 as a group-based activity to assess the retention and the understanding of the problem.

Learning Unit 14-3: Journalizing Entries to Discount a Note Summary: When the customer or seller goes to a bank and exchanges the note for cash, this process is called discounting a note. The company will endorse the note and receive the maturity value of the note (principal plus interest) less what the bank charges for holding the note from the date of discounting until the maturity date. The discount period is the time period during which the bank holds the note (until maturity). The amount that the bank charges the company is called the bank discount. The proceeds of the note is the maturity value less bank discount. If there is a possibility that the note might default, the potential liability is called a contingent liability. Until the note is paid, the organization will state this contingent liability as a footnote on its balance sheet. If the note is endorsed without recourse, the organization will not have any liability. Instead, the bank would have an uncollected receivable.

Key Concepts: Discounting a note, maturity value, discount period, bank discount, proceeds, contingent liability.

Lecture Outline: Discounting a note: .

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1. This is the process or act of transferring the note to a bank before the maturity date.

2. Businesses do this so they can receive cash immediately and not have to wait until the note matures.

3. The company signs the note over to the bank and receives the maturity value of the note (principal plus interest) less the amount the bank charges (bank discount) for it to hold the note until maturity or the bank discount. a) The discount period is the amount of time between the date the note was discounted and the maturity date. (It is the amount of time the bank will hold the note.) b) Steps in discounting a note: (a) Find the maturity value of the note: principal plus interest. (b) Calculate the discount period or the number of days from the date of discounting until the maturity date. (c) Calculate the bank discount (what the bank charges for holding the note until maturity).

Bank Discount = Maturity Value x Bank Discount Rate x (Discount Period/ 360 days) (d) Calculate the proceeds or what the company receives from the bank in the discounting process. (Maturity Value - Bank Discount = Proceeds) Journal entry from the proceeds (discounted note with interest income): (See Figure 14.9) Dr. Cash Cr. Notes Receivable Cr. Interest Income

XX XX (amount of note) XX

c) If the interest on the note does not cover the bank discount rate, there is interest expense instead of interest income. This is more likely to occur when a note is discounted early in the life of a note.

Journal entry (discounted note with interest expenses): (See Figure 14.10) Dr. Cash Dr. Interest Expense Cr. Notes Receivable

XX XX XX (amount of note)

d) When the note is discounted, the company agrees to pay the bank the maturity value of the note. If the maker dishonors the note, this is a contingent liability. (See Figure 14.11) Journal entry Dr. Accounts Receivable Cr. Cash

XX (principal + interest + protest fee) XX

Teaching Tips/Strategy: Use Accounting Coach LU 14-3 to check for understanding of concepts. The Discussion Question #8 is useful to review steps in discounting a note. For lecture demonstration you can utilize Concepts Checks #4 - #7. Assign Problem 14A-2 or 14B-2 for students to complete.

Use the “Ten-Minute Quiz” questions #8, #9, and #10 to reinforce the Learning Objective.

Learning Objective 14-4: Adjustments for Interest Expense and Interest Income .

14-7

Summary: Because interest-bearing notes are often taken out and then paid off in different accounting periods, it is necessary to adjust or bring up-to-date the interest income account and the interest expense account. Adjustments are made for income that has been earned during the period but has not been received or recorded because payment is not yet due. In addition, adjustments are made for interest that has been incurred during the period but has not been paid or recorded because payment is not yet due. Later in this unit, when we talk about adjustments, we will see that as the note matures the discount will be reduced and then charged to interest expense. Note that maturity value here is the same as the original principal because interest is deducted in advance. The discount on notes payable is the amount of interest deducted in advance by the lender. This reduces the notes payable account. The effective interest rate is the true rate of simple interest of the note.

Key Concepts: Discount on notes payable, effective interest rate.

Lecture Outline: 1. Discounting a business’s own note is done when the company borrows money from the bank in the form of a note.

2. There are several steps involved: a) Compute the discount which is the amount of interest deducted in advance by the lender.

Bank discount = Maturity Value x Interest Rate x (Discount Period /360 days) Journal entry to record the receipt of cash and the discount: Dr. Cash Dr. Discount on Notes Payable Cr. Notes Payable

XX XX XX

Journal entry to record the transaction when the note is paid: Dr. Notes Payable Cr. Cash

XX XX

b) Compute the effective interest rate which is based on the amount of cash the business is actually borrowing: (Maturity Value of Note) x (Bank Interest Rate) = Effective Interest Rate Amount of Cash Proceeds Received from Note c) Adjusting for interest is often necessary because interest-bearing notes are often paid in a different period from when the note was initiated. i) Payee must adjust for interest income that has been earned during the period but has not been received or recorded because payment is not yet due. ii) Maker must adjust for interest expense that has been incurred during the period but has not been paid or recorded because payment is not yet due. iii) The steps in recording the interest income or expense: Step #1: Calculate the interest on the note: Principal x Rate x Time.

Step #2: Calculate the number of days the note has already run before the end of the current period.

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Step #3: Calculate interest for this period: (# Days in current period) x Total Interest; # Days of the note Alternate calculation: principal x interest rate x (# days in Current period) 360 days Journal entry to record interest income (seller or holder): Dr. Interest Receivable Cr. Interest Income

XX XX

Journal entry to record interest expense (buyer or debtor): Dr. Interest expense Cr. Interest Payable

XX XX

Journal entry for the seller when the note is paid and no reversing entry: Dr. Cash Cr. Interest Receivable Cr. Notes Receivable Cr. Interest Income

XX XX (from adjusting entry) XX XX (for current period)

Journal entry for the seller when the note is paid with a reversing entry: Dr. Cash Cr. Notes Receivable Cr. Interest Income

XX XX XX

Journal entry for the buyer when the note is paid (no reversing entry): Dr. Notes Payable Dr. Interest Expense Dr. Interest Payable Cr. Cash

XX XX (for current period) XX (from adjusting entry) XX

Journal entry for the buyer when the note is paid (with reversing entry): Dr. Notes Payable XX Dr. Interest Expense XX (for current period) Cr. Cash XX 3. When a business discounts its own note and adjusts for interest expense over more than one accounting cycle, the discount on notes payable must be adjusted as well. a) Calculate the percentage of time that has elapsed between the start of the note and the end of the accounting cycle. b) Multiply this percentage by the discount on notes payable.

Journal Entry to record the interest expense: (See Figure 14.17) Dr. Interest Expense Cr. Discount on Notes Payable

.

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XX XX

Teaching Tips/Strategy: The Problem 14A-4 is an excellent review for the entire chapter objectives. This problem can be assigned or completed in groups during class time.

Use the “Ten-Minute Quiz” questions 6, 7, 8, 9 and 10 to reinforce the Learning Objective #2-4 concepts.

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Name

Date

Section

CHAPTER 14 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which of the following is not a required element needed to compute interest? a. principal b. rate c. time d. payer 2.

The party signing a note payable is called: a. the maker b. the payee c. the lender d. none of the above

3.

Interest on a $7,500, 8%, 120-day note is: a. $197 b. $600 c. $6,000 d. $72,000

4.

The amount being borrowed is called the: a. loan b. defaulting note c. principal d. note obligation

5.

The entry to record the payment of an interest-bearing promissory note is: a. Cash XX Notes Payable XX b. Notes Payable XX Interest Expense XX Cash XX c. Notes Payable XX Cash XX d. Interest Expense XX Cash XX Notes Payable XX

6.

When a customer cannot pay their account receivable and is willing to sign a note payable, the seller entry is: a. Debit Notes Payable, credit Accounts Payable b. Debit Accounts Payable, credit Notes Payable c. Debit Notes Receivable, credit Accounts Receivable d. Debit Accounts Receivable, credit Notes Receivable

7.

The entry by the seller when a note is dishonored is: a. Notes Payable XX Interest Expense XX Accounts Payable XX b. Cash XX Accounts Receivable XX c. Accounts Payable XX Cash XX d. Accounts Receivable XX Interest Income XX .

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Notes Receivable

XX

8.

The entry to record discounting a note with interest income is: a. Cash XX Interest Expense XX Notes Receivable XX b. Cash XX Notes Receivable XX Interest Income XX c. Notes Receivable XX Interest Income XX Cash XX d. Notes Receivable XX Interest Expense XX Cash XX

9.

On December 1, Jones Company borrows $10,000 by giving First National Bank and Trust a 10%, 60-day note and First National deducts the interest in advance. What is the amount of the discount that Jones Company will record on December 1? Assume a 360 day year. a. $1,000 b. $166.66 c. $83.33 d. $2.78

10.

On December 1, Jones Company borrows $10,000 by giving First National Bank and Trust a 10%, 60-day note and First National deducts the interest in advance. What is the effective interest rate?

Assume a 360 day year. a. 10% b. 11.9% c. 5.1% d. 10.2%

Answer Key to Chapter 14 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

d a a c b c d b b d

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14-12

Chapter 15 Accounting for Merchandise Inventory Chapter Overview This chapter discusses the business dilemma of having the right quantities of inventory available for sale to customers. Having too small of an inventory risks running short of inventory and missing out on sales revenue. Having too much of an inventory risks having too much of the company’s money tied up in inventory overstocks. The periodic inventory system does not provide real-time balances of inventory items.

What happens with a periodic inventory systems is that periodically (at the end of the accounting period.

Inventory is counted (physical count) and as a result: both inventory balances and cost of goods sold are updated.

Therefore, with the periodic inventory system, managers do not have accurate (real-time) inventory balances nor an accurate cost of goods sold amount until the accounting period ends.

The current business trend is to utilize perpetual systems that have current information (real-time data) about how much inventory is on hand. With the perpetual system, managers know when inventory levels are getting low so they can reorder product and avoid running out of stock. The perpetual inventory system provides this information on a transaction-by-transaction basis. Periodically, physical counts of inventory are also done to validate the accounting records.

The chapter concludes with valuing ending inventory. When it is not practical or not possible to take a physical inventory, there may be important reasons why a business needs to value its inventory. For example, the need to issue interim financial statements make an estimating method necessary. Also, in the case of a loss of inventory because of fire or other disasters make it necessary, for insurance claims, to estimate the value of the inventory. There are two methods that allow a business to estimate an ending inventory: the retail method and the gross profit method.

Learning Objectives After studying Chapter 15, your students should gain proficiency in the following: 1. Journalize Transactions for a Perpetual and Periodic Inventory System.

2. Explain Using Subsidiary Ledgers in Calculating Cost of Ending Inventory in a Perpetual System.

3. Explain Inventory Methods to Calculate Ending Inventory in a Periodic System.

4. Estimate Ending Inventory by the Retail and Gross Profit Methods.

Copyright © 2023 Pearson Education, Inc.

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Chapter 15 Assignment Grid Learning Assignment Topic(s) Objective(s) Discussion Questions and Critical Thinking/Ethical Case 1 Perpetual vs. Periodic Inventory 1 2 Perpetual Inventory Accounts 1 3 Perpetual Inventory Entries 1 4 Perpetual Inventory Entries 1 5 Subsidiary Inventory Ledger 2 6 Flow of Goods and Method Selection 1 7 Methods of Inventory Valuation 3 8 Methods of Inventory Valuation 3 9 Methods of Inventory Valuation 3 10 Inventory Valuation 3 11 Inventory Valuation Errors 3 12 Retail Method and Gross Profit Method 4 13 Ethical Case 1 Concept Checks 1 Transaction Analysis 1 2 Perpetual Inventory Journal Entries 1 3 Perpetual Inventory Journal Entries 1 4 Perpetual Inventory Journal Entries 1 5 Estimating Inventory Value 3 6 Retail Inventory Method 4 7 Gross Profit Method 4 Exercises (Set A) E15A-1 Perpetual Inventory Journal Entries 1 E15A-2 Perpetual Inventory Journal Entries 1, 2 E15A-3 Perpetual Inventory Journal Entries 1, 2 E15A-4 Perpetual Inventory Computations 2,3 E15A-5 Periodic Inventory Computations 3 E15A-6 Inventory Computation 3 E15A-7 Retail Inventory Method 4 E15A-8 Gross Profit Method 4 Exercises (Set B) E15B-1 Perpetual Inventory Journal Entries 1 E15B-2 Perpetual Inventory Journal Entries 1, 2 E15B-3 Perpetual Inventory Journal Entries 1, 2 E15B-4 Perpetual Inventory Computations 2,3 E15B-5 Periodic Inventory Computations 3 E15B-6 Inventory Computation 3 E15B-7 Retail Inventory Method 4 E15B-8 Gross Profit Method 4 Problems (Set A) 15A-1 Perpetual Inventory Entries 1 15A-2 Subsidiary Inventory Ledger 1, 2 15A-3 Perpetual Inventory Computations 1, 2 15A-4 Periodic Inventory Computations 3 15A-5 Retail Method 4 15A-6 Gross Profit Method 4 Copyright © 2023 Pearson Education, Inc.

Estimated Time in Minutes

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Easy Easy Easy Easy Medium Medium Medium

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Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

1 1, 2 1, 2 3 4 4

20 40 30 30 20 20

Medium Hard Medium Medium Medium Medium

Financial Report Problem Reading Amazon’s Annual Report/Internet Project

3

10

Easy

Keeping It Real Suarez Digital Services

3

45

Medium

Assignment Topic(s) Problems (Set B) 15B-1 Perpetual Inventory Entries 15B-2 Subsidiary Inventory Ledger 15B-3 Perpetual Inventory Computations 15B-4 Periodic Inventory Computations 15B-5 Retail Method 15B-6 Gross Profit Method

Learning Unit 15-1: Transactions for a Perpetual and Periodic Inventory System Summary: Perpetual inventory system is an inventory system of a company that keeps a continuous (perpetual) record of inventory on hand and of the cost of goods sold. A periodic inventory system needs a final physical inventory to calculate the cost of the goods sold. A major weakness of the periodic system is that inventory is checked and counted only at the end of the accounting period; and, therefore, managers do not know the actual amount of inventory on hand or the actual cost of goods sold until the end of the accounting period. The perpetual system of accounting for merchandise inventory provides this information on a transaction-by-transaction basis. In the perpetual inventory system, we have two key accounts: Merchandise Inventory and Cost of Goods Sold. The Merchandise Inventory account is an asset account that will reveal the current balance of inventory at all times (perpetually). This account is the same one used in the previous discussion of the periodic inventory system, but in the periodic system the balance of the Merchandise Inventory is correct only at the end of each accounting period. In the perpetual system entries are recorded to the Merchandise Inventory account each time the store purchases new merchandise and each time the store sells merchandise to a customer. The other key account is the Cost of Goods Sold account. As merchandise is sold to customers, an entry will be recorded that will remove the cost of the merchandise from the Merchandise Inventory account and transfer that cost to the Cost of Goods Sold account. Thus, the Merchandise Inventory account will show the correct cost for the inventory on hand, and the Cost of Goods Sold account will show the cumulative total cost of all merchandise that has been sold to customers during the accounting period.

Key Concepts: Perpetual inventory system Lecture Outline: 1. A perpetual inventory is: a. Perpetual inventory system keeps a continuous record of inventory on hand and the cost of goods sold. b. Merchandise Inventory account is an asset account representing the current balance of inventory. c. Cost of goods Sold account is a cost account and is treated similar to an expense account.

Copyright © 2023 Pearson Education, Inc.

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i.

As merchandise is sold, an entry will be recorded to remove the cost of the inventory from the merchandise inventory account and transferred to the cost of goods sold account. d. The entries involving inventory when a perpetual inventory system is used: The purchase of inventory is recorded as: Dr. Merchandise Inventory Cr. Accounts Payable

XX (Cost) XX (cost)

When the inventory is sold, there are two entries: One entry records the sale at the sales price: Dr. Cash XX (Sales Price) Cr. Sales Revenue XX (Sales Price) The other entry records the transfer of goods from the inventory account to cost of goods sold account and is recorded at the cost paid for the inventory: Dr. Cost of Goods Sold Cr. Merchandise Inventory

XX (Cost) XX (Cost)

If the merchandise is returned to the seller, there are two entries for the seller and one entry for the buyer: The seller records the following entry at the sales price: Dr. Sales Returns and Allowances Cr. Accounts Receivable

XX (Sales Price) XX (Sales Price)

The seller records the following entry at the cost of the inventory: Dr. Merchandise Inventory Cr. Cost of Goods Sold

XX (cost) XX (cost)

The buyer of the goods records the following entry: Dr. Accounts Payable Cr. Merchandise Inventory

XX XX

2. Comparing the perpetual and periodic inventory systems: a. In a perpetual system: i.

Merchandise inventory is an active account that shows the movement of inventory. ii.

Cost of goods sold is an actual account that is updated with every transaction. b. Periodic system: i.

Less control ii.

Inventory is not updated constantly. c. Inventory internal controls - periodic and perpetual system uses: i.

Physical inventory is taken at least once a year to verify the accuracy of inventory records ii.

Detect inventory recording errors iii.

Detect shoplifting iv.

Check for damaged inventory v.

Check for obsolete inventory Copyright © 2023 Pearson Education, Inc.

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Teaching Tips/Strategy: Differentiate and compare the periodic inventory system and the perpetual inventory systems entries, refer to Figure 15.6. To emphasize all procedures of a perpetual inventory system, start with the Success Coach LU 15-1 and then discuss the Discussion Questions 1 through 4. Demonstrate the journal entries in Exercise 15A-1, and assign Exercise 15B-2.

Learning Unit 15-2: Using a Subsidiary Ledger for Inventory; Calculating Cost of Ending Inventory Using a Perpetual System Summary: How do stores such as Wal-Mart keep track of the thousands of items that they keep in inventory?

The answer is found in the use of a subsidiary ledger for inventory and the use of computers to maintain the subsidiary ledger. The Merchandise Inventory account becomes a control account keeping track of the total balance of inventory, while the details are kept in separate inventory records in a subsidiary ledger for inventory. A business with a variety of products in inventory will use an inventory subsidiary ledger with an individual record for each different product. These records will contain the details about the quantity and cost of inventory on hand and will allow calculation of the cost of goods sold on each sale. Most modern computerized accounting systems can handle a perpetual inventory system with ease. You have no doubt seen such systems in operation when the clerk at your local store used a laser scanner or a bar code to enter your purchases into the cash register. The transaction entered into the cash register will record the sale and update the cost of goods sold and inventory.

Key Concepts: None Lecture Outline: Subsidiary ledgers are used to keep track of the costs and balances of a variety of inventory items.

1. The subsidiary ledger for merchandise inventory operates similar to the subsidiary ledger for accounts receivable or accounts payable. a. The purchase of inventory is recorded in the general journal, posted to the general ledger, and also to the subsidiary ledger (See Figure 15.7) b. The sale of inventory is recorded in the general journal, posted to the general ledger, and also to the subsidiary ledger (See Figure 15.8) c. The cost of goods sold is computed and recorded at the time of the sale.

Teaching Tips/Strategy: For classroom demonstration purposes use Exercises 15A-2 and 15A-3. Assign Exercises 15B-2 and 15B-3.

Learning Unit 15-3: Inventory Methods to Calculate Ending Inventory in a Periodic System Summary: For a small business or any business using the periodic inventory system, the method used to assign costs to ending inventory will have a direct effect on the company’s cost of goods sold and gross profit.

If all inventory brought into a store had the same cost, it would be simple to calculate the ending inventory, and we would not have to have this discussion. Unfortunately, things are not that easy. Often the same products are purchased and brought into the store at different costs during the same accounting period. On the date inventory is taken, goods in transit should be added to inventory if the ownership of the inventory has been transferred to the buyer. For example, if the merchandise was purchased F.O.B. shipping point, the buyer becomes the owner of the merchandise when the merchandise is placed on the carrier at the shipping point. On the other hand, if the buyer purchases the merchandise F.O.B. destination, the seller has ownership of the merchandise until the merchandise reaches the destination; and it should not be included in the cost of the buyer’s inventory.

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Consignment means that a business (the consignor) is selling its merchandise through an agent (the consignee) who does not own the merchandise but who has possession of it. Consigned merchandise belongs to the consignor and should not be included in the consignee’s inventory cost. If the merchandise is not saleable, it should not be added to the cost of the inventory. For merchandise that is saleable but at a lower cost, the value of that inventory should be estimated at a conservative amount and added to the cost of the inventory.

Over the years, four generally accepted methods have been developed to assign a cost to ending inventory.

The reason these methods are needed is that often inventory is made up of many past purchases at different prices. Think of the inventory methods as ways of tracing costs or inventory flow: the methods are (1) specific invoice (identification); (2) first-in, first-out (FIFO); (3) last-in, first-out (LIFO); and (4) weighted-average. Both the perpetual and periodic inventory methods are based on an assumed flow of costs, not on the actual physical movement of goods sold in a store. In summary, periodic inventory system is an inventory system that counts inventory only at the end of the accounting period.

Key Concepts: Periodic inventory system, specific invoice method, FIFO (first-in, first-out) method, LIFO (last-in, first-out) method, weighted-average method, consistency, full disclosure principle, consignment, consignor, consignee.

Lecture Outline: The method used to assign costs to ending inventory will have a direct effect on the company’s cost of goods sold and gross profit. The flow of moving inventory and the method chosen to cost it do not have to match. There are four generally accepted methods used to compute inventory: 1. Specific Invoice (Identification) – the method of valuing inventory where each item is identified with a specific invoice. a. Pros: i. This is simple to use if a company has a small amount of high-cost goods, such as autos, jewels, boats, or antiques. ii. The flow of goods and the flow of costs are the same. iii. Costs are matched with the sales they helped to produce. b. Cons: i. Difficult to use for goods with large unit volume and small unit prices such as nails at a hardware store or packages of toothpaste at a drug store. ii. Difficult to use for decision-making purposes. Ordinarily an impractical approach because companies usually deal with high-cost unique items.

2. First-In, First-Out Method (FIFO) – the method of valuing inventory that assumes the oldest goods are sold first. Therefore, the items in ending inventory are the newest goods purchased. a. Pros: i. The cost flow tends to follow the physical flow. Most businesses try to sell the old goods first (perishables such as fruit or vegetables). ii. The amount for ending inventory is made up of current costs on the balance sheet (because inventory left over is assumed to be from the last goods purchased). b. Cons: i. During periods of inflation this method will produce higher income on the income statement and thus more taxes to be paid. ii. Recent costs are not matched with recent sales, because we assume old goods are sold first.

3. Last-In, First-Out Method (LIFO) – the method of valuing inventory that assumes the newest goods are sold first. Therefore, the items in ending inventory are the oldest goods purchased. a. Pros: i. Cost of goods sold is recorded at or near current costs, because costs of latest goods acquired are used. ii. LIFO matches current costs with current selling prices.

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iii. During periods of inflation this method produces the lowest net income, which is a tax advantage. (The lower cost of ending inventory means a higher cost of goods sold. With a higher cost of goods sold, gross profit and ultimately net income are smaller and thus taxes are lower.) b. Cons: i. Ending inventory is valued at very old prices. ii. LIFO does not match physical flow of goods (but can still be used to calculate flow of costs).

4. Weighted-Average Method – the method of valuing inventory where each item is assigned the same unit cost (a weighted-average). This unit cost is found by dividing cost of goods available for sale by the total number of units for sale. a. Pros: i. Weighted-average considers the number of units purchased at each amount, not a simple average cost. This method is good for products sold in large volume, such as grains and fuels. ii. Accountant assigns an equal unit cost to each unit of inventory. Therefore, when the income statement is prepared, net income will not fluctuate as much as with other methods. b. Cons: i. Current prices have no more significance than prices of goods bought months earlier. ii. Compared with other methods, the most recent costs are not matched with current sale.

This fact is important in financial reporting so as to provide an accurate picture of the company. iii. Cost of ending inventory is not as up-to-date as it could be using another method.

5. When can the inventory method be changed? Repeated switching of methods is not permitted because significant changes would occur in the profit being reported. a. Principle of Consistency – the accounting principle that requires companies to follow the same accounting methods or procedures from period to period. b. Full Disclosure Principle – the requirement to disclose company changes that may affect an investor’s opinion of the company. With regard to inventory, the full disclosure principle is a financial statement footnote of the change in inventory methods, the effects of the change on profit and inventory valuation, and the justification for the change.

6. Items to be included in the cost of inventory a. Goods in transit – should be added to the buyer’s inventory if ownership of the inventory has been transferred to the buyer. b. F.O.B. shipping point is free shipping for the shipper. The buyer pays for the shipping, and ownership transfers to the buyer as soon as the inventory is shipped from the seller. c. F.O.B. destination is free shipping for the buyer. The seller pays for the shipping, and ownership transfers to the buyer as soon as the inventory is delivered to the buyer.

Teaching Tips/Strategy: Explain and demonstrate the different methods of determining the value of inventory. Start by using the Blueprint for the concepts. Also, use the Success Coach 15-3. For class discussion use Discussion Questions 6 through 9, and for classroom demonstration use Concept Check 5.

Use the “Ten-Minute Quiz” questions 2, 3, 4, 5 and 6 to reinforce the Learning Objective concepts.

Learning Unit 15-4: Estimating Ending Inventory by the Retail and Gross Profit Methods Summary: The actual taking of a physical inventory is time consuming and expensive. Because of the time and expense involved, most businesses take a physical inventory only once a year. For the business using the Copyright © 2023 Pearson Education, Inc.

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periodic inventory system, the need to have an inventory cost amount more often may become necessary, especially when a business makes interim financial reports. This business may find that estimating the inventory rather than taking a physical inventory is accurate enough. Another reason to estimate the ending inventory is in case of a fire or other disaster when the inventory may be destroyed. The business would need an inventory cost amount when it submits a claim of loss to the insurance company. Two common and recognized ways to estimate ending inventory are the retail method and the gross profit method. To use the retail method, a business must have the following information available: beginning inventory at cost and at retail (selling price), cost of net purchases at both cost and at retail, and net sales at retail price. The gross profit method is a method used to determine the value of the ending inventory using a predetermined gross profit rate. This method can be used to determine value of ending inventory if a loss from fire occurs. The retail method is a method used to determine the value of the ending inventory using a cost-to-retail ratio.

Key Concepts: Retail method, gross profit method.

Lecture Outline: There is a need for estimating inventories when an estimate is accurate enough that a physical inventory is not necessary or when a fire or other catastrophe causes inventory to be destroyed.

There are two methods for estimating inventory: 1. The retail method is a method used to determine the value of the ending inventory using a cost-to-retail ratio. This method is often used to prepare interim financial statements. The information needed is: a. Beginning inventory at cost and retail b. Cost of net purchases at both cost and retail c. Net sales at retail d. Steps in calculating ending inventory: i. Calculate cost of merchandise available for sale at cost and retail. ii. Calculate the cost ratio (cost of goods available for sale at cost divided by cost of goods available for sale at retail). iii. Deduct net sales from retail value of merchandise available for sale to arrive at an estimated ending inventory at retail. iv. Multiply cost ratio times ending inventory at retail to arrive at ending inventory at cost.

2. Gross profit method is a method used to determine the value of the ending inventory using a predetermined gross profit rate. Information needed: a. Average gross profit rate (= gross profit/net sales) b. Net sales, beginning inventory, and net purchases c. Steps in calculating ending inventory: i. Determine cost of goods available for sale (beginning inventory + net purchases). ii. Estimate cost of goods sold by multiplying cost percentage times net sales, iii. Subtract cost of goods sold from cost of goods available for sale to arrive at an estimated inventory amount.

3. How does an incorrect valuation of inventory affect financial statements?

If the inventory is Overstated Understated_____ Beginning Inventory Profit is understated Profit is overstated Ending Inventory Profit is overstated Profit is understated Teaching Tips/Strategy: Use the “Ten-Minute Quiz” questions 7, 8, 9 and 10 to reinforce the Learning Objective concepts.

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Name

Date

Section

CHAPTER 15 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

On December 22, a business buys merchandise inventory under the terms F.O.B. destination. The goods are shipped on December 31, arrive on January 4, and are paid for on January 14. When would the business record the purchase of inventory? a. December 22. b. December 31 c. January 4. d. January 14.

2.

Which inventory method during periods of inflation will always produce the lowest ending inventory cost? a. FIFO b.

LIFO c. Both FIFO and LIFO d.

Neither FIFO nor LIFO

3.

Which method of inventory assumes recent costs are not matched with recent sales, because the method assumes old costs are sold first? a. FIFO b.

LIFO c. Both FIFO and LIFO d.

Neither FIFO nor LIFO

4.

A company had the following information regarding inventory

Beginning Balance Purchase: March 14 Purchase: March 19 Purchase: August 3 Purchase: December 22

# items 23 20 15 30 12

cost per unit $10.00 $10.50 $11.00 $11.50 $12.50

If the ending inventory contained 25 items and the company uses FIFO, what is the value of ending inventory? a. $251.00 b. $274.50 c. $299.50 d. $349.00 5.

A company had the following information regarding inventory

Beginning Balance Purchase: March 14 Purchase: March 19 Purchase: August 3 Purchase: December 22

# items 23 20 15 30 12

cost per unit $10.00 $10.50 $11.00 $11.50 $12.50

If the ending inventory contained 25 items and the company uses LIFO, what is the value of ending inventory? a. $251.00 b. $274.50 c. $299.50 d. $349.00 6.

A company had the following information regarding inventory Copyright © 2023 Pearson Education, Inc.

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# items cost per unit Beginning Balance 23 $10.00 Purchase: March 14 20 $10.50 Purchase: March 19 15 $11.00 Purchase: August 3 30 $11.50 Purchase: December 22 12 $12.50 If the ending inventory contained 25 items and the company uses weighted-average, what is the value of ending inventory? a. $251 b. $275 c. $300 d. $349 7.

A company had a fire destroy all of its inventory but the accounting records allowed the following information to be reconstructed.

Beginning Inventory $25,000 Net Purchases $330,000 Sales $510,000 Gross Profit Rate 35% Using the gross profit method, what is the amount of gross profit? a. $21,200 c. $178,500

8.

b. d.

$23,500 $331,500

A company had a fire destroy all of its inventory but the accounting records allowed the following information to be reconstructed.

Beginning Inventory $25,000 Net Purchases $330,000 Sales $510,000 Gross Profit Rate 35% Using the gross profit method, what is the amount of inventory destroyed? a. $21,200 c. $178,500

9.

b. d.

$23,500 $331,500

A company uses the retail inventory method and had the following costs: Cost Retail Price Beginning Inventory $34,800 $68,100 Purchases $253,500 $508,500 Sales $490,000 How much is gross profit? a. $28,830 c. $245,000

10.

b. d.

$43,300 $288,300

A company uses the retail inventory method and had the following costs: Cost Retail Price Beginning Inventory $34,800 $68,100 Purchases $253,500 $508,500 Sales $490,000 What is the value of ending inventory? a. $28,830 b. $43,300 Copyright © 2023 Pearson Education, Inc.

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c. $245,000

d.

$288,300

Answer Key to Chapter 15 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

c b a c a b c b c b

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Chapter 16 Accounting for Property, Plant, Equipment, and Intangible Assets Chapter Overview Property, plant, equipment, and intangible assets are used in a business to earn revenue for more than one year or operating cycle. They lose value over that period of time and eventually will be written off the books. This chapter discusses the cost of an asset and some of the depreciation methods used to write off a portion of the cost each year. The methods of straight-line and units-of-production consider the cost of the asset less its residual value in determining the depreciation per year or per unit of production. The declining balance method computes a depreciation rate and multiples that rate by the book value of the asset until the book value of the asset decreases enough to equal the residual value. The modified accelerated cost recovery (MACRS) system multiples the cost of the asset by the percentages listed in the MACRS tables.

The chapter also discusses the difference between capital and revenue expenditures, the concept of amortization, and the preparation of journal entries for retiring, selling, or exchanging capital assets. The chapter concludes with an explanation of amortization and how it applies to intangible assets.

Learning Objectives After studying Chapter 16, your students should gain proficiency in the following: 1. Calculate the Cost of Property, Plant, and Equipment.

2. Explain and Calculate Depreciation Methods.

3. Journalize Entries for Capital and Revenue Expenditures and Disposal of Plant Assets.

4.

Journalize Transactions for Natural Resources and Intangible Assets.

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Chapter 16 Assignment Grid Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Cost of Property, Plant, and Equipment 1 2 Land Improvement Account 1 3 Capital and Revenue Expenditures 3 4 Depreciation 2 5 Modified Accelerated Cost Recovery System 2 6 Capital and Revenue Expenditures 3 7 Depreciation 2 8 Discard, Selling, and Exchanges 3 9 Discard, Selling, and Exchanges 3 10 Depletion 4 11 Intangible Assets 4 12 Ethical Case 1 Concept Checks 1 Cost of Property, Plant, and Equipment 1 2 Depreciation Methods 2 3 Depreciation Schedules 2 4 Units-of-Production Method 2 5 Double Declining-Balance Method 2 6 Capital and Revenue Expenditures 3 7 Loss and Gains 3 8 Exchange with Gain 3 9 Exchange with Loss 3 Exercises (Set A) 16A-1 Cost of Property, Plant, and Equipment 1 16A-2 Depreciation Methods 2 16A-3 Depreciation Methods 2 16A-4 Intangible Assets and Amortization 4 16A-5 Modified Accelerated Cost Recovery System 2 Exercises (Set B) 16A-1 Cost of Property, Plant, and Equipment 1 16A-2 Depreciation Methods 2 16A-3 Depreciation Methods 2 16A-4 Intangible Assets and Amortization 4 16A-5 Modified Accelerated Cost Recovery System 2 Problems (Set A) 16A-1 Property, Plant, & Equipment Entries 1, 3 16A-2 Depreciation Methods 2 16A-3 Depreciation Methods 2

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Estimated Time in Minutes

Level of Difficulty

5 5 5 5 5 5 5 5 5 5 5 10

Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Medium

5 10 10 10 10 5 5 15 15

Easy Easy Easy Easy Medium Easy Easy Medium Medium

15 30 30 10 10

Medium Medium Medium Medium Medium

15 30 30 10 10

Medium Medium Medium Medium Medium

30 60 60

Medium Hard Hard

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

Problems (Set B) 16B-1 Property, Plant, & Equipment Entries 16B-2 Depreciation Methods 16B-3 Depreciation Methods

1, 3 2 2

30 60 60

Medium Hard Hard

Financial Report Problem Reading Amazon’s and Target’s Annual Reports

1,2

20

Medium

Assignment Topic(s)

Learning Unit 16-1: Calculating the Cost of Property, Plant, and Equipment Summary: The cost of property, plant, and equipment is not just the price one pays to buy it. One must also include the cost involved in getting it into position and in condition for use in the company. Thus, the cost of a machine includes freight, assembly, and all other costs that are needed to get the machine up and ready to run. When land (which has unlimited useful life) is purchased, many incidental costs are usually considered part of the cost of the land. These costs include surveying, commissions to attorneys and real estate brokers, title searches, and grading, draining, and clearing the property. Any special one-time assessment made for paving a street or installing sewers should be charged to cost of land, because it adds “permanent value” to the land.

Land Improvements is an asset account that records improvements to land that have a limited useful life.

Some examples are driveways, fences, shrubbery, paving of parking lots, and sprinkler systems. These improvements are subject to depreciation, and thus we need an account that is kept separate from the Land account which does not depreciate. The cost of buying a building would include the purchase price and all the cost of repairs and other expenses to get the building ready for use. For construction of a new building, the cost would include all reasonable and necessary payments for labor, insurance, building permits, architect’s fees, legal fees, and so on to get the building ready for use. If a building and land are purchased for one lumpsum payment, the cost must be separately allocated for each; because land will not depreciate, but buildings will.

Key Concepts: Land improvements Lecture Outline: 1. Land and land improvements: a. Land – there are some types of costs associated with the purchase of land which add permanent value to the land and are added to the costs. Examples are: i. Surveying ii. Attorney’s and/or real estate broker’s commissions iii. Title searches iv. Grading, draining, and clearing of property b. Land Improvements – an asset account that records improvements made to land. Such improvements have a useful life and are subject to depreciation. Examples are: i. Driveways ii. Fences

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iii. Shrubbery iv. Paving of parking lots v. Sprinkler system c. Buildings: i. Cost of purchased building includes the purchase price and all cost of repairs and other expenses to get the building ready for use. ii. Cost of construction of a building includes all reasonable costs for labor, insurance, building permits, architect fees, legal fees, etc. to get the building ready for use. d. Equipment – the cost of equipment is similar to the cost of buildings and includes all associated fees to get the equipment ready for its intended use.

Teaching Tips/Strategy: Describe each asset, its classification, and the related costs included in the acquisition cost. Explain why the classification will help determine the useful life, the depreciation rate, and the cost recognition. The Discussion Questions 1 and 2 are excellent to explain the “reasonable and necessary cost” terms. The “cost” question is discussed in this objective. Students have a common misconception that cost is only the amount paid for the asset. Be prepared to explain additional items that are also included in the cost such as installation, shipping, setup costs, and many other incidental charges. Concept Check #1, Exercise 16A-1, and Exercise 16B-1 are excellent to support the concepts.

Use the “Ten-Minute Quiz” Question #1 to reinforce the learning concepts.

Learning Unit 16-2: Depreciation Methods Summary: When a company calculates its periodic depreciation expense, different methods will produce significantly different results. Thus, the method of depreciation chosen will affect the net income for current as well as future periods and the book value (cost of asset less accumulated depreciation) of the asset on the balance sheet. The following are the three common depreciation methods that an organization could use: straight-line method, units-of-production method, and double declining-balance method. The straight-line method is simple to use because it allocates the cost of the asset (less residual value) evenly over its estimated useful life. (At the time an asset is acquired, an estimate is made of its usefulness or useful life in terms of number of years it would last, amount of output expected, and so forth.). With the units-ofproduction method, it is assumed that passage of time does not determine the amount of depreciation taken.

Depreciation expense is based on use, be it total estimated miles, tons hauled, or estimated units of production (e.g., the number of shoes a machine could produce in its expected useful life). The double decliningbalance method is an accelerated method in which a larger depreciation expense is taken in earlier years and smaller amounts in later years. For this reason, it is called an accelerated depreciation method. This method depreciates at twice the straight-line rate, which is why it is called the double declining-balance method. A key point in this method is that residual value is not deducted from cost in the calculations, and the asset cannot be depreciated below its residual value.

A system for businesses to calculate depreciation for tax purposes based on the Tax Laws of 1986 and 1989 is called the Modified Accelerated Cost Recovery System. The tax law requires a business to depreciate assets based on recovery classification and the MACRS depreciation rate.

Key Concepts: Book value, residual (salvage) value, straight-line method, useful life, units-of-production method, double declining-balance method, accelerated depreciation method, modified accelerated cost recovery system (MACRS).

Lecture Outline: 1. Terms needed:

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a. Book value – the cost of an asset less accumulated depreciation. b. Useful life – the length of time that an asset is expected to be productive. c. Residual or salvage value – the assumed value of the asset at the end of its useful life.

2. Depreciation methods: a. Straight-line depreciation method is the method that allocates an equal amount of depreciation over its useful life. The annual depreciation expense computation: (Cost – residual value) / Useful life in years. b. Units-of-production method is the method based on usage, and depreciation is allocated in equal amounts per unit produced. i. The annual depreciation expense per unit computation is done in two parts. The first part computes the depreciation cost per unit produced: (Cost – residual value) / Estimated Units of Production ii. The depreciation for a year is the per unit depreciation rate times the number of units produced. c. Double declining-balance method is an accelerated depreciation method that calculates depreciation as twice the straight-line rate times the book value of the assets. (Book value = cost less accumulated depreciation). a. An accelerated depreciation method is a method where more depreciation is taken in earlier years compared to later years. b. Unlike the other depreciation methods, this method does not subtract the residual value from the book value when computing depreciation. Instead, it depreciates the asset UNTIL the book value equals the residual value. c. The depreciation rate is computed as (100% / Useful Life) times 2. d. Depreciation is expensed as the depreciation rate times the book value and is the lesser of: i. Book value times twice the depreciation rate or ii. Book value less residual value 3. Depreciation for partial years: a. When assets are purchased during the year, depreciation is calculated based on the number of months the business owned the asset. i. Any asset purchased before the 15th of the month is considered owned by the business for the entire month. ii. Any asset purchased after the 15th of the month is not depreciated for that month. b. Straight-line depreciation is the annual depreciation times (number of months in service during the year /12 months) c. Units-of-production method is not affected because it is based on the actual number of units produced during the year. d. Double declining-balance method is the annual depreciation times (number of months in service during the year /12 months) 4. Modified Accelerated Cost Recovery System (MACRS): a. Used to calculate depreciation for tax purposes b. Based on the Tax Laws of 1986, 1989, and 2010 c. Also known as the General Depreciation System (GDS) d. Provides the opportunity to expense more of an asset in a shorter time i. Resulting in increased depreciation expense and ii. Lower business taxes e. Requires recovery classification and MACRS depreciation rates for computing depreciation expense

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Teaching Tips/Strategy: Define the term: residual value or salvage value, disposal value, useful life, and depreciable cost. Emphasize that depreciable cost differs from cost, and that useful life is not the actual physical life. Differentiate the three depreciation methods and point out the uses of each one of the methods.

For lecture demonstration of the straight-line method, complete Concept Check #2. For demonstration of the units-of-production method, complete Concept Check #4. For the double declining-balance method, use the Concept Check #5. Integrate the Exercise 16A-2 as a practice quiz or a group activity since this exercise covers all three methods.

Direct students to the IRS website www.irs.gov and look for Publication 946-How to Depreciate Assets under MACRS. This publication can help students gain a basic understanding of MACRS and how it is utilized.

Use the “Ten-Minute Quiz” questions 5, 6, 7, and 8 to reinforce the learning concepts.

Learning Unit 16-3: Journalizing Entries for Capital and Revenue Expenditures and Disposal of Plant Assets Summary: Capital expenditures include the original cost of an asset as well as payments that improve on or enlarge existing assets. Capital expenditures may be broken down into three categories: additions or enlargements, extraordinary repairs, and betterments. The differences between these three categories are based on whether the change will add to the value of the asset, extend the life of the asset, or only improve the asset’s efficiency. For example, adding a new wing to a school building will increase the value of the asset, so it is categorized as an addition or enlargement. Overhauling an aircraft engine definitely extends the life of the asset, so it is categorized as an extraordinary repair. Adding a CB radio to a fleet of delivery trucks improves the efficiency of the asset but does not extend its life, so it is categorized as a betterment (See Figure 16.2). Another type of expenditure occurs after an asset has been acquired. Revenue expenditures are payments made for ordinary maintenance of an asset or unnecessary or unreasonable situations. These expenditures occur on a regular basis and are recorded as expenses. Examples include changing oil and greasing a car, replacing windowpanes, changing tires on a truck, repainting a car, and adding a sunroof.

The assets can be disposed of in the following ways: discarding plant assets, selling plant assets, and exchanging for similar plant assets. Remember that depreciation is recorded up until the date a plant asset is disposed of. A company discards a plant asset when it is no longer operational (e.g., machinery or a truck that no longer works). That also means that no other company is willing to buy or exchange something for the asset. You can dispose of the asset at no gain or no loss, at a gain, or at a loss. A trade-in allowance is given when you are buying a new car. For example, you receive a trade-in allowance when you trade in your old one for a sum of money that is applied to the price of the new car. A loss on exchange will result if the book value of the old machine is greater than what is received for the trade-in allowance.

Key Concepts: Capital expenditures, additions or enlargements, extraordinary repairs, betterments, revenue expenditures.

Lecture Outline: 1. Capital expenditures include the original cost of an asset as well as payments that improve on or enlarge existing assets. a. Additions or enlargements are major changes or improvements that increase the value of an asset. i. Example: a new wing to a building ii. The cost of the asset is debited to the asset account.

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b. Extraordinary repairs are infrequent expenditures that extend an asset’s useful life. i. Example: a new engine in a car ii. These expenditures may cancel some of the past accumulated depreciation for the cost of the extraordinary repairs: iii.

Dr. Accumulated Depreciation XX Cr. Cash XX iv. These extraordinary repairs extend the useful life of the asset for depreciation purposes from this point forward. c. Betterments are improvements that increase the efficiency of an asset by adding accessories or replacing parts with more effective/powerful ones. i. Example: stairway replaced by escalator ii. They do not extend the life of an asset.

2. Revenue expenditures are payments made for ordinary maintenance of an asset. a. Occur on a regular basis b. Recorded as an expense c. Examples: changing oil, painting, changing tires, adding a sunroof to a car, etc.

3. Disposal of Plant Assets (Discard/Abandon/Donation) occurs when the asset is no longer functional to the business, and there is no salvage value. a. No gain or loss is recognized because the asset is fully depreciated.

The journal entry to record the disposal: Dr. Accumulated Depreciation, Truck Cr. Truck

XX XX

b. There is a loss on the disposal when the asset is not fully depreciated, or the salvage value is unattainable.

The journal entry to record the disposal: Dr. Loss on Disposal of Plant Asset Dr. Accumulated Depreciation, Truck Cr. Truck

XX XX XX

c. A loss from fire occurs when settling an insurance claim on an asset being disposed.

The journal entry to record the disposal: Dr. Cash Dr. Loss from Fire Dr. Accumulated Depreciation, Machinery Cr. Machinery

XX XX XX XX

5. Disposal by Selling Plant Assets: a. A gain on the sale occurs when the cash received is more than the book value of the asset.

The journal entry to record the disposal: Dr. Cash Dr. Accumulated Depreciation, Truck Cr. Truck Cr. Gain on Sale of Plant Asset

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XX XX XX XX

b. A loss on the sale occurs when the cash received is less than the book value of the asset.

The journal entry to record the disposal: Dr. Cash Dr. Accumulated Depreciation, Truck Dr. Loss on Sale of Plant Asset Cr. Truck

XX XX XX XX

6. Disposal by exchanging for similar plant assets: a. A gain is absorbed into the cost of the new machine if the exchange is for similar items. The value of the new asset is the book value of the old asset plus the gain on the exchange less the cash received in the exchange.

The journal entry to record the disposal is:

Dr. Machinery (new) Dr. Accumulated Depreciation (old) Cr. Machinery (old) Cr. Cash

XX XX XX XX

b. A loss on the exchange occurs when the exchange is less than the book value of the asset being exchanged. The value of the new asset is the book value of the old asset less the loss on the exchange plus the cash paid for the new asset.

The journal entry to record the disposal is: Dr. Equipment (new) Dr. Accumulated Depreciation, Equipment Dr. Loss on Exchange Cr. Cash Cr. Equipment (old)

XX XX XX XX XX

Teaching Tips/Strategy: Define capital and revenue expenditures. Use Discussion Question #3 to expand on the subject. Distinguish between revenue and capital expenditures. Concept Check #6 is excellent to demonstrate the characteristic of each expenditure. Use Figure 16.2 to explain the three categories of capital expenditures: additions, extraordinary repairs, and betterments.

Describe the different options for disposing an asset. Differentiate each one and its implications on the financial statements. Calculate the gain and losses under all the possible alternatives for discarding, selling, or exchanging an asset. Concept Checks 7, 8, and 9 are excellent options for classroom demonstration .

Use the “Ten-Minute Quiz” Questions 2 and 9 to reinforce the learning concepts.

Learning Unit 16-4: Transactions for Natural Resources and Intangible Assets Summary: Another type of a long-term asset is natural resources. Natural resources consist of natural assets such as oil, coal, or timber. The acquisition of oil wells or timber is recorded at cost; and as the oil, timber, or coal is extracted from the earth, the allocation of that cost occurs through a process known as depletion.

Depletion is similar to the units-of-production method of depreciation which was discussed earlier in the chapter. Depletion expense is listed as an operating expense on the income statement. Natural resources of oil,

.

16-8

coal, and timber are used up and, therefore, expensed. Intangible assets are long-lived assets that have no physical existence but do represent valuable legal rights and monetary relationships that benefit a company.

(In fact, prepaid insurance, notes receivable, and accounts receivable are intangibles, but they are classified as current assets.) Intangible assets classified in the long-term asset section are patents, copyrights, franchises, and goodwill. The assets are recorded at cost on the balance sheet and usually have no contra-accounts. The process of allocating the cost of an intangible asset over all the periods it provides benefits is called amortization and is included on the income statement as expenses. The expense incurred in acquiring these assets is amortized which means the assets are written off (or expensed) over a fixed number of years.

A patent is an exclusive right of the owner to sell or produce his or her discovery or invention. Copyrights are exclusive rights granted to owners by the federal government to publish artistic, literary, or musical work.

In the United States a copyright is granted for the life of the creator and for 70 years thereafter. The cost of the copyright is recorded as a cost and amortized over its expected useful life in an account called amortization expense, copyrights, because the useful life of a copyright is short.

A franchise is the result of someone purchasing an exclusive privilege or right to sell a manufacturer’s product or a service in a specifically defined geographical location. The useful life of many franchises is indefinite and thus not amortized.

When all or part of a business is purchased, the difference between the price paid and the value of the identifiable assets is called goodwill. Goodwill occurs when the expected rate of future earnings is greater than the rate of earnings for the industry standard. Thus, in the accounting profession it is agreed not to put a cost on goodwill until a company is bought or sold. According to generally accepted accounting principles (GAAP), goodwill is not amortized, because the goodwill of companies increases in value.

Key Concepts: Depletion, amortize, amortization expense, patent, copyright, franchise, goodwill, impairment.

Lecture Outline: 1. Depletion is the amount of natural resources that has been exhausted by mining, pumping, and so forth for a period of time. a. The depletion amount expensed during the period - (total intangible asset cost / estimated quantity of intangible asset extracted during period) The entry to record the depletion is: Dr. Depletion of Coal Deposit Cr. Accumulated depletion, coal

XX XX

b. Accumulated depletion is a contra-asset account similar to accumulated depreciation. c. Intangible assets are those assets having no physical substance such as patents and franchises. i. Amortizing is charging a portion of expenditure over a fixed number of days. ii. Intangible assets with indefinite lives are not subject to amortization. (i) Patents are the exclusive right to sell or produce one’s discovery or invention. The useful life is for 20 years. (ii) Copyrights are the exclusive right granted by the federal government to sell and reproduce literary, musical, or artistic works for a period of time. A copyright is granted for the life of the creator and for 70 years thereafter. (iii) Franchises are rights granted by business or government to produce or sell goods in a specific geographic region. Examples are Burger King, Holiday Inn, etc. The useful life of many franchises is indefinite and thus not amortized.

.

16-9

(iv) Goodwill is the amount of value a company increases because of brand names, business location, service, or other elements. Goodwill plays an important part in the expected future earnings of a business. A company does not value goodwill arbitrarily, and goodwill can only be recorded when a company is purchased or sold.

It is the difference between the purchase price and the value of the identifiable assets.

Goodwill is never amortized. iii. Impairment occurs when the value of an intangible asset decreases allowing a write-off to be taken. A loss in value as a result of impairment of an intangible asset is recorded as follows: Dr. Loss on Intangible Asset Cr. Intangible Asset

XX XX

Teaching Tips/Strategy: Review a list of all possible intangibles and explain the individual characteristics of each intangible. Explain the difference between an intangible asset and a physical asset. The Discussion Question #11 and the Success Coach LU 16-4 are excellent starting points.

Use the “Ten-Minute Quiz” Question #3 to reinforce the learning concepts.

.

16-10

Name

Date

Section

CHAPTER 16 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Each of the following should be classified as property, plant, and equipment except: a. automobile c. equipment 2.

4.

delivery charges for new equipment sales tax on purchase of vehicle utilities expense on the air conditioner property taxes on the purchase of land

Which of the following is not an intangible asset? a. patent b. c. goodwill d.

debit accumulated depreciation; credit equipment debit accumulated depreciation; credit depreciation expense debit depreciation expense; credit equipment debit depreciation expense; credit accumulated depreciation

A machine costing $15,000 was purchased. Delivery and installation cost $2,000 and the residual value is $1,000. If the company keeps the machine for its entire life, how much of the machine will be depreciated? a. $2,000 c. $16,000

6.

b. d.

$15,000 $17,000

A machine costing $15,000 was purchased. Delivery and installation cost $2,000, and the residual value is $1,000. If the estimated life is 4 years and the business uses straight-line depreciation, what is the annual depreciation? a. $3,750 c. $4,250

7.

franchise oil reserve

The entry to record equipment depreciation is: a. b. c. d.

5.

pavement burger king franchise

Which of the following should be a revenue expenditure instead of a capital expenditure? a. b. c. d.

3.

b. d.

b. d.

$4,000 $8,500

A machine costing $15,000 was purchased. Delivery and installation cost $2,000 and the residual value is $1,000. If the estimated life is 4 years and the business uses double declining-balance depreciation, what is the first year’s annual depreciation? a. $3,750 c. $4,250

b. d.

.

16-11

$4,000 $8,500

8.

A company bought equipment classified as 7-year property for $9,000. What is the MACRS depreciation for year 2? a. $1,285 c. $1,574

9.

b. d.

A company recently added seats with built-in heaters for its employees driving in low temperatures.

This expenditure can be classified as: a. addition c. extraordinary repair

10.

b. d.

enlargement betterment

The entry to record a machine costing $25,000 and having accumulated depreciation of $23,000 was traded along with cash of $18,000 for a new machine costing $27,000 is: a. Machinery Accumulated Depreciation Machinery Cash

20,000 23,000

b. Machinery Accumulated Depreciation Machinery Cash

27,000 23,000

c. Machinery

18,000

25,000 18,000

25,000 18,000

Cash

18,000

d. Machinery

20,000 Cash Gain on trade

Answer Key to Chapter 16 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

$2,204 $1,124

d c d d c b d b d a

.

16-12

18,000 2,000

Chapter 17 Partnership Chapter Overview This chapter discusses another form of a business organization – the partnership. A partnership is the association of two or more persons who co-own a business. Partners are governed by the Uniform Partnership Act or laws that are enacted in most states to govern how a partnership is formed, operated, and liquidated.

Partnership characteristics include: limited life, mutual agency, unlimited liability, and co-ownership. A partnership does not pay taxes, but the partners pay taxes on the share of income allocated to them. The partnership agreements dictate the division of net income and net losses and may include salary allowances or interest allowances, and the chapter explains how to make those calculations.

With regard to the recording of business transactions involving assets, liabilities, revenue, and expenses, the transactions are handled similarly for sole proprietorships and partnerships. The major difference in recording business transactions for these two forms of organization lies in the capital account(s). A sole proprietorship has only one capital and withdrawal account while a partnership has a separate capital and withdrawal account for each partner. The chapter explains those calculations and entries along with recording partner withdrawals when a partner takes assets of greater or less than book equity. The chapter concludes with the steps and entries involved in the liquidation of a partnership.

Learning Objectives After studying Chapter 17, your students should gain proficiency in the following: 1. Journalize Entries to Form a Partnership.

2. Journalize Entries to Record Division of Net Income and Net Loss Among Partners.

3. Journalize Entries to Record Admissions and Withdrawals of Partners.

4. Journalize Entries to Record Liquidation of a Partnership.

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Chapter 17 Assignment Grid Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Partnership Equity 1 2 Partnership Characteristics 1 3 Articles of Partnership 1 4 Partnership Operations 1 5 Mutual Agency 1 6 Salary & Interest Allowance 2 7 Fractional Ratio 2 8 Statement of Partners’ Capital 2 9 Side Transaction 3 10 Bonus When Admitting New Partner 3 11 Partner Withdrawals 3 12 Partner Withdrawals 3 13 Liquidation Process 4 14 Ethical Case 1 Concept Checks 1 Forming a Partnership 1 2 Division of Net Income 2 3 Division of Net Income Based on Beginning Capital Balances 2 4 Calculating Total Salary & Interest Allowances 2 5 Share of Net Income to Partners: Deficit Sharing 2 6 Admission of a New Partner 3 7 Investing into Existing Partnership 3 8 Calculating Profit-and-Loss Ratio 2 9 Liquidation 4 Exercises (Set A) 17A-1 Forming a Partnership 1 17A-2 Update Capital Balances 2 17A-3 Retiring Partner 3 17A-4 Admitting New Partner 3 17A-5 Liquidation 4 Exercises (Set B) 17B-1 Forming a Partnership 1 17B-2 Update Capital Balances 2 17B-3 Retiring Partner 3 17B-4 Admitting New Partner 3 17B-5 Liquidation 4 Problems (Set A) 17A-1 Income Allocation 2 17A-2 Admission of New Partner 3 17A-3 Withdrawal of Partner 3 17A-4 Liquidation 4

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Estimated Time in Minutes

Level of Difficulty

5 5 5 5 5 5 5 5 5 5 5 5 5 10

Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Medium

10 10

Easy Easy

10 15

Easy Medium

15 10 15 15 15

Medium Easy Easy Easy Medium

20 20 20 20 20

Easy Easy Medium Easy Medium

20 20 20 20 20

Easy Easy Medium Easy Medium

30 30 30 30

Medium Medium Medium Hard

Learning Objective(s)

Estimated Time in Minutes

Level of Difficulty

Problems (Set B) 17B-1 Income Allocation 17B-2 Admission of New Partner 17B-3 Withdrawal of Partner 17B-4 Liquidation

2 3 3 4

30 30 30 30

Medium Medium Medium Hard

Financial Report Problem Reading Amazon’s Annual Report/Internet Project

1

15

Easy

Assignment Topic(s)

Learning Unit 17-1: Journalizing Entries to Form a Partnership Summary: A partnership, as defined by the Uniform Partnership Act, is “an association of two or more persons to carry on as co-owners of a business for profit”. Partnerships can be formed by an oral or written agreement. Although the oral agreement is binding, it makes more sense to seek legal advice and have a formal written agreement prepared. When two or more people agree orally or in writing to be partners, a contract results. Formalizing agreements in writing may minimize conflicts in the future. This written agreement, which formalizes the partners’ relationship, is called the articles of partnership.

A partnership has a limited life which affords more flexibility than some other forms of ownership to react to the marketplace, because legal restrictions are minimal. Mutual agency means that the actions of one partner are binding on all the other partners. Unlimited liability means that if a partnership is unable to pay its obligations all general partners are individually liable to cover with their personal assets the obligations the partnership cannot meet.

Think of a general partner as one who risks not only the personal investment in the partnership but also personal assets. If the personal assets of some of the partners are exhausted, the other partners have the responsibility for covering the debts outstanding. Note that a few exceptions apply to this rule. First, a partner just entering an existing partnership is not held liable for past obligations before joining the partnership. Second, in some states some members of a partnership have liability only up to the amount they invested in the partnership. These people are called limited partners. Co-ownership of property means that all partners share all the assets of the partnership. The partnership itself does not pay taxes, but the partners pay taxes on the share of net income that has been allocated to each of them.

Key Concepts: Partnership, Uniform Partnership Act, articles of partnership, limited life, mutual agency, unlimited liability, general partner, limited partner, co-ownership of property.

Lecture Outline: 1. Articles of Partnership are written contracts that spell out the details of the agreement among the partners. a. Name and address of each partner, along with the date of the agreement b. Rights and responsibilities of each partner c. Amount that each partner is investing

.17-3

d. Specific manner in which partners’ profits or losses will be shared e. Provisions for one or more partners leaving the partnership f. How many new partners will be admitted g. How assets will be distributed if the business is completely terminated h. How accounting records will be maintained.

2. Characteristics of Partnerships: a. Limited Life – a partnership is dissolved by admission, withdrawal, or death of a partner. Although the partnership is dissolved, a new one can be formed and the operations of the business can continue without interruption. b. Mutual Agency – an act of one partner is binding on all members of the partnership. i.

Entering into contracts that are in the normal scope of the operations of the business. ii.

Each partner can act for the partnership as a whole, and poor judgment on the part of one partner could result in losses for all partners. iii.

Credit rating is usually higher because more than one partner is responsible for the company’s debt. c. Unlimited liability – partners may be personally liable for debts of the partnership. i.

All partners are individually liable to cover with their personal assets the obligations the partnership cannot meet. ii.

The partner has the obligation of covering the obligations the other partners cannot meet. a) New partner just entering the partnership is not responsible for past obligations before joining the partnership. b) In some states, some members of a partnership have liability only up to the amount they have invested in the partnership.

1. Limited partner – the partner’s liability is limited to the amount of investment in the partnership.) d. Co-ownership of Property – each partner owns a share of the assets. All partners share all the assets of the partnership, and partners do not have specific claims to the assets they invest in the business. e. Taxation – the partnership itself does not pay taxes. The partners pay taxes on the share of the net income that has been allotted to each of them. Like a proprietorship, owners are not paid salaries but take withdrawals from the company.

3. Formation of a Partnership: a. The assets partners invest in the business should be recorded at their fair market value as per an appraiser. b. The journal entry to record investing from an old business into the partnership for the first partner: Cash Accounts Receivable Store Equipment Allowance for Doubtful Accounts Notes Payable Owner’s Capital account

XX XX XX XX XX XX

c. The store equipment does not have accumulated depreciation. d. The partnership will begin with property, plant, and equipment based on appraised value. e. The journal entry for the 2nd partner’s investment of cash: Cash

XX Owner’s Capital account

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XX

Teaching Tips/ Strategy: Use the Concept Check #1 to prepare journal entry of partnership formation.

Discussion Questions 1 through 5 are useful to introduce the topic during lecture. Review the Success Coach LU 17-1 to further review the concept.

Use the “Ten-Minute Quiz” questions 1 and 2 to reinforce the learning concept.

Learning Unit 17-2: Journalizing Entries to Record Division of Net Income and Net Loss Among Partners Summary: One way of calculating a partner’s share is through a salary allowance. A salary allowance is not the same thing as the salary expense involved in paying employees; and it is not, in fact, a salary at all. It is just a way to divide net income. It is usually used to account for unequal service contributions among partners, such as if one partner worked full-time for the business and the other put in only 20 hours a week. Another way to divide net income among partners is through interest allowance. This method is usually used when partners have put different amounts into the partnership as an initial investment. Some partnerships share net income according to an agreed-upon ratio. If a ratio is 3:2:1, it means that 3/6 of net income goes to one partner, 2/6 to the next, and 1/6 to the last. Such a fractional ratio could be based on service as well as capital investment. Such ratios are called profit-and-loss ratios. Whether net income covers the salaries and interest makes no difference in calculating the salary or interest allowance. A deficit (negative reduction to each partner) is not a loss. Think of it as a reduction in the share of profits, because all the interest and salary allowance was not covered.

Key Concepts: Salary allowance, interest allowance, profit-and-loss ratio, deficit, statement of partners’ equity.

Lecture Outline: Partners cannot legally hire themselves and pay themselves a salary. a. Partners work to gain a share of the net income of the company. b. Ways to divide up net income or loss among partners: I. Based on talents and abilities II. Based on time spent working for the partnership III. Amount invested in the partnership 1. Salary allowance is a mechanism for dividing earnings of a partnership based on personal services provided by the partners. It is: a. Used to account for unequal service contributions to the partnership. b. Net income is distributed, not salary expense. c. Usually used when partners contributed different amounts into the partnership on the initial investment. d. For fairness based on investment percentage.

2. Interest allowance method is a mechanism for dividing earnings of a partnership based on a percentage of capital balances of the partners and is not an expense. a. If the partners cannot agree on sharing net income, it is divided equally. b. The partner’s share of net income is the ratio of their beginning capital investments (See Figure 17.3). Each partner’s share is computed by: (partner’s capital investment / total capital investment) times net income c. Alternative to ratio based on investment only – some partnerships share net income and net losses according to an agreed-upon ratio.

3. Each partners’ ownership: a. Annual salary allowance based on personal services provided b. Plus interest on their capital investments provided c. Remaining net income or net loss shared equally

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4. Partners’ services and capital contributions are unequal, but net income does not cover salary and interest allowance. Partners must all share in the reduction of profits. Each partners’ ownership: a. Annual salary allowance based on personal service provided b. Plus interest on their capital investments provided. c. Calculate deficit to be shared: Net Income - Salary and Interest = Deficit to be shared 5. Journal entry for distribution of net income / loss would be the same in all situations except for the dollar amount.

Income Summary XX Partner 1, Capital XX Partner 2, Capital XX Partner 3, Capital XX 6. Statement of Partners’ Equity (See Figure 17.6) a. Similar to a statement of owner’s equity. b. The ending balances for each partner would then be reported on the balance sheet.

Teaching Tips/Strategy: Use the Concept Checks 2 through 5 to discuss the details of the partnership divisions based on income, ratios, and other situations. Exercises 17A-2 and 17B-2 are excellent to practice the unit calculations.

Use the “Ten-Minute Quiz” questions 3 through 6 to reinforce the learning concepts.

Learning Unit 17-3: Journalizing Entries to Record Admissions and Withdrawals of Partners Summary: This unit looks at how the capital structure of a partnership may change due to (1) admission of a new partner or (2) withdrawal of a partner. Joining a partnership can happen in two ways: purchase of an equity interest from one or more of the existing partners or make an investment in the business.

No matter what approach is taken, the admission of a new partner will technically dissolve the old partnership.

As an alternative to buying equity from an existing partner, one may simply invest assets in the partnership on one’s own. When the equity of a partnership in reality is worth more than the amounts recorded in its accounting records, the partners may require an incoming partner to pay an additional amount or bonus that will increase the old partners' equity. This situation could result if a company had an outstanding earnings record with even higher expectations in the future compared with other companies in the industry.

A firm often is anxious to bring into the company a new partner who has special skills, business contacts, or abilities. The old partners then must accept a reduction in their capital balances to make up the difference in what the new partner invests compared with the new partner’s capital balance. When a partnership contract is drawn up, it usually states the procedures to be followed when a partner withdraws. Often the procedures include an audit of the accounting records and the adjustment of the assets to their current fair market value.

Often, when a partner retires, the assets may be revalued. In this case the partners have to agree whether the assets are overvalued and whether the withdrawing partner should settle for less than the book value of his or her equity. Remember that when a partner dies the partnership ends, and the estate is entitled to receive the proper value of the capital account of the deceased after an audit and revaluation of the assets. Journal entries for the death of a partner are similar to those for other situations when a partner leaves. To have enough cash to

.17-6

pay the full value of the deceased partner’s capital account, partnerships often carry life insurance policies on partners.

Key Concepts: Purchase of an equity interest, bonus.

Lecture Outline: 1. Partnership’s structure changes with the admission or withdrawal of a partner. a. Admission of a new partner dissolves the old partnership and can occur: i.

With a purchase of an equity interest from one or more of the existing partners.

The entry to record the buying of equity interest: Dr. Original partner’s capital Cr. New partner’s capital

ii.

XX

a) The other partners need to agree on the equity change, and a new partnership agreement will be formed. b) If the other partners do not agree, the partner still has a right to share in the profit and loss of the partnership. However, the new partner will not have a voice in running of the company until he or she is an admitted partner.

With a cash investment in the business.

The entry is recorded: Dr. Cash Cr. Partner, capital

iii.

XX

XX XX

a) The partners must agree on how to share the profit and loss. b) The example in the text (See details above Figure 17.9) shows two existing partners having a total of $4,000 in equity. a) If the new partner wants a 1/3 interest, the other partners will have 2/3 interest in the company. b) If $4,000 is 2/3 interest, then $2,000 will be a 1/3 interest. c) The new partner must contribute $2,000.

Recording a bonus to the old partners when admitting a new partner (See Figure 17.10): a) Usually happens when the equity of a partnership is worth more than the amounts recorded in the accounting records. a) Bonus – when a partner is admitted, he or she may pay more or less than equity interest. If the new partner pays more, the old partners share a bonus in the profit-andloss ratio. Of course, the opposite could result, and the new partner could receive a bonus if he or she invests less than equity interest. b) Situation could result if a company had an outstanding earnings record with even higher expectations in the future compared with other companies in the industry. c) Calculation of the bonus – the difference between the new partner’s required investment to be an equal partner (3 partners = 1/3) and the amount the current partners want the new partner to invest.

The journal entry is: Dr. Cash Cr. Partner 1, Capital Cr. Partner 2, Capital Cr. Partner 3, Capital

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XX XX XX XX

iv.

Recording a bonus to a new partner – a firm is anxious to bring into the company a new partner who has special skills, business contacts, or abilities. a) The old partners must accept a reduction in their capital balances to make up the difference in what the new partner invests compared to the new partner’s capital balance. b) Using the example in the text (See Figure 17.11), a partnership with a combined capital of $4,000 is anxious to bring in a new partner with special skills. They are willing to have the new partner contribute $1,400 for a 1/3 interest. c) Calculation: Old partners’ Capital + new partners’ Capital = Capital of new partnership

$4,000 1,400 $5,400

One third interest is $1,800 (1/3 of $5,400). Since the new partner is contributing only $1,400, the other partners capital accounts must be reduced by $400 ($1,800 – 1,400). The entry to record the admission of the new partner: Dr. Cash 1,400 Dr. Partner 1, Capital 200 Dr. Partner 2, Capital 200 Cr. Partner – new, Capital

1,800

b. Recording the permanent withdrawal of a partner – procedures are usually established in the partnership agreement and often include: i. ii.

An audit of the accounting records Adjustment of assets to their fair market value to reflect current value of the retiring partner’s equity in the business when a partner takes assets of less value than book equity Journal entry to revalue the current merchandise inventory to fair market value (adjustment based on percentage of equity):

Dr. Partner 1, Capital XX Dr. Partner 2, Capital XX Dr. Partner 3, Capital XX Cr. Merchandise Inventory

XX

a) If assets are not revalued, the partners have to agree whether the assets are overvalued and whether the withdrawing partner should settle for less than the book value of his or her equity. b) Usually happens when a partner is extremely anxious to withdraw from the partnership. c) The remaining partners will share in appropriate equity ratio portions of the equity that the departing partner does not take.

Journal entry to record the withdrawal of the partner: Dr. Partner (leaving partner), Capital Cr. Cash

XX XX

c. Recording permanent withdrawal when a partner takes assets of greater value than book equity i.

Partnership assets are undervalued. ii.

The other partners are anxious to have the partner retire.

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iii.

The other capital accounts will be reduced to cover the increase in the leaving partner’s capital.

The journal entries: Dr. Partner 1, Capital XX Dr. Partner 2, Capital XX Cr. Partner (leaving partner), Capital XX Dr. Partner (leaving partner), Capital Cr. Cash

XX XX

Teaching Tips/Strategy: Use the Concept Checks #6 and #7 to practice a partnership’s ownership changes.

Exercises 17A-3, 17A-4, 17B-3, and 17B-4 are excellent to practice the calculations.

Use the “Ten-Minute Quiz” questions 7 through 10 to reinforce the learning concepts.

Learning Unit 17-4: Entries for the Liquidation of a Partnership Summary: Up to this point we have looked at the admission and withdrawal of partners. Each time this happens, a new partnership is formed and any losses or gains are shared in an agreed-upon ratio. The operations of the business continue, of course, even when the new partnership is formed. In this unit we look at three situations in which a partnership is liquidated. Liquidation occurs when the business is completely terminated by converting assets into cash and paying off obligations and equity.

The following steps complete a liquidation: 1. Assets are sold for cash with any loss or gain recognized.

2. Any loss or gain is divided among the partners based on their profit-and-loss ratio.

3. Creditors are paid off.

4. Remaining cash is distributed to the partners based on their capital balances.

Key Concepts: Liquidation, realization.

Lecture Outline: Liquidation occurs when a business is finished, the assets are sold, and the liabilities are paid off.

1. Steps in completing the liquidation process. a. Temporary accounts have been closed out. b. Assets are sold for cash with any loss or gain recognized. c. Any loss or gain is divided among the partners based on their profit-and-loss ratio. d. Creditors are paid off. e. Remaining cash is distributed to the partners on their capital balances.

2. Selling assets at a gain: a. Record sale of assets along with any loss or gain from realization – the conversion of noncash assets into cash during the liquidation process. (See Fig. 17.20) b. Loss or gain from realization is allocated to each partner in equity ratio. (See Figure 17.21) c. Pay claims of creditors. (See Figure 17.22) d. Distribute remaining cash to partners. (See Figure 17.23) e. Statement of Liquidation – provides a comprehensive report of the liquidation process.

3. Selling assets at a loss:

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a. Record sale of assets with a loss or gain from realization. (See Figure 17.24 for an example of assets sold at a loss) b. Loss from realization is allocated to each partner (See Figure 17.25) c. Pay claims of creditors (See Figure 17.26) d. Distribute remaining cash. Note: no profit is left to be distributed. (See Figure17.27) Teaching Tips/Strategy: Exercises 17A-5 and 17B-5 are excellent to practice partnership liquidation.

.17-10

Name

Date

Section

CHAPTER 17 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which of the following is not a characteristic of partnerships? a. Actions of one partner are binding on all partners. b. The removal of one partner dissolves the partnership. c. The partnership does not pay taxes. d. The partnership has an unlimited life.

2.

Which of the following is an advantage of a partnership? a. The partnership has unlimited liability. b.

The partnership has pooled resource of talents. c. The partnership has mutual agency. d.

The partnership may never be dissolved.

3.

Partner A has a capital balance of $120,000; Partner B has a capital balance of $80,000; Partner C has a capital balance of $100,000; Net income for the year totaled $27,000 and the partnership agreement allocates income according to the capital account percentages. How much net income is allocated to Partner A? a. $7,200 b. $9,000 c. $9,500 d. $10,800

4.

Partner A has a capital balance of $120,000; Partner B has a capital balance of $80,000; Partner C has a capital balance of $100,000; Net income for the year totaled $24,000 and the partnership agreement allocates income equally. How much net income is allocated to Partner A? a. $6,200 b. $8,000 c. $8,500 d. $9,600

5.

Partner A has a capital balance of $120,000; Partner B has a capital balance of $80,000; Partner C has a capital balance of $100,000; Net income for the year totaled $36,000 and the partnership agreement includes an interest allowance at 10% of their capital account balances and remaining income allocated as a percentage of capital. How much net income is allocated to Partner A? a. $9,600 b. $12,000 c. $14,400 d. $16,000

6.

Partner A has a capital balance of $120,000; Partner B has a capital balance of $80,000, Partner C has a capital balance of $100,000; Net income for the year totaled $36,000 and the partnership agreement includes a salary allowance of $7,000 for Partner A, $3,500 for Partner B, and $0 for Partner C and remaining income allocated as a percentage of capital. How much net income is allocated to Partner A? a. $6,752 b. $8,039 c. $10,209 d. $17,200

.17-11

7.

What is the entry to record admission of a partner that resulted in a bonus to the new partner? a. Cash XX Partner A, Capital XX Partner B, Capital XX Partner C, Capital XX b. Cash Partner A, Capital Partner B, Capital Partner C, Capital c. Cash Capital C, Capital d. Partner C, Capital Cash

XX XX XX XX XX XX XX XX

8.

What is the entry to record admission of a partner that resulted in a bonus to the old partners? a. Cash XX Partner A, Capital XX Partner B, Capital XX Partner C, Capital XX b. Cash XX Partner A, Capital XX Partner B, Capital XX Partner C, Capital XX c. Cash XX Capital C, Capital XX d. Partner C, Capital XX Cash XX

9.

What is the entry to record the permanent withdrawal when a partner takes assets of less value than book value? a. Partner A, Capital XX Partner B, Capital XX Partner C, Capital XX Cash XX b. Partner A, Capital XX Partner B, Capital XX Partner C, Capital XX Cash XX c. Partner A, Capital XX Cash XX d. Partner A, Capital XX Cash XX Gain from Realization XX

10.

What is the entry to record the permanent withdrawal when a partner takes assets of greater value than book value? a. Partner A, Capital XX Partner B, Capital XX Partner C, Capital XX Cash XX

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b. Partner A, Capital XX Partner B, Capital Partner C, Capital Cash c. Partner A, Capital XX Cash d. Partner A, Capital XX Cash Gain from Realization

Answer Key to Chapter 17 Quiz

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

d b d b c d a b b a

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XX XX XX XX XX XX

Chapter 18 Corporations: Organizations and Stock Chapter Overview This chapter discusses another form of organization – the corporation. It begins with the steps involved in forming a corporation along with the advantages and disadvantages of corporations. Corporations have the advantages of limited liability because they are separate legal entities. They also have unlimited life, and ease of transferring ownership interest. There is no mutual agency as there is in partnerships but corporations have the added ability to raise capital easier than other forms of business organization. The disadvantages of the corporate form include difficulty to form corporations due to legal requirements and double taxation of earnings – once as corporate income and a second time when the dividends are taxed to the shareholders.

The chapter distinguishes between common and preferred stock as well as the advantages to each. The main advantages to common stock is that it is the purest of corporate ownership carrying with it voting rights while preferred stock usually produces more stable earnings than common stock but usually does not include voting rights. Preferred stocks take preference over common stock in one of several ways: cumulative preferred stock, non-cumulative preferred stock, non-participating preferred stock, or participating preferred stock. The chapter illustrates how to calculate dividends and concludes with discussing the recording of stock issuance for a single sale or under a subscription plan.

Learning Objectives After studying Chapter 18, your students should gain proficiency in the following: 1. Explain the Advantages and Disadvantages of the Corporate Structure.

2. Explain Retained Earnings and Stockholders’ Equity.

3. Journalize Capital Stock Transactions and Calculate Dividends.

4. Journalize Entries to Record Capital Stock Transactions for a Subscription Plan.

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Chapter 18 Assignment Grid Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Articles of Incorporation and Charter 1 2 Board of Directors 1 3 Corporation Advantages 1 4 Paid-In Capital and Retained Earnings 2 5 Issuing Stock 2 6 Preemptive Right 2 7 Legal Capital, Par Value, and No-par Value 2 8 Preferred Stock Rights 2 9 Discount on Common Stock 2 10 Paid-In Capital 2 11 Paid-In Capital 2 12 Organization Costs 2 13 Common Stock Subscribed 4 14 Ethical Case 1 Concept Checks 1 Stockholders’ Equity 2 2 Cumulative Preferred 3 3 Journalizing Sales of Stock 2, 3 4 Cumulative and Participating Preferred 3 5 Stock Subscriptions 4 Exercises (Set A) 18A-1 Journal Entries for Issuing Stock 2, 3 18A-2 Journal Entries for Issuing Stock for Equipment 3 18A-3 Calculating Dividends 3 18A-4 Journalizing Stock Subscriptions 4 18A-5 Stockholders’ Equity 4 Exercises (Set B) 18B-1 Journal Entries for Issuing Stock 2, 3 18B-2 Journal Entries for Issuing Stock for Equipment 3 18B-3 Calculating Dividends 3 18B-4 Journalizing Stock Subscriptions 4 18B-5 Stockholders’ Equity 4 Problems (Set A) 18A-1 Journal Entries for Issuing Stock 3, 4 18A-2 Calculating Dividends 3 18A-3 Stockholders’ Equity 4 18A-4 Entries and Stockholders’ Equity 3, 4 Problems (Set B) 18B-1 Journal Entries for Issuing Stock 3, 4 18B-2 Calculating Dividends 3 18B-3 Stockholders’ Equity 4 18B-4 Entries and Stockholders’ Equity 3, 4

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Assignment Topic(s) Financial Report Problem Reading Amazon’s Annual Report/Internet Project

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Learning Unit 18-1: The Advantages and Disadvantages of the Corporate Structure Summary: A corporation is a separate legal entity. Four steps are involved in forming a corporation: (1) The incorporators, those wishing to form the corporation, apply to a state for a charter and articles of incorporation are completed. (2) The Office of the Secretary of State reviews the application and, if deemed in order, a charter (often called a certificate of incorporation) is issued to the incorporators. (3) Stock is issued by the corporation to the owners (called stockholders). (4) Stockholders meet to elect a board of directors and adopt the bylaws of the corporation. The advantages of the corporate form of organization are, limited liability/separate legal entity, unlimited life, ease of transferring ownership interest, no mutual agency, and ease of raising capital.

Disadvantages include difficulties in forming a corporation/government regulations and corporate taxation.

Key Concepts: Incorporators, articles of incorporation, charter, certificate of incorporation, stockholders, directors, minute book, limited liability, stock certificate.

Lecture Outline: Corporations are another form of organization.

1. There are four steps involved in forming a corporation: 2. The incorporators, those wishing to form the corporation, submit articles of incorporation and apply to the state for a charter. a. The articles of incorporation include: i.

Name of corporation and the incorporation date ii.

Purpose of the business iii.

Organizational structure iv.

Expected life (usually “forever”) v.

Primary location of business vi.

Types of stocks to be offered 3. Advantages of the corporate form of organization – like sole proprietorships and partnerships, there are some advantages and disadvantages to the corporate form of organization. The advantages are: a. Limited Liability / Separate Legal Entity – Stockholders have limited liability. They are not personally liable for the obligations of the corporation, because a corporation is a separate and distinct legal entity. The shareholders can only lose their investment in the business. b. Unlimited Life – A corporation’s life continues perpetually (forever) unless there is a bankruptcy, merger, or vote by the shareholders to dissolve. c. Ease of Transferring Ownership Interest – The ownership is represented through a stock certificate. The shareholders can sell or transfer their shares. d. No Mutual Agency – Shareholders cannot enter into a contract on behalf of the corporation. e. Ease of Raising Capital – Corporations can raise large amounts of capital by offering ownership to individuals.

4. The disadvantages to the corporate form of organization. a. Difficulty in forming a corporation due to government regulations. (More difficult than a partnership and sole proprietorship.)

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b.

Corporate taxes – A “C” corporation is taxed twice. The corporation pays taxes on its income, and its shareholders are taxed on any income distributed to them. An “S” corporation is taxed at the stockholder level similar to a partnership.

Teaching Tips/Strategy: Use Success Coach LU 18-1 to assess some basic corporate characteristics introduced in the chapter. The first three Discussion Questions may be useful in engaging students in discussion.

Use the “Ten-Minute Quiz” questions 1, and 2 to reinforce the Learning Objective concepts.

Learning Unit 18-2: Retained Earnings and Stockholders’ Equity Summary: The equity section of a balance sheet of a corporation differs from that of a sole proprietorship or a partnership. With the corporation, the stockholders’ equity section is broken down into two major parts: PaidIn Capital and Retained Earnings. Paid-In Capital is the amount that stockholders have invested in the business. Retained earnings are accumulated profits that are retained or kept in the corporation. Various equity terms are defined in this chapter. Also, characteristics of common stock and preferred stock are listed and explained.

Dividends are paid to stockholders as their share of the corporation’s profits. A dividend must be voted and approved by the board of directors. If there is only common stock, then all the dividends declared will be given to common stockholders. If a corporation has both preferred stock and common stock outstanding, then care has to be taken with regard to the specific type of preferred stock. Preferred stock receives preferential treatment over common stock so preferred stockholders will receive dividends before common stockholders do.

Key Concepts: Paid-in capital, retained earnings, capital stock, authorized capital stock, issued capital stock, outstanding capital stock, common stock, preemptive right, preferred stock, dividends, cumulative preferred stock, dividends in arrears, noncumulative preferred stock, nonparticipating preferred stock, participating preferred stock, par value, legal capital, no-par stock, stated value.

Lecture Outline: 1. The equity section of a corporation’s balance sheet differs from other forms of organization. a. Paid-in capital shows the amount that stockholders have invested in the business. b. Retained earnings are accumulated profits that are retained or kept in the corporation after dividends to shareholders. c. Capital stock is issued by the corporation to shareholders in return for their investment in the corporation. i.

Authorized capital - The charter of the corporation indicates the maximum amount of shares of each class of capital stock. ii.

Issued capital stock is the stock that has been sold to the shareholders by the corporation. iii.

Outstanding capital stock is the stock sold that is still in the stockholders’ possession.

2. There are two classes of capital stock: a. Common stock is the most basic type of stock. i.

Common stockholders are entitled to certain rights due to owning this class of stock. ii.

The right to vote at stockholders’ meetings. iii.

The right to share in profits by receiving dividends. iv.

The right to dispose of or sell their stock. v.

The right to maintain their proportionate ownership interest in the company – also called preemptive right. vi.

The right, when a company is liquidated, to share in assets after creditors and others when prior claims are paid off.

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b. Preferred stockholders have claim to a corporation’s profits and assets over common stockholders. i.

Corporations watch current market conditions and try to offer preferred stock that will be attractive to investors. ii.

In return for preferred stock’s more stable earnings, preferred stockholders give up some of the rights that go with common stock – such as voting rights, preemptive rights, or even some earning potential. c. Dividends on common and preferred stock: i.

Voted on by the board of directors and are paid to shareholders as their share of the corporation’s profit. ii.

Several ways for preferred stockholders to receive a prior claim on a corporation’s earnings over common stockholders. iii.

Cumulative preferred stock: a) Gives the holders a right to a certain dividend each year. b) If dividends are not issued in certain years, the right to that amount continues to accumulate until paid. c) These accumulating dividends are called dividends in arrears and must be paid before common stockholders receive their dividends. iv.

Noncumulative preferred stock: a) Stock that does not entitle its holders to a dividend for years in which dividends are not declared. v.

Nonparticipating preferred stock: a) Stock that provides its shareholders with a certain percentage as a dividend while the remainder goes to common stockholders. vi.

Participating dividend: a) Stock that entitles its holders to a fixed dividend with a split of the remainder (in various ways) with common stockholders. d. Stock value for capital stock: i.

Par value is an arbitrary value that is placed on each share of stock. ii.

Par value represents legal capital and not market value. iii.

The value is an arbitrary amount stated on the stock certificate. iv.

It is established along with the corporate charter. v.

No-par stock is stock with no-par value. vi.

Most states permit (or require) the company set a stated value on no-par shares.

Teaching Tips/Strategy: Explain par value and stated value. Use Exercise 18A-2 to demonstrate the issuance of the stock using par. When issuing stock for non-cash, explain that market value is the key for the amount to include on the journal entry. Explain preferred stock and how this type of stock has preference over the common stock for dividends. Explain the type of stock and the specific characteristics of each type of preferred stock (participative, cumulative, etc.)

Use the “Ten-Minute Quiz” questions 3 and 4 to reinforce the Learning Objective concept.

Learning Unit 18-3: Capital Stock Transactions and Calculating Dividends Summary: In this unit we look at how to record the issuing of stock that has (1) par value, (2) no-par value, and (3) no-par value with stated value. We also see how to record transactions in which stock is exchanged for noncash assets. When recording the sale of stock that has par value, the common stock is recorded based on the number of shares times par value. That value represents the legal capital. When selling preferred stock at par, the preferred stock is recorded at the number of shares times par value. When selling common stock at a

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premium (more than par value), the common stock is recorded at par value. Because this stock is sold at a premium (more than par value), the excess of the par value will be recorded in a new account called paid-in capital in excess of par value—common. Note in the transactional analysis that follows that this account is part of stockholders’ equity. On the balance sheet it will be listed below common stock in the paid-in capital section of stockholders’ equity. Selling common stock at a premium, the sale of stock is recorded at more than par value. In this book we use the account paid-in capital in excess of par to record the premium received. The paidin capital in excess of par value—common is the difference between what stockholders invest and par value.

This amount is not credited to the common stock account.

Selling common stock at a discount (below par), occurs when a stock is sold below par. As a result, a discount on stock results. An account called discount on common stock records the discount. It is a contra-stockholders’ equity account that will reduce the common stock account to which it is related. Some states do not allow stock to be sold at a discount. Selling no-par common stock with a stated value at an amount of above stated value means the excess over the stated value will be recorded in a stockholders’ equity account called paid-in capital in excess of stated value—common. A discount on stock is the difference between the par value of the stock and an amount less than the par value that the stockholders have contributed. Discounts do not happen often. The paid-in capital in excess of stated value—common is the difference between what stockholders invest and the stated value placed on stock by the board of directors. This amount is not credited to the stock account.

When recording transactions in which stock is exchanged for noncash assets, the assets are recorded at fair market value. Common stock is recorded at par value. If fair market value is not available for assets, one can try to find the market (not par) value of the stock. In this chapter we assume that fair market value of assets is available. The difference between fair market value and par is recorded in the account paid-in capital in excess of par. Par value is never used to measure the selling price of the assets. Issuing stock to organizers of a business for services performed may occur. The organization cost in the formation of a corporation (legal fees, printing of stock certificates, etc.) is an intangible asset on the balance sheet. It is usually amortized over 5 years (can be up to 40 years), because that life is used for income tax returns.

To calculate preferred dividends, you multiply the number of preferred shares times the par value per share times the rate of dividend. The result is the dividend allocated to preferred stockholders. To calculate the common stock dividend, you multiply the number of shares times the par value per share times the same rate of dividend. The result is the allocated common stock dividend. If the preferred shares are participating—which means it can share in additional dividends beyond the allocated dividend—the next step is to find the total par value and allocate the remainder of the dividend based on the total par. Because preferred receives preferential treatment, dividends are allocated first to preferred stockholders with the remainder being allocated to common stockholders.

Key Concepts: Premium, paid-in capital in excess of par value-common, discount on stock, paid-in capital in excess of stated value-common, organization cost Lecture Outline: 1. Journal entries: a. When recording sale of common stock at par value (Figure 18-2) For example: 200 shares @ 10 par value = $2,000 The journal entry is: Dr. Cash Cr. Common Stock

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2,000 2,000

b. Recording sale of preferred stock at par value (See Figure 18.3). (300 shares @ $50 par value = $15,000) The journal entry is: Dr. Cash Cr. Preferred Stock

15,000 15,000

c. Selling common stock at a premium (See Figure 18.4). Premium is a term that records the sale of stock at more than par value. For example: 50 shares of $10 par-value common stock are sold at $15 per share for a total amount of $750. The amount attributable to the par value is: 50 shares @ $10 each = $500.

The amount of premium is 50 shares @ ($15 - $10) = $250.

The journal entry is: Dr. Cash

750 Cr. Common Stock Cr. Paid in Capital in excess of Par Value – Common

500 250

d. Selling common stock at a discount or below par (See Figure 18.5). For example, 100 shares of $10 par are sold at $8 for a total of $800. The amount to par value is: 100 shares @ $10 par = $1,000. The amount to the discount is: 100 shares @ ($8 - $10) = 200.

The journal entry is: Dr. Cash Dr. Discount on Common Stock Cr. Common Stock

800 200 1,000

2. Recording sale of stock with no par value and no stated value (See Figure 18.6). a. For example: 300 shares of no-par common stock for $20 per share = $6,000.

The journal entry is: Dr. Cash

6,000 Cr. Common Stock

6,000

b. Selling no-par common stock with a stated value (See Figure 18.7). For example: 200 shares of no-par common stock @ $50 with a $40 stated value = $10,000. The amount attributable to the stated value is: 200 shares @ $40 stated value = $8,000. The amount in excess of the stated value is: 200 shares @ ($50 - $40) = $2,000.

The journal entry is: Dr. Cash

10,000 Cr. Common Stock 8,000 Cr. Paid in Capital in excess of Stated Value – Common 2,000

3. Recording transaction in which stock is exchanged for non-cash assets (See Figure 18.8): a. The assets are recorded at fair market value b. Common stock is recorded at par value. c. The difference is recorded as Paid-in-Capital in Excess of Par Value

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The journal entry: Dr. Asset Account(s) XX (fair market value) Cr. Common Stock Cr. Paid-in-Capital in Excess of Par Value – Common

XX (par value) XX (market value-par value)

b. Issuing stock to organizers of a business for services performed (See Figure 18.9). Organizational costs are intangible assets on the balance sheet and usually amortized over 5 years.

The journal entry is: Dr. Organization Costs Cr. Common Stock

XX (total value of services at market value) XX

4. Dividend calculations (See Table 18.1): a. Calculate preferred dividends: multiply the number of shares times the par value per share times the rate of the dividend. b. Calculate the common stock dividend: multiply the number of shares times the par value per share times the same rate of dividend. c. Find the total par value: number of preferred shares times par value per preferred share plus the number of common shares times the par value per common share. d. Allocate the remainder of the dividend based on par value.

Teaching Tips/Strategy: Review Success Coach LU 18-3 while lecturing the topic. To review, use Concept Checks #2 and #4 to explain the allocation of dividends between preferred and common stock. Exercise 18A-3, Exercise 18B-3, Problem 18A-2, or 18B-2 are excellent to use as demonstration exercises or homework.

Use the “Ten-Minute Quiz” questions 5, 6, 7, 8 and 9 to reinforce the Learning Unit Objectives 2 and 3 concepts.

Learning Unit 18-4: Journalizing Entries to Record Capital Stock Transactions for a Subscription Plan Summary: In the last unit, we assumed that stocks were immediately issued and full payment of cash or other assets was received. In this unit, we examine stock transactions under stock subscription plans. Under such plans, buyers pledge to buy certain stocks but pay in installments or in a later lump sum. In most cases, companies will not issue the actual stock certificates to these buyers until payment is complete. Because the stock certificates will not be issued until paid in full, the organization records the ownership at par value in a temporary stockholders’ equity account called Common Stock Subscribed. The amount due is recorded in an account called Subscriptions Receivable—Common Stock. The difference between the par value and the issue price is accumulated in a permanent account called Paid-In Capital in Excess of Par Value—Common. A stock subscription is a contractual agreement to buy a certain number of shares of stock from a corporation at a specific price. Common Stock Subscribed is a temporary stockholders’ equity account that records at par value stock that has been subscribed to but not fully paid for. Subscriptions Receivable—Common Stock is a current asset on the balance sheet that represents the amount due on stock subscriptions. The source-of-capital approach is a method of preparing paid-in capital by listing classes of stockholder sources of capital. The legal capital approach is a method of preparing paid-in capital by listing the legal section first.

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Key Concepts: Stock subscription, common stock subscribed, subscriptions receivable-common stock, sourceof-capital approach, legal capital approach.

Lecture Outline: 1. Stock subscription is a contractual agreement: a. Buyers pay in installments or a lump sum later on. b. Actual stock certificate is not issued until payment is complete.

2. Using the example in the chapter: the company accepted subscription of 1,000 shares at $160 per share. a. The amount is recorded in Common Stock Subscribed – a temporary stockholder’s equity account that records, at par value, stock that has been subscribed to but not fully paid. b. Shown in the Paid-in-Capital section below the common stock issued. c. The amount due is recorded in an account Subscriptions Receivable – Common Stock. d. The difference between the par value and issue price is accumulated in a permanent account called Paid-in-Capital in Excess of Par value – Common Journal entry to record 1,000 shares of $100 par value @ $160 per share (See Figure 18.10): Dr. Subscription Receivable 160,000 (1,000 x $160) Cr. Common Stock Subscribed 100,000 (1,000 x $100) Cr. Paid-in Capital in Excess of Par - Common 60,000 (1,000 x $60) Journal entry when received first installment (half) on common stock subscription (Fig. 18.11): Dr. Cash

80,000 Cr. Subscription Receivable – Common Stock 80,000

Journal Entry when received final installment from common stock subscription (Figure 18.12): Dr. Cash 80,000 Cr. Subscription Receivable – Common Stock 80,000

Issued 1,000 shares of fully paid Common Stock (See Figure 18.13): Dr. Common Stock Subscribed Cr. Common Stock

100,000 100,000

3. Stockholders’ Equity – two approaches of presentation on the balance sheet. a. Sources-of-Capital Approach – the method of preparing Paid-in-Capital by listing classes of stockholder sources of capital. b. Legal Capital Approach – the method of preparing Paid-in-Capital by listing the legal section first.

Teaching Tips/Strategy: Use Success Coach LU 18-4 to clarify the concepts. Then proceed to use Discussion Question #13 to engage the students on the topic. To assess the knowledge, utilize the Concept Checks #5 and Exercises 18A-4 and 18B-4.

Use the “Ten-Minute Quiz” question #10 to reinforce the Learning Objective concepts.

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Name

Date

Section

CHAPTER 18 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which of the following is not an advantage of corporations? a. corporations are separate legal entities b. corporations are simple to form c. corporations have an unlimited life d. transferring ownership between corporations is easy 2.

The board of directors is elected by: a. the president of the company c. the common stockholders

b. d.

the president of the board the preferred stockholders

3.

Which of the following is a characteristic of common stock? a. the right to accumulate dividends b. the right to participate in dividends with the preferred stockholders. c. the right to make contracts on behalf of the corporation d. the right to dispose of or sell the stock.

4.

Retained earnings are: a. the total earnings of a business b. the total earnings of a business less distributions to shareholders c. the cumulative total of dividends paid d. the total received in the sale of stock

5.

Preferred stockholders' claims on assets and income come ________ those of creditors. a. before b. after c. simultaneously d. before or simultaneously

6.

Preferred stockholders' claims on assets and income come ________ those of common stockholders. a. before b. after c. simultaneously d. before or simultaneously

7.

Par value is: a. an arbitrary value c. the same as the stated value

b. d.

based on the market price preemptive right

8.

Paid-in-Capital in Excess of Par is calculated as: a. number of shares times the market price b. number of shares times the difference between the market price and the par value c. number of shares times the par value d. the number of shares times the discount on the stock

9.

Shares outstanding is: a. the number of shares issued by the corporation and still in the possession of the shareholders b. the number of shares affected by the organization costs c. the number of shares allowed by the corporate charter

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d. the number of shares issued by the corporation 10.

When stock is issued under a stock subscription plan: a. paid in capital in excess of par does not exist b. stock is recorded only at the par value c. common stock is credited d. common stock subscribed is the account used until the cash is received

Answer Key to Chapter 18 Quiz 1. b 2. c 3. d 4. b 5. b 6. a 7. a 8. b 9. a 10. d

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Chapter 19 Corporations: Stock Values, Dividends, Treasury Stocks, and Retained Earnings Chapter Overview This chapter continues the discussion of owners’ equity, started in chapter 18, by discussing stock values.

Stock is valued in several ways including redemption value, market value, and book value per share. When there is more than one type of class, the stockholders’ equity must be allocated for each class of stock before calculating book value. The chapter continues to discuss dividends. There are three important dates involved in dividend issuance, the date of declaration, the date of record, and the date of payment. The date of declaration and date of payment require journal entries while the date of record shows which shareholders are entitled to receive the dividend. The discussion of dividends continues to explain how and why dividends are declared and paid, the dates involved in issuing dividends, how to record cash and stock dividends, and how and why a company purchases treasury stock. Treasury stock is stock repurchased by the company from the stockholders. The chapter concludes with a discussion of restrictions on retained earnings, and the statement of stockholders’ equity.

Learning Objectives After studying Chapter 19, your students should gain proficiency in the following: 1. Calculate Redemption, Market, and Book Value.

2. Calculate and Journalize Dividends.

3. Journalize Treasury Stock Transactions.

4. Explain Appropriation of Retained Earnings and Statement of Retained Earnings.

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Chapter 19 Assignment Grid Assignment Topic(s)

Learning Objective(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Market and Book Value 1 2 Dividend Dates 2 3 Entries for Dividends 2 4 Stock Dividends 2 5 Stock Dividends 2 6 Stock Dividends 2 7 Stock Dividends and Stock Splits 2 8 Treasury Stock 3 9 Treasury Stock 3 10 Paid-In Capital from Treasury Stock 3 11 Appropriation of Retained Earnings 4 12 Restrictions on Retained Earnings 4 13 Statement of Retained Earnings 4 14 Ethical Case 2 Concept Checks 1 Book Value per Share for Preferred & Common 1 2 Cash Dividend 2 3 Stock Dividend 2 4 Treasury Stock 3 5 Prior Period Adjustment 4 Exercises (Set A) 19A-1 Book Value for Preferred and Common 1 19A-2 Dividend Journal Entries 2 19A-3 Dividend Journal Entries 2 19A-4 Stock and Treasury Stock Journal Entries 3 19A-5 Statement of Retained Earnings 4 Exercises (Set B) 19B-1 Book Value for Preferred and Common 1 19B-2 Dividend Journal Entries 2 19B-3 Dividend Journal Entries 2 19B-4 Stock and Treasury Stock Journal Entries 3 19B-5 Statement of Retained Earnings 4 Problems (Set A) 19A-1 Book Value of Stock 1 19A-2 Dividend Entries 2 19A-3 Stock Entries and Retained Earnings Statement 2, 3, 4 19A-4 Stock Entries and Stockholders’ Equity 2, 3, 4 Problems (Set B) 19B-1 Book Value of Stock 1 19B-2 Dividend Entries 2 19B-3 Stock Entries and Retained Earnings Statement 2, 3, 4

Copyright © 2023 Pearson Education, Inc.

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Financial Report Problem Reading Amazon’s Annual Report/Internet Project

Learning Unit 19-1: Redemption, Market, and Book Value Summary: When a corporation issues preferred stock, it often reserves the right to retire or redeem that stock at a specific price. At the time the stock is issued, this price per share, called redemption value, is determined, and people buy the stock knowing that the corporation can redeem it at this price. The price at which shares of capital stock are bought and sold in the open market is called the market value. Economic conditions, a company’s earnings, and investors’ expectations all play a factor in determining the market price.

Book value per share is the total of stockholders’ equity (assets minus liabilities) divided by the number of shares issued. When a corporation has only common stock, book value is calculated using the following equation: Book Value per Share

Total Stockholders’ Equity/Total Shares Outstanding

When a company has two classes of stock, before book value can be calculated, the stockholders’ equity must be allocated (divided up) for each class of stock. First, for preferred stock, a corporation assigns the redemption value (or par value if the stock has no redemption value) of the stock along with any dividends in arrears (any dividends that are owed to holders of preferred stock but have not yet been paid out). This total of redemption value plus dividends in arrears is divided by the number of preferred shares outstanding. The remainder of stockholders’ equity is assigned to the common stockholders, and the book value of the common stock is calculated by that amount divided by the number of common stock shares outstanding.

Key Concepts: Redemption value, market value, book value per share.

Lecture Outline: 1. Redemption value is the price per share a corporation pays to redeem or retire capital stock.

2. When preferred stock is issued, the corporation reserves the right to retire or redeem that stock for the specified redemption value.

3. Market value is the price a buyer pays to purchase shares of capital stock in the open market. The market price varies based on conditions such as: economic conditions, company earnings, and investor expectations.

4. Book value per share is the total of stockholders’ equity divided by the number of shares issued. It does not represent what an owner might receive if the assets of a company were liquidated.

Book value is used for several reasons: a. Banks may specify a company maintain a specific one in order to approve a loan. b. Book value may be a factor in setting an exchange ratio of stock during a merger. c. Book value may be used when contracts are made. d. When there is only one class of stock: Calculating book value per share with only one class of stock: Book Value per share = Total Stockholders’ Equity/Total Shares Outstanding

Copyright © 2023 Pearson Education, Inc.

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e.

When there is both preferred and common stock, the stockholders’ equity must be allocated to each class of stock. (If there is no redemption value available, par value is used.)

Book value per share of preferred stock = (Redemption Value + Dividends in Arrears) Number of shares of preferred stock outstanding

Book value per share of common stock = (Stockholders’ Equity – Amount Assigned to Preferred) Number of shares of common stock outstanding f.

When preferred stock is redeemed, the paid-in capital in excess of par is not returned and thus is not included as part of the preferred equity in the book value calculation. g. Stockholders’ Equity section of the balance sheet – See Figure 19.2 Teaching Tips/Strategy: Explain to students the concept of book value per share. Differentiate book value per share based upon only one class of stock (common stock) or two classes of stock (common and preferred stock). As a class demonstration, utilize the Concept Check #1 to provide guidance on computing book value per share. Exercises 19A-1 or 19B-1 may be used as a demonstration, and the other one assigned as homework. Also, Problems 19A-1 or 19B-1 may be used as homework.

Use the “Ten-Minute Quiz” question #1 to reinforce the learning concepts.

Learning Unit 19-2: Calculating and Journalizing Dividends Summary: Dividends, as we have seen, are the distribution of earnings of the corporation. It is important to realize that only the board of directors of a corporation has the authority to determine whether a dividend is to be paid, how much it will be, who receives it, and when and how it will be paid. Three important dates are associated with the dividend process: • Date of declaration: The day the board of directors announces its decision to pay a dividend. This date creates a liability to the company called Dividend Payable.

• Date of record: The date established by the board of directors that determines which stockholders will receive the dividend. These stockholders can be identified in the corporation’s subsidiary stockholders’ ledger at this date of record.

• Date of payment: The date that the dividend is actually paid to stockholders of record.

The distribution of earnings of a corporation in the form of cash to its stockholders is called a cash dividend.

A stock dividend occurs when a corporation issues its own stock instead of a distribution of assets to its stockholders. When a corporation does not have enough cash to pay a cash dividend, it may offer a stock dividend instead of a cash dividend to: (1) satisfy stockholders’ expectations.

(2) increase permanent capital in the business (because more stock is issued) (3) reduce the market value of the stock, because the price may be too high in the trading on the open market (4) because income tax is avoided until the stock received is sold.

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A stock dividend will not reduce total stockholders’ equity the way a cash dividend does. The end result of a stock dividend is to transfer an amount based on market value from retained earnings to paid-in capital. After a stock dividend, a stockholder will own a larger number of shares; but the total ownership equity stays the same.

A Common Stock Dividend Distributable is a stockholders’ equity account that accumulates a stock dividend that has been declared but not yet issued and distributed. A stock split is the issuance by a corporation of additional stock to cause a large drop in the market price of the outstanding stock. No assets are received in return. The corporation reduces the par value or stated value of the authorized stock with an increase in the number of shares authorized, issued, and outstanding. The stock split, however, does not change the retained earnings account as a stock dividend did. To repeat, the stock split will do the following: increase the number of shares outstanding and reduce the par or stated value in proportion.

Key Concepts: Dividend, date of declaration, dividend payable, date of record, date of payment, cash dividend, stock dividend, common stock dividend distributable, stock split.

Lecture Outline: Dividends are: 1. The distribution of a company’s earnings to its owners.

2. Only the board of directors of a corporation has the authority: a. To determine whether a dividend is to be paid, b. How much it will be, c. Who receives it, d. And when and how it will be paid.

3. There are several dates important to the issuance of dividends. a. Date of declaration: (a) The date upon which the board of directors of a corporation formally declares a dividend. (b) Creates a liability called dividend payable.

The journal entry on the date of declaration: Dr. Retained Earnings XX Cr. Dividends Payable XX b. Date of record: (a) The date of ownership that determines which stockholders will receive the dividend. (b) No journal entry is needed. c. Date of payment: (a) The date the dividend is paid. (b) Cash dividends are dividends paid in cash.

Journal entry: Dr. Dividends Payable XX Cr. Cash XX 4. Stock dividends are dividends in stock instead of cash or other assets. a. There are several reasons a company may declare a stock dividend: (a) To satisfy stockholders’ expectations when there is not enough cash to pay a cash dividend. (b) To increase permanent capital in the business by issuing more stock. (c) To reduce the market value because the price may be too high and more stock outstanding will reduce the market value per share.

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(d) Because income tax is avoided until the stock received is sold. b. Stock dividend does not reduce stockholders’ equity: (a) Transfers value from retained earnings to the stock account and paid-in capital.

Journal entry: date of declaration – Dec. 27 Dr. Retained earnings 30,000 Cr. Common Stock Dividend Distributable 20,000 (1,000 shares @ $20 par) Cr. Paid-in Capital (Excess of Par value) 10,000 Journal entry on the date of payment – January 27 Dr. Common Stock Dividend Distributable 20,000 Cr. Common Stock 20,000 c. Review the Stockholders’ Equity Section of the balance sheet – (Figure 19.7) 5. A stock split is the issuing of additional shares of stock to stockholders, but the total par or stated value remains the same. a. two main reasons for a stock split: (a) To increase the number of shares outstanding. (b) To reduce the par or stated value per share. b. for a stock split on 10,000 shares of $20 par value. (a) Before the stock split, the par value is 10,000 shares @ $20 par = $200,000 (b) After the stock split, the par value is 20,000 shares @ $10 par = $200,000 c. benefits from the stock split if: (a) The stock price rises on the market. (b) Dividends per share are increased.

Teaching Tips/Strategy: Discuss the different options available for dividends and the characteristics of each distribution. Discussion Questions 4 through 7 are excellent to start lecture discussion on the related topics.

It might be useful to review the basic concepts with the Success Coach LU 19-2 and Concept Checks #2 and #3. These items can help understand different dividends terminology and their corresponding journal entries.

Use the “Ten-Minute Quiz” questions 2, 3, 4, 5, and 6 to reinforce the learning concepts.

Learning Unit 19-3: Journalizing Treasury Stock Transactions Summary: Treasury stock is stock (common or preferred) that has been reacquired by the corporation (or given as a gift to the corporation). Reasons include: (1) a need to issue more stock for stock option plans, for use in acquiring other corporations, (2) desire to reduce the number of shares of stock outstanding, or (3) anticipation of an opportunity at a later date to reissue stock at a higher price. Treasury stock characteristics are: (1) purchasing does not change the amount of issued stock, (2) does reduce outstanding stock, (3) does not have dividends or voting rights (because it is not outstanding), (4) the account is a contra-stockholders’ equity account (opposite), (5) is recorded at the purchase price and does not reduce the balance in the retained earnings account, and (6) can have restrictions by many state laws on the amount of retained earnings available for dividends if treasury stock exists since the purchase of treasury stock reduces assets and stockholders’ equity. When treasury stock is sold above the cost acquired, the excess is recorded in the paid-in capital from treasury stock. The balance of this account can never be negative.

Key Concepts: Treasury stock, paid-in capital from treasury stock.

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Lecture Outline: Treasury stock is stock that has been issued but has been bought back by the corporation or received as a gift.

1. There are several reasons a company would reacquire treasury stock: a. A need to issue more stock for stock option plans or for use in acquiring other corporations. b. A desire to reduce the number of shares of stock outstanding, which might create a favorable market for the sale of the stock. c. Anticipation of an opportunity at a later date to reissue stock at a higher price.

2. There are several characteristics of treasury stock: a. The purchase of treasury stock does not change the amount of issued stock. b. The purchase of treasury stock does not reduce issued stock; it reduces the number of shares outstanding. c. Treasury stock does not have rights to dividends or voting rights because it is not outstanding. d. Treasury stock is a contra-stockholders’ equity account. e. When treasury stock is bought, it is recorded at the purchase price. It does not reduce the balance in the retained earnings account. f. Many state laws will restrict the amount of retained earnings available for dividends if treasury stock exists, because the purchase of treasury stock reduces assets and stockholders’ equity (like a cash dividend).

Purchase of treasury stock: Example: 1,000 shares of common stock repurchased by a company at $12 per share for a total of $12,000 – Journal entry: Dr. Treasury Stock – common Cr. Cash

12,000 (Cost) 12,000 (Cost)

Treasury stock can be reissued at a price above or below its purchase price.

If the stock is resold for more than the purchase price, then the cost is credited to treasury stock, and the excess goes to the Paid-in-capital as a credit.

Example: 1,000 shares of treasury stock are resold for $15 per share – Journal entry: Dr. Cash 15,000 (1,000 shares @ $15 per share) Cr. Treasury Stock – common 12,000 (cost) Cr. Paid-in Capital from Treasury Stock 3,000 If the stock is resold for less than the purchase price, paid-in capital from treasury stock is credited until the balance in the account is zero. Any further decreases are recorded as a reduction of retained earnings because paid-in capital from treasury stock cannot have a negative balance.

Teaching Tips/Strategy: Discuss all the entries necessary for treasury stock. The Discussion Questions 8 through 10 are excellent to engage students in discussion of treasury stock topics. As a class demonstration, Concept Check #4, Exercise 19A-4, and Exercise 19B-4 will help students understand treasury stock transactions and their impact on the stockholders’ equity section of the balance sheet. Emphasize and explain that the treasury stock is not an increase in equity and why.

Use the “Ten-Minute Quiz” question 7 and 8 to reinforce the learning concepts.

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Learning Unit 19-4: Appropriation of Retained Earnings and the Statement of Retained Earnings Summary: Appropriated (restricted) retained earnings are the portion of retained earnings that are not available for dividends. This appropriating of retained earnings could be either voluntary or contractual. For example, the board of directors could voluntarily decide that a portion of earnings should be used for plant expansion instead of for dividends. If a company enters into a loan with a bank, the bank may require the company to keep a minimum balance in retained earnings to protect its rights until the loan is repaid. The statement of retained earnings is the financial report that reveals the changes in retained earnings for a particular period of time. The changes in retained earnings result from the following: net income or loss, dividends declared, and effects of prior period adjustments. Often an error in a financial report of a company from a prior period may not be discovered until a later period. If the error is considered material, a prior period adjustment should be made to the beginning balance of retained earnings.

Key Concepts: Appropriated (restricted) retained earnings, statement of retained earnings, prior period adjustment.

Lecture Outline: 1. Appropriated Retained Earnings a. Appropriated retained earnings are not available for declaration of dividends because they are restricted voluntarily by the board to be used as a reserve for future expansion or contractual due to a bank requirement. b. Historically, the amounts were transferred to retained earnings – appropriated account and transferred back to retained earnings after the appropriation or restriction has passed. c. Today, most companies state the restrictions in a footnote to the retained earnings account. d. Changes in retained earnings occur from: (a) Net income or loss (b) Dividends declared (c) Effects of prior period adjustments – a correction made in the current year of a mistake made in previous years. e. Statement of Retained Earnings – See Figure 19.14 2. Accounting cycle for a corporation: a. There is a sample worksheet of a corporation – See Figure 19.15 b. The net income shown on the income statement could be substantially different from that reported for tax purposes because there are certain deductions on the tax return that differ from the expenses on the books.

Teaching Tips/Strategy: Use Success Coach LU 19-4 to review the basic concepts on the topic. Use the Concept Check #5 to evaluate a prior period adjustment and its consequences on the retained earnings amount of the corporation.

Use the “Ten-Minute Quiz” questions 9 and 10 to reinforce the learning concepts.

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Name

Date

Section

CHAPTER 19 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

When there is only common stock, the book value per share is calculated as: a. total assets / total shares outstanding b. total stockholders' equity less dividends in arrears / total shares outstanding c. total stockholders' equity / total shares outstanding d. common stock / total shares outstanding 2.

The entry to record the declaration of a dividend for a company that declares a $3 dividend per share on the 3,000 shares is: a. Retained Earnings 9,000 Dividends Payable 9,000 b. Dividends Payable 9,000 Cash 9,000 c. Cash 9,000 Retained Earnings 9,000 d. Retained Earnings 9,000 Common Stock 9,000

3.

The entry to record the payment of a dividend for a company that declares a $3 dividend per share on the 3,000 shares is: a. Retained Earnings 9,000 Dividends Payable 9,000 b. Dividends Payable 9,000 Cash 9,000 c. Cash 9,000 Retained Earnings 9,000 d. Retained Earnings 9,000 Common Stock 9,000

4.

The entry to record the declaration of a stock dividend of 100 shares of $10 par stock with a market value of $15 is: a. Common Stock Dividend Distributable 1,000 Paid-in Capital in Excess of Par Value - Stock 500 Retained Earnings 1,500 b. Cash 9,000 Paid-in Capital in Excess of Par Value - Stock 500 Common Stock Dividend Distributable 1,000 c. Retained Earnings 1,500 Paid-in Capital in Excess of Par Value - Stock 500 Common Stock Dividend Distributable 1,000 d. Common Stock Dividend Distributable 1,500 Common Stock 1,500

5.

The entry to record the distribution of a three-for-one stock split of 100 shares of $15 par stock with a market value of $18 is: Copyright © 2023 Pearson Education, Inc.

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a. Retained Earnings 1,500 Common Stock Dividend Distributable 1,500 b. Common Stock Dividend Distributable 1,800 Common Stock 1,500 Common Stock Dividend Distributable 300 c. Retained Earnings 1,800 Paid-in Capital in Excess of Par value - Stock 300 Common Stock Dividend Distributable 1,500 d. No journal entry required, only a memorandum notation in the journal 6.

Which of the following is not a characteristic of stock splits? a. The number of shares outstanding increases after a stock split. b. Proportional ownership is unchanged after a stock split. c. The market price per share decreases after a stock split. d. The par value of the stock remains the same.

7.

The entry to record the purchase of 100 shares of treasury stock purchased for $10 while the market value is $9 per share is: a. Treasury stock - common 900 Cash 900 b. Treasury stock - common 900 Retained earnings 900 c. Treasury stock - common 1,000 Cash 1,000 d. Treasury stock - common 1,000 Retained earnings 1,000

8.

The entry to record the sale of 100 shares of treasury stock purchased for $10 and sold for $9 per share is: a. Treasury Stock- common 900 Additional paid-in capital (or retained earnings) 100 Retained earnings 1,000 b. Cash 900 Additional paid-in capital (or retained earnings) 100 Treasury Stock- common 1,000 c. Cash 900 Treasury Stock- common 900 d. Treasury Stock- common 900 Retained earnings 900

9.

The Stockholders' Equity Section of the balance sheet includes all of the following except: a. par value per share b. market value per share c. additional paid-in capital d. retained earnings

10.

Appropriated retained earnings may be: a. voluntary b. contractual c. either voluntary or contractual d. neither voluntary nor contractual Copyright © 2023 Pearson Education, Inc.

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Answer Key to Chapter 19 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

c a b c d d c b b c

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Chapter 20 Corporations and Bonds Payable Chapter Overview This chapter begins with a discussion of the ways corporations can raise funds - they could issue either stock or long-term notes payable. Commonly, stock and notes are sources of funds, and current conditions and interest rates help the company decide the best method for them at the time the funds are needed. If a company decides to use bonds, they need to understand the different types of bonds available: secured, debentured, serial, registered, callable, or convertible. The company also needs to consider the interest rate that will be stated on the bonds. The difference between the current and market value interest rate will dictate if the bonds are issued at a discount or premium. The discount or premium may be amortized using the straight-line method or the interest method, and this chapter illustrates both methods. It also illustrates how to handle sale of bonds between interest payments and the year-end adjustments needed to properly record interest expense. In order to pay the bondholders at the end of the period, the company may also establish a sinking fund. This chapter concludes with illustrations on establishing, earning interest, and eliminating a bond sinking fund to pay off the bond.

Learning Objectives After studying Chapter 20, your students should gain proficiency in the following: 1. Journalize Issuance and Interest Payments of Bonds.

2. Explain and Journalize Amortization of Bonds by the Straight-Line Method.

3. Explain and Journalize Amortization of Bonds by the Interest Method.

4. Journalize Bond Sinking Fund Transactions.

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Chapter 20 Assignment Grid Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Bond Selling Price 1 2 Types of Bonds 1 3 Dividends 1 4 Accrued Interest on Bond Purchase 1 5 Bond Premium 2 6 Discount on Bonds Payable 2 7 Premium on Bonds Payable 2 8 Amortizing Bond Discount or Premium 3 9 Carrying Value of Bond 3 10 Interest Method of Amortization 3 11 Retirement of Bonds 4 12 Bond Sinking Fund 4 13 Ethical Case 1 Concept Checks 1 Bond Journal Entries 1 2 Bond Issued at a Discount 2 3 Interest and Amortization of Discount with Straight-Line Method 2 4 Bond Issued at Premium 2 5 Interest and Amortization of Premium with Straight-Line Method 2 6 Amortization of Bond Discount by Interest Method 3 7 Journalizing the Semiannual Payment of Amortization of Discount 3 8 Amortization of Bond Premium by Interest Method 3 9 Journalizing the Semiannual Payment and Amortization of Bond Premium 3 10 Sinking Fund 4 Exercises (Set A) 20A-1 Earnings per Share 1 20A-2 Bond Journal Entries 1 20A-3 Entries: Bond & Straight-Line Amortization 1, 2 20A-4 Entries: Bond & Straight-Line Amortization 1, 2 20A-5 Entries: Bond & Interest Method Amortization 1, 3 20A-6 Sinking Fund Entries 4 20A-7 Balance Sheet Presentation 2, 4 Exercises (Set B) 20B-1 Earnings per Share 1 20B-2 Bond Journal Entries 1 20B-3 Entries: Bond & Straight-Line Amortization 1, 2 20B-4 Entries: Bond & Straight-Line Amortization 1, 2 20B-5 Entries: Bond & Interest Method Amortization 1, 3 20B-6 Sinking Fund Entries 4

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Estimated Time in Minutes

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5 5 5 5 5 5 5 5 5 5 5 5 10

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15 10

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10 15

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15

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20

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10

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10 10

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30 30 50 50 50 35 30

Medium Medium Medium Medium Medium Medium Medium

30 30 50 50 50 35

Medium Medium Medium Medium Medium Medium

20B-7 Balance Sheet Presentation 2, 4 Problems (Set A) 20A-1 Bond Journal Entries 1, 2 20A-2 Amortization Schedule – Straight-Line 1, 2 20A-3 Bond Schedule and Entries – Interest Method 1, 2, 3 20A-4 Bond Schedule and Entries – Interest Method 1, 2, 3

30

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Estimated Time in Minutes

Level of Difficulty

Problems (Set B) 20B-1 Bond Journal Entries 1, 2 20B-2 Amortization Schedule – Straight-Line 1, 2 20B-3 Bond Schedule and Entries – Interest Method 1, 2, 3 20B-4 Bond Schedule and Entries – Interest Method 1, 2, 3

60 60 70 70

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Financial Report Problem Reading Amazon’s Annual Report/Internet Project

10

Easy

Learning Objective(s)

Assignment Topic(s)

1

Learning Unit 20-1: Journalizing Issuance and Interest Payments of Bonds Summary: A bond is an interest-bearing note payable usually in $1,000 denominations issued by a corporation to a large group of lenders. Each bond certificate, usually issued in denominations of $1,000, contains the following: face value (principal or par value) and contract rate (interest rate). The face value is the amount that the corporation must repay to the lender at the maturity date. The contract rate, stated interest rate or coupon rate, is the annual interest rate based on face value. Usually, this interest is paid semi-annually or twice per year. The dates of interest payment are also printed on the certificate. A bond certificate is a piece of paper held by a bondholder showing evidence of a bond issued by a corporation to be payable on a specific date for a specific sum to the order of the person named in the bond certificate or to the bearer.

A bond indenture is the information on the bond certificate written by the corporation into a more formal agreement. This agreement is usually monitored by a trustee (often a bank), who represents the group of bondholders. A trustee organization, a bank or person, monitors a bond indenture for the protection of bondholders. A secured bond pledges specific assets such as equipment or property as security for meeting the terms of the bond agreement. A debenture bond does not pledge any assets as collateral. Therefore, the bonds are unsecured. Serial bonds are issued in a series, each having its own maturity date.

A registered bond is a bond that the owners are registered with the issuing company, and interest is mailed to the bondholders on record. Callable bonds have a provision stating that they can be called in by a corporation after a certain date. When a bond issue is called in, the corporation usually has to pay a price above the face value of the bond. A convertible bond allows bondholders to convert their bonds into shares of stock. For this right, bondholders give up fixed interest payments for what they hope will be higher dividends and/or stock prices.

There are three journal entries to be made for the bonds: the issuance, the interest payment, and the maturity date payment. The issuance payment is done when the bond is issued or sold. The entry is a debit to the Cash account and a credit to the Bonds Payable account. The interest payments are made twice a year. The entry needed is a debit to the Interest Expense account and the credit to the Cash account. The maturity payment is made at the end of the bond term. The entry is a debit to Bonds Payable and a credit to Cash.

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Key Concepts: Bond, bond certificate, face value, contract rate, bond indenture, trustee, secured bond, debenture bonds, serial bonds, registered bond, callable bond, convertible bond.

Lecture Outline: Bond terminology: 1. Face value – the amount the corporations must repay to the lender on the maturity date.

2. Contract rate or stated interest rate – the annual interest rate, which is usually paid semiannually as stated on the certificate. Remember: Interest = Principal x Rate x Time.

3. The same information is written into the more formal agreement called the bond indenture. (This agreement is monitored by a trustee (often a bank) who represents the group of bondholders.)

Types of bonds: 1. Secured bonds – bonds issue by a corporation that pledges specific assets as security.

2. Debenture bonds – bonds that are unsecured and are issued only on the general credit of a corporation.

3. Serial Bonds – bonds issued in a series with each series having its own maturity date.

4. Registered bonds – bond owners are registered with the corporation, and interest checks are sent directly to the owners of record.

5. Callable bonds – bonds with a provision, that after a certain date, they can be called in by the corporation for a price usually above the face value of the bond.

6. Convertible bonds – bond may be allowed to convert bonds into shares of stock.

Stocks vs. Bonds: 1. Corporations raise funds through the selling of bonds or stocks.

2. Decision is based on the advantages/disadvantages of the following factors: income taxes and cash flows. (a) Income and taxes: (i) Bond interest expense reduces earnings and income taxes. (ii) Stock dividends do not affect earnings, and taxes remain unchanged. (iii) Earnings per share (EPS) is computed as: After-Tax Earnings – Dividends for Preferred Stock Number of Shares of Common Stock Outstanding (iv) Bond interest expense reduces earnings so the numerator of the EPS calculation is lower than selling stock. (v) Stock issuance increases the number of shares outstanding compared to bond issuance.

This increases the denominator of the EPS calculation. (b) Cash flow: (i) Bond interest requires the company to pay interest and pay the owners the face value of the bond at maturity. A company needs to consider their ability to pay this debt. (ii) The interest rates may affect a company’s ability or desire to make the interest payments or pay back the bond. (iii) Stock issuance does not require the company to pay interest or pay the face value of the stock to the owners.

Bond’s Journal Entries: 1. Issuance of bonds: $500,000 @ 12% for 10 years (See Figure 20.1): Dr. Cash 500,000 Cr. Bonds Payable

500,000

2. Semiannual interest payments. The interest expense is $500,000 x 12% x 6/12 = $30,000 (See Figure 20.2):

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Dr. Bond Interest Expense Cr. Cash

30,000 30,000

3. Retirement of bond issue when the bond is paid (See Figure 20.3): Dr. Bonds Payable Cr. Cash

500,000 500,000

Bonds sold between interest dates: 1. The purchaser of the bonds pays the purchase price of the bond plus the interest that has accrued since the last interest payment.

2. When the next interest payment date arrives, the company pays the purchaser the interest for the entire six months.

Example: Bonds discussed above were issued on January 1 and sold on March 1 (two months or 59 days).

The interest is $ 10,000. (Principal x Annual Interest Rate x Time) $500,000 x 12% x 2/12 = $10,000 Dr. Cash

510,000 Cr. Bonds Payable Cr. Bond Interest payable

500,000 10,000

Bond Payment date (for the first 6 months): Dr. Bond Interest payable Dr. Bond Interest Expense Cr. Cash

10,000 20,000 30,000

Teaching Tips/Strategy: Clarify the bond concept and the different types of bonds as well as characteristics of each bond. Discuss the difference between a loan and a bond. Illustrate the different kinds of bonds and why certain bonds are more appealing to investors than others. Evaluate the interest rate concept and how it is a determinant factor while pricing bonds. To review all related entries, use the “Try It! LU 20-1”. Utilize the Success Coach LU 20-1 as an assessment. For class demonstration, utilize the Concept Checks 1 and 2 to practice the bond’s required entries.

Use the “Ten-Minute Quiz” question 1 to reinforce the learning concept.

Learning Unit 20-2: Journalizing Amortization of Bonds by the StraightLine Method Summary: The bonds issued might have a rate of interest stated on the bond, the contract rate, which may be lower or higher than the current market rate of interest. Investors may require higher rates of interest if the bond issue appears to be different from others offered by companies that may have had fewer financial difficulties. The effective rate is the real or actual rate of interest to the borrowing corporation. Bond Quotes (bond prices) are determined by the comparison of the contract rate and the market rate. The carrying value (book value) is the face value of a bond less bond discount or plus bond premium. A Discount on Bonds Payable, a contra-liability account, is an account used when bonds are issued below face value. This indicates market rate of interest is higher than contract rate. The amortization of the discount on Bonds Payable is the writing off of the bond discount as an increase to interest expense for each interest period. A Premium on Bonds

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Payable, liability account, is an account used when bonds are issued above face value. This indicates market rate of interest is lower than the contract rate. The amortization of the premium on Bonds Payable is the writing off of the bond premium as a decrease to the interest expense for each interest period. Straight-line amortization is a method that recognizes equal amounts of interest expense for each period when amortizing a bond discount or premium.

Examples of $1,000 bond quotes: If the contract interest rate = market rate, the bond is sold at $1000 or par value.

If the contract interest rate > market rate, the bond is sold at premium (an amount higher than $1000).

If the contract interest rate < market rate, the bond is sold at discount (an amount below $1,000).

Key Concepts: Effective rate, carrying value (book value), discount on bonds payable, amortization of discount on bonds payable, amortization of premium on bonds payable, straight-line method, premium on bonds payable.

Lecture Outline: 1. Interest rate – The market interest rate may be lower or higher than the stated rate. a. The bond purchasers are interested in receiving the market rate of interest, and the company adjusts the price of the bond so the effective rate of interest is the market rate. b. When the company pays off the bond, the purchaser will receive the full face value of the bond regardless of the price paid for the bond. c. The difference between the amount paid for the bond and the face value of the bond combines with the interest payments to yield the effective interest rate. d. The straight-line method is an amortization method which divides interest expense evenly over the life of bond.

2. Bonds sell at par – The market rate is the same as the stated rate. The bond price is the same as the face value of the bond. The bond price or quote is stated as 100. Example: The bond is $200,000 at an interest rate of 12% payable semi-annually.

The journal entry for the bond issuance is: Dr. Cash Cr. Bonds Payable

200,000 200,000

3. Bond discount – Market rate is higher than the stated rate. The bond price is less than the face value of the bond, and the difference is a bond discount. Bond price (quote) is stated as less than 100. Example: The journal entry for the bond issuance at 97 is: Dr. Cash ($200,000 x .97) 194,000 Dr. Discount on Bonds Payable 6,000 Cr. Bonds Payable 200,000 a. The balance sheet would show the bond as: Long-term Liabilities 12% Bonds Payable Less: Discount on Bonds Payable

$200,000 - 6,000 194,000 (Carrying value of bond)

b. Each semi-annual interest payment would reduce the discount on bonds payable.

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(a) The bond interest per the bond is: $200,000 bonds x 12% interest x ½ year = $12,000 (b) Over the life of the bond (10 years), the interest per bond certificate is $240,000. (c) The effective interest rate is: Principal of bonds Interest due per bond certificate Total amount to be paid to bondholder Total amount received from sale of bond Interest to be paid over the life of bond

$200,000 240,000 $440,000 194,000 $246,000

The semiannual interest expense is $12,300 ($246,000 / 10 years) x ½ year (d) If the interest due (payment) the bond holder is $12,000 and the semiannual interest expense is $12,300, the difference of $300 will be credited to the discount on bonds payable account.

This will result in a $300 increase in interest expense and a reduction of the discount on bonds payable. (e) The amortization or reduction of the discount is done by $300 with each interest payment as shown in Table 20.2. At the end of the 10-year life of the bond, the discount on bonds payable account will be zero. Amortizing discounts on bonds payable with this method is the straightline method. (f) The journal entry to record each semiannual interest payment is: Dr. Bond Interest Expense (246,000/10 x 6/12) 12,300 Cr. Discount on Bonds Payable 300 Cr. Cash (200,000 x .12 x 6/12) 12,000 4. Bond Premium – Market rate is lower than the stated rate. The bond price is higher than the bond face value, and the difference is a bond premium. Bond price (quote) is stated higher than 100. Example: The journal entry for the bond issuance at 101 is: Dr. Cash ($200,000 x 1.10) Cr. Premium on Bonds Payable Cr. Bonds Payable

202,000 2,000 200,000

Teaching Tips/Strategy: This topic is particularly difficult for students to understand. Utilize examples such as: Discussion Question 8, Concept Checks 3 through 5, and Exercise 20A-3 and 20A-4. It will be beneficial to present the bond quotes as they are presented in the Wall Street Journal investment section. It will relate the textbook terminology to actual investing terms that some of the students are used to hearing and reading about.

Use the “Ten-Minute Quiz” questions 3, 4, and 5 to reinforce the learning concepts.

Learning Unit 20-3: Journalizing Amortization of Bonds by the Interest Method* Summary: The straight-line method of amortization recognizes an equal amount of interest for each period even though the bond’s carrying value changes while the interest method of amortization recognizes a constant percentage of the bond carrying value. Accountants think it is inconsistent for interest expense to stay the same while the amount owed changes. Generally Accepted Accounting Principles (GAAP) state interest should be a

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Commented [CS1]: Should this be a 1?

constant percentage of the carrying value. Usually, the straight-line method may be used only if the results do not materially differ from those of the interest method. The effective interest method amortizes the premium or discount to record interest expense, being equal to the carrying value of the bond times the market rate times the time period. The interest expense is a constant percentage of the carrying value. The discount or premium to be amortized is the difference between the interest to be recorded and the interest paid to bondholders. (Tables 20.4 and 20.5) Key Concepts: Interest method of amortization Lecture Outline: 1. Bond Amortization utilizing the effective interest rate method. a. Carrying value of bonds at beginning of period x market interest rate = interest expense to be recorded b. Face value x contract rate = interest payment to bondholders c. The discount to be amortized is the difference between (a) interest paid and (b) interest expense recorded.

Example: A company issued $200,000 of 12%, 10-year bonds with interest to be paid on October 1 and April 1. The selling price of the bonds is $178,808, and the market interest rate is 14%. The discount on the bonds is $200,000 - $178,000 = $21,192. The entry to record the semiannual interest payment is: October 1 - payment of interest: Dr. Bond Interest Expense ($178,808 x 14% x ½ year) 12,517.00 Cr. Discount on Bonds Payable ($12,517 – $12,000) 517.00 Cr. Cash (200,000 x .12 x 6/12) 12,000.00 Dec 31 – Adjusting entry for three months: Dr. Bond Interest Expense [(178,808 + 517) x 14% x 3/12]6,276.50 Cr. Discount on Bonds Payable (6276.20 - 6000) 276.50 Cr. Bond Interest Payable (200,000 x .12 x 3/12) 6,000.00 January 1 (Reversing Entry): Dr. Bond Interest Payable Dr. Discount on Bonds Payable Cr .Bond Interest expense

6,000.00 276.50 6,276.50

2. Bond Amortization utilizing the effective interest rate method. a. Carrying value of bonds at beginning of period x market interest rate = interest expense to be recorded b. Face value x contract rate = interest payment to bondholders c. The premium to be amortized is the difference between (a) interest paid and (b) interest expense recorded.

Example: A company issued $200,000 of 12%, 10-year bonds with interest to be paid on October 1 and April 1. The selling price of the bonds is $224,926, and the market interest rate is 10%. The premium on the bonds is $224,926 - $200,000 = $24,926. The entry to record the semiannual interest payment is:

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October 1 - payment of interest: Dr. Bond Interest Expense ($224,926 x 10% x ½ year) Dr. Premium on Bonds Payable ($12,000 – $11,246) Cr. Cash (200,000 x .12 x 6/12)

11,246.00 754.00 12,000.00

Dec 31 – Adjusting entry for three months: Dr. Bond Interest Expense [($224,926 - 754) x 10% x 3/12]5,604.50 Dr. Premium on Bonds Payable ($6,000 – 5,604.50) 395.50 Cr. Bond Interest Payable ($200,000 x .12 x 3/12) 6,000.00 January 1 (Reversing Entry): Dr. Bond Interest Payable Cr. Premium on Bonds Payable Cr .Bond Interest Expense

6,000.00 395.50 5,604.50

Teaching Tips/Strategy: For the lecture, use a step-by step process to record all necessary entries. Utilize the “Try It!” Learning Unit 20-3 and the Success Coach LU 20-3.

To review the basic concepts, explain Concept Check #6. As a group-based activity, students can work together on Problems 20A-3 or 20A-4. The activity can be timed, and points can be awarded based on accuracy and proper completion of the problem. The groups that were not able to complete the problem get paired with students that were able to finish the problem (Pair and Share). Then assign Problems 20B-3 or 20B-4 as an individual activity.

Use the “Ten-Minute Quiz” questions 6 7, 8, and 9 to reinforce the learning concepts.

Learning Unit 20-4: Journalizing Bond Sinking Fund Transactions Summary: Often a corporation will agree to establish a fund that will accumulate assets over the life of the bond so as to pay off the bondholders at maturity. The Sinking Fund accumulates cash to pay off bonds when they are retired. A sinking fund is often a requirement stated in the bond indentures. The sinking fund interest earned is a revenue account used to record earnings on the sinking fund balance. The interest is earned on the balance in the sinking fund, and the account is credited with the interest amount. (Figure 20.21) Key Concepts: Sinking fund, bond sinking fund interest earned.

Lecture Outline: For callable bonds, companies retire them and issue new bonds at a lower rate of interest. This is called bond refunding. If bonds are not callable, companies can repurchase its bonds in the open market and retire them.

1. When bonds are retired before they reach maturity, the following points need to be recognized: a. Amortization of discount or premium needs to be up-to-date. b. The premium or discount as well as the bond liability account must be removed. c. Any gain or loss is recognized on the retirement of the bonds as other income or other expense that will be shown up on the income statement.

Example: On June 30, the corporation retired a $500,000, 10% bond issue that had an unamortized premium of $19,000. The bonds were called in at 105 (105% of face value).

The entry to record the retirement is:

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Commented [CS2]: Small rounding variation

Dr. Bonds Payable Dr. Premium on Bonds Payable Dr. Loss on Bond Retirement Cr. Cash ($500,000 x 1.05)

500,000 19,000 6,000 525,000

2. The Bond Sinking Fund is a fund that will accumulate cash to pay off bonds when they are retired. a. Sinking fund tables are available to make the payments easy to calculate.

For example, a company issued 8%, 15-year bonds for $80,000. (a) The sinking fund table for 8% and 15 periods has a factor of 0.0368295 (b) $80,000 x 0.0368295 = $2,946.36 The Journal Entry to record the establishment of a sinking fund (See Figure 20.20) Dr. Bond Sinking Fund ($80,000 × 0.0368295= $2,946.36) 2,946.36 Cr. Cash 2,946.36 b. Interest is earned on the sinking fund, and the book example has interest earned of $235.71. The entry is: Dr. Bond Sinking Fund 235.71 Cr. Bond Sinking Fund Interest Earned 235.71 c. When the bonds are paid off, the entry (assuming $50 extra in the sinking fund) is: Dr. Cash 50 Dr. Bonds Payable 80,000 Cr. Bond Sinking Fund 80,050 Teaching Tips/Strategy: Discussion Question 12 is useful to review the concept of a sinking fund and its uses. As a pre-lecture use the Success Coach LU 20-4 to start working on the basic topic of the sinking fund.

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Name

Date

Section

CHAPTER 20 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

A company is issuing a $100,000 bond that can be repurchased by the company in at least five years for a price of $105,000. This is a a. convertible bond b. callable bond c. series bond d secured bond 2.

Bonds payable should be shown on the balance sheet a. at their maturity value b. at their face value c. at their face value plus any unamortized discount. d. at their face value less any unamortized discount.

3.

When the market interest rate is higher than the stated interest rate on a bond a. the bond will be issued at face value b. the bond will be issued at a discount c. the bond will be issued at a premium d. the bond will be issued at its maturity value

4.

On April 1, the market rate of interest was 10% and a company issued $100,000 of 8%, 10-year bonds for $87,538. The entry to record the bond issuance is a. Bonds Payable 87,538 Cash 87,538 b. Bonds Payable 100,000 Discount on Bonds Payable 12,462 Cash 87,538 c. Cash 87,538 Discount on Bonds Payable 12,462 Bonds Payable 100,000 d. Cash 87,538 Bonds Payable 87,538

5.

On April 1, the market rate of interest was 8.5% and a company issued $100,000 of 8%, 10-year bonds at 99. If the company uses the straight-line method to amortize the bond discount, the semiannual amortization amount is a. $50 b. $207.50 c. $1,000 d. $4,207.50

6.

On April 1, the market rate of interest was 8.5% and a company issued $100,000 of 8%, 10-year bonds at 99. If the company uses the effective interest method to amortize the bond discount, the semiannual amortization for the first six months is a. $50 b. $207.50 c. $1,000 d. $4,207.50

7.

On April 1, 202X the market rate of interest was 8.5% and a company issued $100,000 of 8%, 10-year bonds at 99. If the company uses the effective interest method to amortize the bond discount, the total interest expense for the year ended December 31, 202X is a. $4,000 b. $4,207.50 c. $6,000 d. $6,315.66

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Commented [CS3]: From April 1 through December 31 is 9 months or ¾ of full year.

8.

On January 1,202X the market rate of interest was 8.5% and a company issued $100,000 of 8%, 10-year bonds at 99. If the company uses the straight-line method to amortize the bond discount, the total interest expense for the year ended December 31, 202X is a. $4,050 b. $4,207.50 c. $8,100 d. $8,415

9.

When a bond is sold on April 1 and interest payments are Jan. 1 and July 1, the amount of cash received when the bond is issued will be a. decreased by interest accrued from April 1 to July 1 b. decreased by interest accrued from Jan. 1 to April 1 c. increased by interest accrued from April 1 to July 1 d. increased by interest accrued from Jan. 1 to April 1

10.

A bond may be retired by all below except a. purchasing the bonds and then retiring them b. converting the bonds into common stock if the bonds are convertible c. calling the bonds into the company at a price based upon a percentage of face value d. declaring the bonds retired

Answer Key to Chapter 20 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

b d b c a b d c d d

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Chapter 21 Statement of Cash Flows Chapter Overview In addition to the income statement, balance sheet, and the statement of equity; there is a fourth financial statement – the statement of cash flows. This chapter discusses that financial statement. It consists of three main sections, structured to help the reader understand how the company received or used cash for operating, investing, and financing activities.

Operating activities are those activities that occur naturally in the functioning of the business. Investing activities are those activities involved in buying or selling non-current assets or investments in the company. Financing activities are those activities involved in borrowing or repaying loans as well as activities involved with the owners of the company through receiving investments by owners or paying earnings back to the owners.

There are two methods used to present the statement of cash flows, the indirect and direct methods. The two methods differ in their presentation of the cash flows from operations section. The indirect method begins with the income as stated on the income statement and adjusts the net income or loss to the net increase or decrease in cash while the direct method begins with the cash received directly from customers and reports all cash related income and expense activities.

Learning Objectives After studying Chapter 21, your students should gain proficiency in the following: 1. Prepare a Statement of Cash Flows by the Indirect Method.

2. Prepare a Statement of Cash Flows by the Direct Method.

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Chapter 21 Assignment Grid Estimated Time in Minutes

Level of Difficulty

1 1 2 1 1 1 1 1

5 5 5 5 5 5 5 5

Easy Easy Easy Easy Easy Easy Easy Easy

1 1 2 1, 2 1, 2

15 20 30 15 15

Easy Medium Medium Easy Easy

1 1 2 2

45 45 45 10

Easy Medium Medium Easy

1 1 2 2

45 45 45 10

Easy Medium Medium Easy

1 2

60 60

Hard Hard

Problems (Set B) 21B-1 Statement Preparation – Indirect Method 21B-2 Statement Preparation – Direct Method

1 2

60 60

Hard Hard

Financial Report Problem Reading Amazon’s Annual Report/Internet Project

1

20

Medium

Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Sections of Statement of Cash Flows 2 Indirect Method 3 Direct Method 4 Investing Activities 5 Analysis of Statement of Cash Flows 6 Financing Activities 7 Depreciation and the Indirect Method 8 Ethical Case Concept Checks 1 Operating Activities – Indirect Method 2 Operating Activities – Indirect Method 3 Operating Activities – Direct Method 4 Cash Flows from Financing 5 Change in Cash Exercises (Set A) 21A-1 Operating Activities – Indirect Method 21A-2 Operating Activities – Indirect Method 21A-3 Operating Activities – Direct Method 21A-4 Cash Flows Sections Exercises (Set B) 21B-1 Operating Activities – Indirect Method 21B-2 Operating Activities – Indirect Method 21B-3 Operating Activities – Direct Method 21B-4 Cash Flows Sections Problems (Set A) 21A-1 Statement Preparation – Indirect Method 21A-2 Statement Preparation – Direct Method

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Learning Unit 21-1: Preparing a Statement of Cash Flows by the Indirect Method Summary: In this chapter we turn our attention to a fourth major financial statement that is used to better understand the cash flows related to the operating, investing, and financing activities of a company. The Statement of Cash Flows summarizes the sources and uses of cash by a company during an accounting period. It also gives readers of the financial statements a good basis for estimating the possible future cash flows. Internal users of the financial statements (such as management) can also benefit by understanding how to read the statement of cash flows.

The statement of cash flows consists of three main sections: (1) net cash flows from operating activities, (2) net cash flows from investing activities, and (3) net cash flows from financing activities.

Operating activities include selling products or services to customers. Cash inflows from operating activities include cash collected from customers. Cash outflows from operating activities include paying for merchandise inventory, salaries, rent, and other such expenses. Investing activities include such things as purchase or sale of plant and equipment, buying and selling stocks and bonds (of other companies), and making and collecting loans to other businesses or individuals. Financing activities include raising money by issuing stocks and bonds, repurchasing of the company’s stock, and paying cash dividends to the stockholders.

A fourth classification reported on the statement of cash flows is called noncash investing and financing activities, which includes such transactions as issuing shares of stock in exchange for assets such as land and buildings. Although cash is not involved, the event is reported because no other financial statement specifically discloses the transaction. In the indirect method of reporting cash flows from operating activities, you are converting the net income on the income statement from the accrual basis to the cash basis. As we have been learning throughout this text, businesses normally report their net income on the accrual basis, which places the primary emphasis on when the revenues are earned and when the expenses are incurred. The indirect method’s name comes from the way we view the income statement.

Key Concepts: Comparative balance sheet, operating activities, cash inflow, cash outflow, investing activities, financing activities, noncash investing and financing activities, indirect method.

Lecture Outline: The statement of cash flows is the fourth financial statement: 1. Summarizes the sources and use of cash by a company during an accounting period.

2. Gives the reader a good basis for judging the possible future cash flows.

3. Presents cash flow as affected by three sections: a. Cash flows from operating activities. i) These are activities most closely related to conducting the business for which the enterprise was established. ii) These activities usually involve changes in current assets and current liabilities. b. Cash flows from investing activities. i) These are activities such as the purchase and sale of plant and equipment and placing excess cash in stocks, bonds, and notes of other companies. ii) These activities usually involve non-current assets. c. Cash flows from financing activities. i) These are activities related to raising and repaying funds borrowed from investors and creditors such as the issuance of stocks and bonds and long-term notes.

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ii) It also involves the repurchase of outstanding stock and retiring bonds and notes as well as paying dividends. iii) These activities usually involve changes in non-current liabilities and changes in equity.

4. Two methods can be used to present the statement of cash flows, and the only difference is in the presentation of cash flows from operating activities. The two methods as follows: a. The indirect method reconciles net income to cash provided by operations b. The direct method shows all the cash receipts and payments from operating activities.

There are three main sections of the statement of cash flows (indirect method): 1. Net cash flows from Operating Activities: a. Begins with the income per the income statement b. Depreciation is added to net income. Net income has already been reduced by depreciation expense and adding it back adjusts to represent this. c. Changes in current assets (The theory is the same as for adjusting for depreciation.) i) If current assets have decreased, these changes have to be added to net income. ii) If current assets have increased, these changes have to be subtracted from net income. d. Changes in current liabilities (The theory is the same as for adjusting for depreciation.) i) If current liabilities have increased, these changes have to be added to net income. ii) If current liabilities have decreased, these changes have to be subtracted from net income.

2. Net cash flows from Investing Activities typically include non-current assets, investing activities such as: a. The purchase and sale of other companies’ stocks and bonds, b. The buying and disposal of plant assets, and c. Making loans to other parties.

3. Net cash flows from Financing Activities typically include non-current liabilities along with equity accounts affected by cash flows such as: a. Issuance and repayment of long-term notes, b. Issuance of common stock, c. Purchasing and reissuing treasury stock, d. Payment of cash dividends, and e. Issuance and retiring of bonds.

4. The final calculation of cash flows is the total of the cash provided (cash increases) or cash used (cash decreases) in all three activities.

Teaching Tips/Strategy: Examine and present the “layout of a Cash Flows Statement” (Table 21-8) to explain and introduce the format and elements of the statements. Use the Discussion Questions 1, 2, 4, 6, and 7 to analyze the different cash flow categories.

For class lecture, review the Success Coach LU 21-1 to prepare students for the exercises. Use the Concept Check #2 to review the net cash flows operating activities section (indirect method). The Exercises 21A-1 and 21A-2 are excellent to assess the understanding of the indirect method.

Use the “Ten-Minute Quiz” questions 1 through 4 and 6 through 10 to reinforce the learning concept.

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Learning Unit 21-2: Preparing a Statement of Cash Flows by the Direct Method Summary: An alternative way of preparing the net cash from operating activities section of the statement is called the direct method. The direct method requires listing separately the major categories of cash inflows and outflows. The major cash inflow for most firms is the cash received from customers, which is computed by adjusting the sales amount by the change in Accounts Receivable. Cash outflows under the operating activities section include cash paid for inventory, cash paid for salaries, and cash paid for other operating expenses. In each case, the appropriate income statement amount is adjusted by the changes in one or more current asset or current liability accounts. Regardless of the method selected, the net cash from operating activities will be the same. Also, the distinction between the direct and indirect methods only applies to net cash from operating activities.

Key Concepts: Direct method Lecture Outline: The direct method requires listing major groups of operating cash receipts and cash payments.

1. Operating Cash Receipts—include cash received from sales, rent, interest, and dividends.

2. Operating Cash Payments—include cash paid suppliers, for wages and other operating expenses, interest, and income taxes.

Teaching Tips/Strategy: Use Concept Check #3 to review the net cash flows operating activities section (direct method). Review the demonstration exercise as a lecture and have the students divide into groups. All groups should be able to finish Exercise 21A-3 and 21A-4. An assigned group activity can be to prepare a statement of cash flows (Problem 21A-2 or Problem 21B-2) with all details and in full form.

Use the “Ten-Minute Quiz” question #5 to reinforce the concept.

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Name

Date

Section

CHAPTER 21 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which of the following is an operating activity? a. payment of dividends b. payment of utilities c. purchase of equipment d. issuance of stock 2.

Which of the following is an investing activity? a. purchase of vehicle b. issuance of treasury stock c. issuance of bonds d. purchase of inventory

3.

Which of the following is a financing activity? a. purchase of vehicle b. purchase of inventory c. payment of dividends d. payment of utilities

4.

The indirect method a. expands the cash from financing activities b. focuses on cash from investing activities c. lists major groups of cash receipts and payments d. reconciles net income to net cash from operating activities

5.

The direct method a. expands the cash from financing activities b. focuses on cash from investing activities c. lists major groups of cash receipts and payments d. reconciles net income to net cash from operating activities

6.

Depreciation is added to net income a. in the operating section of the direct method b. in the operating section of the indirect method c. in the financing activity section d. in the investing activity section

7.

If accounts receivable has increased, a. the change is subtracted from net income in the indirect method b. the change is added to net income in the indirect method c. the change is subtracted from net income in the direct method d. the change is added to net income in the direct method

8.

If accounts payable has increased, a. the change is subtracted from net income in the indirect method b. the change is added to net income in the indirect method c. the change is subtracted from net income in the direct method d. the change is added to net income in the direct method

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9.

Which of the following is a financing activity? a. purchase of inventory b. purchase of vehicle c. issuance of bonds d. payment of utilities

10.

Which of the following is an investing activity? a. payment of dividends b. purchase of equipment c. payment of utilities d. purchase of inventory

Answer Key to Chapter 21 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

b a c d c b a b c b

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21-7

Chapter 22 Analyzing Financial Statements Chapter Overview This chapter illustrates some analysis techniques used by investors, creditors, and management in making business decisions. The investor is concerned with analysis centered on future profitability, dividend probability, and company growth probability as compared alternative investments. Creditors are concerned that the company has enough cash to pay principal and interest on loans and bonds. The management is concerned with the company operating as efficiently as possible and identifying areas that can be improved.

Financial analysis results need to be placed in context in order to best understand the numbers.

Comparative forms of financial statements have different years listed in columns next to each other.

Horizontal analysis of the balance sheet compares these columns horizontally and compares the most recent year to the current or base year. This analysis shows how the company has changed over time.

Vertical analysis shows each item compared to a base of either total assets, or total liabilities and owners’ equity on the balance sheet, and the base is net sales on an income statement.

The chapter concludes with explanations of various types of ratios. Liquidity ratios measure a company’s ability to meet short-term obligations. Asset management ratios measure how effectively a company is using its assets. Debt management ratios measure how well a company is using debt versus its equity position. Profitability ratios measure a company’s ability to earn a profit.

Learning Objectives After studying Chapter 22, your students should gain proficiency in the following: 1. Prepare a Horizontal and Vertical Analysis of a Comparative Balance Sheet.

2. Prepare a Horizontal and Vertical Analysis of an Income Statement.

3. Calculate Financial Ratios.

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Chapter 22 Assignment Grid Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Financial Statement Analysis 1 2 Horizontal Analysis 2 3 Vertical Analysis 2 4 Common-Size Statements 2 5 Base Year Selection 2 6 How Ratios are Expressed 3 7 Types of Ratios 3 8 Acid Test Ratio 3 9 Accounts Receivable Turnover 3 10 Stockouts 3 11 Debt to Total Assets 3 12 Rate of Return on Assets 3 13 Ethical Case 3 Concept Checks 1 Horizontal Analysis Balance Sheet 1 2 Vertical Analysis Balance Sheet 1 3 Common-Size Income Statement 1, 2 4 Trend Analysis 2 5 Ratios 3 Exercises (Set A) 22A-1 Comparative Income Statement 2 22A-2 Common-Size Income Statement 1, 2 22A-3 Comparative Balance Sheet 1 22A-4 Trend Analysis 2 22A-5 Ratio Analysis 3 Exercises (Set B) 22B-1 Comparative Income Statement 2 22B-2 Common-Size Income Statement 1, 2 22B-3 Comparative Balance Sheet 1 22B-4 Trend Analysis 2 22B-5 Ratio Analysis 3 Problems (Set A) 22A-1 Horizontal and Vertical Analysis 1 22A-2 Horizontal, Vertical, Common-Size Analysis 1,2 22A-3 Ratio Analysis 3 22A-4 Ratio Analysis, Common-Size & Trend 1, 2, 3 Problems (Set B) 22B-1 Horizontal and Vertical Analysis 1 22B-2 Horizontal, Vertical, Common-Size Analysis 1,2 22B-3 Ratio Analysis 3 22B-4 Ratio Analysis, Common-Size & Trend 1, 2, 3

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Estimated Time in Minutes

Level of Difficulty

5 5 5 5 5 5 5 5 5 5 5 5 10

Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy

10 15 15 15 15

Easy Easy Easy Easy Easy

30 30 50 30 30

Medium Medium Medium Medium Medium

30 30 50 30 30

Medium Medium Medium Medium Medium

60 60 60 30

Hard Hard Hard Hard

20 60 60 30

Hard Hard Hard Hard

Estimated

Level

Assignment Topic(s) Financial Report Problem Reading Amazon’s Annual Report/Internet Project

Learning Objective(s)

Time in Minutes

of Difficulty

1, 2, 3

30

Medium

Learning Unit 22-1: Horizontal and Vertical Analysis of Comparative Balance Sheets Summary: Common Size Statements are comparative reports in which each item is expressed as a percentage of a base amount. A Comparative Balance Sheet shows data from two or more periods side by side. (See Figure 22.1) The current year’s balance sheet amounts are placed next to amounts from the preceding year’s balance sheet. The third column shows the amount of increase or decrease between the two years. The last column shows the percentage of decrease or increase between the years. An analysis, in which each item on the report is compared with the same item in another period is called horizontal analysis.

In vertical analysis, each item on a comparative balance sheet is shown as a percentage of a total base (either total assets or total liabilities plus stockholder’s equity).

Key Concepts: Comparative balance sheets, horizontal analysis, vertical analysis, common-size statements.

Lecture Outline: 1. Horizontal analysis (See Figure 22.1): a. Column 1 contains the current year data. b. Column 2 contains the prior year data. c. Column 3 shows the increase or decrease in the current year over the preceding year. d. Column 4 shows the percentage increase – column 3 / column 2. e. Shows the change from one period to another. f. Does not show the changes within each column.

2. Vertical analysis (See Figure 22.2) still uses a comparative format: a. Column 1 contains the current year data b. Column 2 shows the percentages compared to the base. (The base is the total assets or total liabilities plus owners’ equity.) c. The total of Column 2 for the assets should equal 100%. d. The total of Column 2 for liabilities and owners’ equity should equal 100%. e. A shorter version of the vertical analysis of the balance sheet is called a common-size statement. (a) Each item is expressed as a base amount without dollar values shown in a commonsize statement.

3. The common-size statement makes it easier to see and make the comparisons. a. Used to compare companies of different sizes without being influenced by dollar amounts.

Teaching Tips/Strategy: After explaining the procedures for horizontal analysis, trend analysis, vertical analysis, and common-size statement, use the Concept Checks 1 and 2 to illustrate these procedures to analyze financial statements. Exercise 22A-3 can be used for classroom illustration of a common-size statement.

Use the “Ten-Minute Quiz” questions 4, 6, and 7 to reinforce the learning concepts.

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Learning Unit 22-2: Horizontal and Vertical Analysis of Income Statements Summary: Common Size Statements are comparative reports in which each item is expressed as a percentage of a base amount. A Comparative Income Statement shows data from two or more periods side by side. (See Figure 22.4) The current year’s income statement amounts are placed next to amounts from the preceding year’s income statement. The third column shows the amount of increase or decrease between the two years. The last column shows the percentage of decrease or increase between the years.

An analysis, in which each item on the report is compared with the same item in another period is called horizontal analysis.

In vertical analysis, each item on a comparative income statement is shown as a percentage of the same year’s net sales. (See Figure 22.5) For example, the net sales percent of change is 100%. Cost of goods sold percent is computed by dividing the dollar amount of COGS by the dollar amount of net sales within the same year. For 2021 COGS of $198,000 is divided by nets sales of $317,600 yielding a 62.3% amount.

Key Concepts: Trend analysis Lecture Outline: 1. Horizontal analysis (See Figure 22.4) a. Column 1 contains the current year data. b. Column 2 contains the prior year data. c. Column 3 shows the increase or decrease in the current year over the preceding year. d. Column 4 shows the percentage increase – column 3 / column 2 e. Shows the change from one period to another. f. Does not show the changes within each column.

2. Vertical analysis (See Figure 22.5) still uses a comparative format. a. Column 1 contains the current year data. b. Column 2 shows the percentages compared to the base – net sales is the base.

3. Trend analysis is a type of horizontal analysis that deals with percentage changes in items on the financial reports for several years. This analysis: a. Uses a base year to calculate the percentage change within each item. b. Usually uses the earlier year as the base year. c. States each item as a percentage of the base year.

Teaching Tips/Strategy: After explaining the procedures for horizontal analysis, trend analysis, vertical analysis, and common-size statement, use the Concept Checks #3 and #4 to illustrate these procedures to analyze financial statements. Exercises 22A-1, 22A-2, and/or 22A-4 can be used for classroom illustration.

Use the “Ten-Minute Quiz” questions 4, 6, and 7 to reinforce the learning concepts.

Learning Unit 22-3: Calculate Financial Ratios Summary: Another method for understanding the numbers on the financial statement is the use of ratio analysis. A ratio is the relationship of two quantities or numbers, one divided by the other. Ratio analysis looks at the relationship of amounts on the financial statement. To be meaningful, ratios are often compared with other standards, such as past company ratios or industry-wide ratios. The ratios we discuss fall into four general categories:

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•

•

•

•

Liquidity Ratios measure a company’s ability to meet short-term obligations: o Current Ratio (Current Assets/Current liabilities) o Acid Test Ratio: (Current Assets – Merchandise Inventory – Prepaid expenses/Current Liabilities) Asset Management Ratios measure how effectively a company is using its assets. o Accounts Receivable Turnover: Net Credit Sales / Average Accounts Receivable) o Average Collection Period: 365 days / Accounts Receivable Turnover o Inventory Turnover: Cost of Goods Sold / Average Inventory o Asset Turnover: Net Sales / Total Assets Debt Management Ratios measure how well a company is using debt versus its equity position. o Debt to Total Assets: Total Liabilities / Total Assets o Debt to Stockholders’ Equity: Total Liabilities / Stockholder’s Equity o Times Interest Earned: Income Before Taxes and Interest Expense / Interest Expense Profitability Ratios measure a company’s ability to earn profits. o Gross Profit Rate: Gross Profit / Net Sales o Return on Sales: Net Income Before Taxes / Net Sales o Rate of Return on Total Assets: Net Income Before Interest and Taxes / Total Assets o Rate of Return on Common Stockholders’ Equity: (Net Income Before Taxes – Preferred Dividends) / Common Stockholders’ Equity

Key Concepts: Ratio, ratio analysis, liquidity ratios, asset management ratios, debt management ratios, profitability ratios, current ratio, acid test ratio, quick assets, accounts receivable turnover ratio, average collection period, inventory turnover ratio, asset turnover ratio, debt to total assets ratio, debt to stockholders’ equity ratio, times interest earned ratio, gross profit rate, return on sales ratio, return on total assets ratio, return on common stockholders’ equity ratio.

Lecture Outline: Ratios are relationships of two quantities or numbers, one divided by the other.

1. Ratio analysis is an examination of the relationship between two numbers or sets of numbers on financial reports. Analysis over time can give a clear picture of how a company conducts business.

2. Company ratios analyze different aspects of the business.

3. Ratios are better understood when compared with other standards, such as past company ratios or industry ratios.

There are four major categories of ratios 1. Liquidity Ratios: measure a company’s ability to pay its short-term debt. a. Current Ratio: Current Assets / Current Liabilities (a) Indicates a company’s ability to pay its short-term debt. (b) Does not provide as much certainty as the acid test ratio.

Example: Current Assets = $48,000 = 2.26:1 Current Liabilities $21,200 b. Acid Test Ratio (Quick Ratio): (a) Quick assets are those assets – mainly cash, accounts receivable, and notes receivable – that can be easily turned into money. (b) Evaluated in the same terms as the current ratio except that merchandise inventory and prepaid expenses are deducted from the current assets.

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Example; Current Assets – Merchandise Inventory – Prepaid Expenses = $23,040 = 1.09:1 Current Liabilities $21,200 2. Asset Management Ratios: measure how effectively a company uses its assets a. Accounts Receivable Turnover Ratio – (a) A ratio that indicates the number of times accounts receivables are converted to cash within a given period. (b) Measures effectiveness of a company’s credit policy. (c) Usually, the higher the turnover, the better. (d) The turnover rate depends on the length of the credit period.

Example: ______Net Credit Sales_____ = $317,600 = 17.6 Average Accounts Receivable $18,000 b. Average Collection Period: (a) A ratio that shows how long it takes to collect the average accounts receivable. (b) Accounts Receivable Turnover is calculated first, and the turnover is used in this calculation.

Example:

365 = 365 = 20.7 Accounts Receivable Turnover 17.6

c. Inventory Turnover Ratio: (a) Ratio that indicates how quickly inventory moves off the shelf, and, therefore, (b) How well a company sells its product. (c) A high inventory turnover ratio indicates the company has less cash tied up in inventory. (d) A high inventory turnover ratio means less inventory obsolescence.

Example: Cost of Goods Sold Average Inventory

= $198,000 $25,140

= 7.9

d. Asset Turnover Ratio: (a) A ratio that indicates how efficiently a company uses its assets to generate sales. (b) Helps measure the overall efficiency of the company. (c) Usually, the higher the asset turnover ratio, the better the company is operating. (d) A low asset turnover rate compared with industry standards could indicate the company is not generating enough sales for its investment in its assets.

Example: Net Sales Total Assets

=

$317,600 $173,200

= 1.8 times

3. Debt Management Ratios: measure a company’s mix of debt and equity financing. a. Debt to Total Asset ratio: (a) Shows how much of a company’s assets are financed by creditors. (b) A low percentage is favorable to creditors; because, in liquidation, they are more likely to be paid. (c) Stockholders like to see a higher ratio in an attempt to maximize their return.

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Example: Total Liabilities Total Assets

= $81,200 $173,200

= 46.9%

b. Debt to Stockholders’ Equity Ratio: (a) Ratio in which total liabilities are divided by the amount of stock that is owned. (b) Measures the risk creditors run in comparison with stockholders. (c) There is no guideline as to what the ratio of debt to stockholders’ equity should be: Example: Total Liabilities Stockholders’ Equity

= $81,200 = 88.3% $92,000

c. Times Interest Earned (Interest Coverage Ratio): (a) Ratio that indicates the degree of risk to lenders that a company will default on its interest payments. (b) Creditors are interested in this ratio because it indicates the degree of risk to creditors from a company defaulting on interest payments. (c) The higher the ratio, the more likely it is that the interest payment will be made, even if earnings start to decline.

Example: Income Before Taxes and Interest Expense = $36,000 = 8.6 times Interest Expense $4,200 4. Profitability Ratios: measure a company’s ability to earn a profit. a. Gross Profit rate: (a) Indicates how well net sales covers administrative and selling expenses.

Example: Gross Profit = $119,000 = 37.7% Net Sales $317,600 b. Return on Sales ratio: (a) Shows the relationship of net income before taxes to net sales (b) Measures the effectiveness of a company’s pricing policies. (c) Stores with low inventory turnover will have a high return on sales because the goods are priced high. (d) Stores that have a high inventory (grocery stores) will price its goods lower, resulting in a lower return per dollar of sales.

Example: Net Income Before Taxes = Net Sales

$31,800 = 10% $317,600

c. Return on Total Assets ratio: (a) Measures how widely a company has invested in and managed its assets.

Example: Net Income Before Interest and Taxes = $36,000 = 20.8% Total Assets $173,200

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d. Return on Common Stockholders’ Equity ratio: (a) Indicates how well a company is managing debt financing to earn a profit for holders of common stock. (b) Aids in evaluating how well it is earning profit for its common stockholders. (c) Return has to be compared with that of the competitors. (d) If the rate is higher than the industry standards, the company is using debt financing wisely.

Example: Net Income Before Taxes - Preferred Dividends = $31,800 – 0 = 34.6% Common Stockholders’ Equity $92,000 Teaching Tips/Strategy: Refer students to the Demonstration Summary Problem for the five quizzes. Solutions are provided to check student work. After that explain each individual ratio and the implications of the ratio’s calculation on the business performance. The Concept Check #5 and Exercise 22A-5 can be used for classroom illustration. Review all chapter objectives by assigning Problems 22A-3 and 22A-4.

Use the “Ten-Minute Quiz” questions 1, 2, 3, 5, 8, 9, and 10 to reinforce the concepts.

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Name

Date

Section

CHAPTER 22 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Which stakeholder would be most interested in the company's profitability? a. investors b.

IRS c. creditors d. management 2.

Which stakeholder would be most interested in the company's ability to pay principal and interest? a. investors b.

IRS c. creditors d. management

3.

Which stakeholder would be most interested in the company's operations being efficient? a. investors b.

IRS c. creditors d. management

4.

The main way(s) to analyze financial statements are: a. common-size analysis b. inventory and accounts receivable turnover c. horizontal and vertical analysis d. trend analysis

5.

Which of the following is a liquidity ratio? a. accounts receivable turnover b. current ratio c. debt to total assets d. gross profit rate

6.

Horizontal analysis is also known as: a. trend analysis c. vertical analysis

b. common-size analysis d. profitability analysis

Vertical analysis is also known as: a. trend analysis c. vertical analysis

b. common-size analysis d. profitability analysis

7.

8.

Which of the following is an asset management ratio? a. acid test ratio b. average collection period c. debt to stockholders' equity d. return on sales

9.

Which of the following is a debt management ratio? a. rate of return on total assets b. inventory turnover c. current ratio d. times interest earned

10.

Which of the following is a profitability ratio? a. rate of return on common stockholders' equity b. debt to total assets c. acid test ratio d. accounts receivable turnover

.

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Answer Key to Chapter 22 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

a c d c b a b b d a

.

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Chapter 23 The Voucher System Chapter Overview This chapter discusses the need by some businesses to maintain control over the activities of companies as they grow larger and the number of transactions increases. The company develops rules and procedures to ensure that the money is being spent in approved ways. These rules and procedures are called internal control, and this chapter covers one specific type – the voucher system. This is a system designed to control a company’s cash payments. A voucher is a written authorization form used for every cash payment within a company. It contains all the details of the transaction along with the signatures of appropriate employees as authorization. The voucher system is the system in which no payment is made without an approved voucher.

This chapter covers the check register, the paid and unpaid vouchers, and additional or unusual transactions such as purchase returns, partial payments, and recording purchases at the net amount.

Learning Objectives After studying Chapter 23, your students should gain proficiency in the following: 1. Explain How to Handle Transactions in a Voucher System.

2. Explain Purchases Returns and Allowance, Partial Payments, and Recording Purchases at Net or Gross in a Voucher System.

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Chapter 23 Assignment Grid Estimated Time in Minutes

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Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Voucher System 2 Voucher System 3 Voucher System 4 Voucher System 5 Voucher System 6 Voucher System 7 Purchases and Voucher System 8 Purchases and Voucher System 9 Voucher Register 10 Ethical Case Concept Checks 1 Journal Entries to Record and Pay Vouchers 2 Petty Cash 3 Purchases Returns and Allowances 4 Equal Installments 5 Gross versus Net Exercises (Set A) 23A-1 Journal Entries to Record and Pay Vouchers 23A-2 Voucher System and Petty Cash 23A-3 Purchases Returns and Allowances 23A-4 Equal Installments 23A-5 Gross versus Net Exercises (Set B) 23B-1 Journal Entries to Record and Pay Vouchers 23B-2 Voucher Systems and Petty Cash 23B-3 Purchases Returns and Allowances 23B-4 Equal Installments 23B-5 Gross versus Net Problems (Set A) 23A-1 Journal Entries to Record and Pay Vouchers 23A-2 Journal Entries to Record and Pay Vouchers 23A-3 Journal Entries to Record and Pay Vouchers 23A-4 Journal Entries to Record and Pay Vouchers Problems (Set B) 23B-1 Journal Entries to Record and Pay Vouchers 23B-2 Journal Entries to Record and Pay Vouchers 23B-3 Journal Entries to Record and Pay Vouchers 23B-4 Journal Entries to Record and Pay Vouchers Financial Report Problem Reading Amazon’s Annual Report/Internet Report

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Chapter Introduction Summary A voucher is a written authorization form that is used for every cash payment the company makes. It contains all the details of the transaction in question along with the signatures of appropriate employees as authorization. A voucher system, then, is a system in which no payment is made without an approved voucher. This is system used to implement this internal controls.

1. The steps included in a voucher system are: a. Preparing a purchase requisition and getting it authorized. b. Preparing a purchase order with details such as company, number of items, and so forth, and getting it authorized. c. The company receiving the purchase order preparing a sales invoice specifying number, type of goods, and price. d. The company receiving the goods, inspecting the shipment, checking it against the purchase order and the sales invoice, and completing a receiving report. e. Someone in the accounting department verifying the numbers (checking the purchase order, the invoice, and the receiving report to make sure the numbers are in agreement and no steps are left out). This person then issuing a voucher for payment, which is authorized. f. Issuing payment in the form of a check (or electronic form). g. These steps show internal control, in the form of a voucher system, at work.

2. Characteristics of a voucher system. a. Separation of duties – no one person in a company is in control of all transactions. The person who approves the purchase and payment is not the same person in charge of the accounting entries, and that person is different from the person who signs and mails the checks. b. No purchases are made without an approved voucher (source document) to back them up.

At every layer and step the appropriate documents are presented, checked, and approved. c. There is a lot of cross-referencing and cross-checking in a voucher system. d. After a purchase is made and paid for, the documents and forms are kept on file for a certain period of time to allow such cross-checks to be made.

Learning Unit 23-1: Handling Transactions in a Voucher System Summary: A voucher system controls all cash payments, except payments out of the petty cash fund.

Company rules state that all invoices must be compared with purchase requisitions, purchase orders, and receiving reports before payment; and that all payments must, of course, be supported by appropriate documents and authorizations. A voucher is a written authorization form that is used for every cash payment the company makes. It contains all the details of the transaction in question along with the signatures of appropriate employees as authorization. Every document is numbered. Transactions are recorded in different places by different people and backed up by reference to numbers of other documents. In this way it is always possible to trace one transaction all the way through the system.

After a purchase is made and paid for, the documents and forms are kept on file for a certain period of time to allow such cross-checks to be made. Using the approved account distributions, the voucher is recorded in a special journal called the voucher register (Figure 23.4). This journal replaces the purchases journal. Note that the vouchers are entered in the voucher register in numerical order at the time the liability is incurred.

The vouchers payable credit column records the amount due on each voucher (before any discounts) for purchases of merchandise, services, or other assets. Each voucher, once it has been recorded in the voucher register, is filed in an unpaid voucher file (tickler file) according to due date. The company accountant records the payment in a special journal called a check register. The check register replaces the cash .

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payments journal in recording the payment of vouchers payable. A paid voucher file contains all the paid vouchers filed in sequential order according to the voucher numbers. Some companies will file the voucher alphabetically based on the creditor’s name.

Key Concepts: Voucher, voucher system, voucher register, vouchers payable, unpaid voucher file (tickler file), check register, paid voucher file.

Lecture Outline: A voucher system is made up of the following elements: Vouchers, voucher register, unpaid voucher file, check register and paid voucher file. The elements details are: 1. The Voucher (Figure 23.3): a. In preparing the voucher, the accountant responsible for vouchers compares the invoice (Figure 23.2) with the purchase requisition, purchase order (Figure 23.1), and receiving report. b. The original supporting documents are attached to the voucher. c. The voucher format: i. The front contains the voucher number, invoice number and date, purchase order number and verification steps. ii. The back contains the account distribution, space to complete the payment summary, and final approvals.

2. The Voucher Register (Figure 23.4) – a special journal replacing the purchases journal: a. The vouchers are entered in the voucher register in numerical order at the time the liability is incurred. b. The vouchers payable credit column records the amount due on each voucher (before any discounts) for purchases of merchandise, services, or other assets. c. Special debit columns are set up based on how often they are used. d. The sundry column, as in other special journals, records amounts that do not have special columns. e. Date of payment and check number are not filled in until time of payment. f. Accounts payable is used instead of vouchers payable when preparing the balance sheet.

3. Unpaid Voucher File (tickler file) is: a. A file containing unpaid vouchers b. Arranged by due dates. c. The unpaid file is the subsidiary ledger for vouchers payable – schedule of vouchers payable.

4. Check Register (Figure 23.5) – journal that replaces cash payment journal in recording payments of vouchers: a. The columns of the check register record the i. Date ii. Check number iii. Payable to iv. Voucher number v. Vouchers payable – this column is debited in recording the transaction. vi. Purchase discount – this column, if used, is credited in recording the transaction. vii. Cash in bank – this column is credited in recording the transaction. viii. Bank deposits column ix. Bank balance column b. Posting of the check register follows the same rules as other special journals. c. Once the voucher has been paid, it should be marked paid to avoid duplication.

5. Paid Voucher File: a. Records all vouchers paid b. Filed either in sequential order by voucher number or alphabetically based on the creditor’s name. .

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Teaching Tips/Strategy: Students are not familiar with a voucher system. Describe the use and purpose of the voucher process and how the voucher system helps the organization implement internal control procedures. Concept Check #1, Exercise 23A-1, and Exercise 23A-2 can be used to demonstrate and/or to practice the voucher system procedures.

Use the “10-minute Quiz” questions #1 - #7 to reinforce the learning concepts.

Learning Unit 23-2: Purchases Returns and Allowances, Partial Payments, and Recording Purchases at Net or Gross in a Voucher System Summary: Normally invoices are recorded at gross amount (full amount) on the purchases. Another method of recording purchases is to record at net (amount with discount applied). When a discount is missed using the net approach, a title called Discount Lost is shown in the payment column of the check register.

Key Concepts: None Lecture Outline: 1. Situation 1: Purchase returns and allowances after the voucher has been recorded (See Figure 23.6) There are two ways to handle this type of transaction a. Method 1: i.

Cancel the original order. ii.

Prepare a new voucher. b. Method 2: i.

Modify the original voucher, ii.

Make a correcting entry in the general journal.

2. Situation 2: Partial payments planned after voucher prepared for full payment (See Figure 23.7) a. Original voucher is canceled. b. A new voucher is prepared for each installment. c. Check number column indicates which new vouchers are replacing the canceled voucher.

3. Recording purchases at net amount a. Assume the discount will be taken and record the purchases at the amount net of the discount. b. A discount missed is called discount lost and shown as a debit in the check register. c. Example: Mill company buys merchandise on account for $8,000 with terms 2/10, n/30.

The net method (8,000 less a 2 % discount or 98% of the full price) Dr. Purchases ($8,000 x .98) 7,840 Cr. Vouchers Payable 7,840 If the discount is taken on time: Dr. Vouchers Payable Cr. Cash If discount is missed: Dr. Vouchers Payable

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7,840 7,840

7,840

Dr. Discount Lost Cr. Cash

160 8,000

4. Recording purchases at gross amount a. Assume the discount will NOT be taken, and record the purchases at the full amount. b. Example: Mill company buys merchandise on account for $8,000 with terms 2/10, n/30.

The gross method: Dr. Purchases Cr. Vouchers Payable Payment with discount taken: Dr. Vouchers Payable Dr. Purchase Discounts Cr. Cash If the discount is missed: Dr. Vouchers Payable Cr. Cash

8,000 8,000 8,000 160 7,840 8,000 8,000

Teaching Tips/Strategy: Distinguish between the gross and the net method of recording purchases and invoices. Concept Check #5 is excellent for classroom practice, and Exercises 23A-5 and 23B-5 aid in calculating the required amount and recording the necessary journal entries.

Use the “Ten-Minute Quiz” questions #8 - #10 to reinforce the learning concepts.

.

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Name

Date

Section

CHAPTER 23 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

The purpose of the voucher system is to: a. ensure that all cash disbursements are properly approved and recorded b. ensure that all cash receipts are properly recorded c. ensure that the company's cash is spent in approved ways d. ensure that all cash receipts are deposited in the bank 2.

Which of the following is not a characteristic of the voucher system? a. the manager approves the purchase and signs the check b. the manager does not make purchases without approved vouchers c. the manager only uses numbered documents d. the manager cross-references documents for support

3.

What is the proper sequence for preparing these documents in a voucher system?

A - receipt of invoice B - purchase order C - purchase requisition D - receiving report E - voucher approval and payment a. b. c. d.

B, C, A, D, E C, B, A, D, E B, A, C, D, E C, A, B, D, E

4.

The voucher is recorded in a special journal called: a. vouchers payable b. accounts payable c. voucher register d. voucher subsidiary ledger

5.

The unpaid voucher file is also called the: a. accounts payable file b. tickler file c. check register d. voucher register

6.

The check register shows the entry: a. Vouchers Payable XX Purchases Discount XX Cash XX b. Cash XX Purchase Discount XX Vouchers Payable XX .

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c. Vouchers Payable Purchases d. Purchase Discount Vouchers Payable

XX XX XX XX

7.

A characteristic of the voucher system is the requirement that: a. vouchers be paid immediately after preparation b. the voucher lists the account distribution c. a separate voucher be prepared for each expenditure d. vouchers be prepared by the requesting department

8.

A company purchased $2,500 of merchandise with terms 2/10, n/20. The company uses the net method and records the purchase: a. Purchases 2,450 Vouchers Payable 2,450 b. Purchases 2,500 Vouchers Payable 2,500 c. Vouchers Payable 2,500 Purchases 2,500 d. Vouchers Payable 2,450 Purchases 2,450

9.

A company purchased $2,500 of merchandise with terms 2/10, n/20. The company uses the net method and records the payment within the discount period as: a. Cash 2,450 Vouchers Payable 2,450 b. Vouchers Payable 2,450 Purchase Discount 50 Cash 2,500 c. Vouchers Payable 2,500 Purchase Discount 50 Cash 2,450 d. Vouchers Payable 2,450 Cash 2,450

10.

A company purchased $2,500 of merchandise with terms 2/10, n/20. The company uses the net method and records the payment AFTER the discount period as: a. Cash 2,450 Vouchers Payable 2,450 b. Vouchers Payable 2,450 Discount Lost 50 Cash 2,500 c. Vouchers Payable 2,500 Discount Lost 50 Cash 2,450 d. Vouchers Payable 2,450 Cash 2,500

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Answer Key to Chapter 23 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

a a b c b a c a d b

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Chapter 24 Departmental Accounting Chapter Overview This chapter discusses how companies prepare income statements by department so management can see each department’s efficiency and contribution to the company’s overall performance.

The balance sheet shows a company’s assets, liabilities, and equity as of a certain date and cannot be broken down by department. However, the income statement can be broken down by department. There are three approaches to presenting the departmental income statement. One method focuses on gross profit by department. This approach allows the profit centers to illustrate the revenue and costs generated by each department. A second method focuses on departmental net income with direct costs directly traced to specific departments and indirect costs allocated to each department based on a reasonable method. The third method assumes that indirect expenses are not controlled by department managers and should not be part of the departmental evaluations. This method shows each department’s contribution margin less direct costs.

Learning Objectives After studying Chapter 24, your students should gain proficiency in the following: 1. Explain the Income Statement Focused on Gross Profit by Departments.

2. Explain How Operating Expenses Are Broken Down by Departments.

3. Explain Contribution Margin on the Income Statement: Calculate Contribution Margin.

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24-1

Chapter 24 Assignment Grid Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Cost Center and Profit Center 1 2 Gross Profit Calculation 1 3 Departmental Accounting 1 4 Indirect and Direct Expenses 2 5 Simultaneous Direct and Indirect Costs 2 6 Allocation Methods 2 7 Departmental Income before Tax 3 8 Contribution Margin 3 9 Ethical Case 3 Concept Checks 1 Appropriation Based on Sales 2 2 Appropriation Based on Square Footage 2 3 Net Income from Total Operating Expenses 2 4 Departmental Income before Tax 2 5 Contribution Margin 3 Exercises (Set A) 24A-1 Appropriation Based on Sales 2 24A-2 Appropriation Based on Square Footage 2 24A-3 Net Income 2 24A-4 Departmental Income before Tax 2 24A-5 Contribution Margin 3 Exercises (Set B) 24B-1 Appropriation Based on Sales 2 24B-2 Appropriation Based on Square Footage 2 24B-3 Net Income 2 24B-4 Departmental Income before Tax 2 24B-5 Contribution Margin 3 Problems (Set A) 24A-1 Departmental Gross Profit Income Statement 2 24A-2 Departmental Expense Allocation 2 24A-3 Income Statement with Departmental Income 2 24A-4 Departmental Contribution Margin 2, 3 Problems (Set B) 24B-1 Departmental Gross Profit Income Statement 2 24B-2 Departmental Expense Allocation 2 24B-3 Income Statement with Departmental Income 2 24B-4 Departmental Contribution Margin 2, 3 Financial Report Problem Reading Amazon’s Annual Report/Internet Project

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Learning Unit 24-1: The Income Statement Focused on Gross Profit by Departments Summary: The first example in this section is of a store where each department’s manager has the responsibility for controlling and incurring certain costs, as well as generating revenue for that unit. This type of unit is known as a profit center. If a manager had the responsibility to control costs, but not for directly generating revenue, the unit would be called a cost center. To break down the gross profit by department, a company must gather information about each department. It does so by setting up separate accounting records for each department with separate accounts for Sales, Sales Returns and Allowances, Sales Discount, and Cost of Goods Sold. Once this information is separated by department, we can calculate the gross profit of each department.

Key Concepts: Profit center, cost center.

Lecture Outline: 1. Each individual unit or department is called: a. Profit center – a unit or department that incurs costs and generates revenue. b. Cost center – a unit or department that incurs costs but does not generate revenues.

2. Gross profit per unit – requires the company to gather information about each department. a. Computers aid companies with keeping separate records for each department. b. Income statements can be: i. Separated by departments, but that is not possible for the balance sheet. ii. Used to analyze how well a business or department is performing.

Teaching Tips/Strategy: Students need to differentiate between a cost center and profit center. The Success Coach LU 24-1 and Discussion Question #1 are excellent discussion items to help clarify the objective.

Use the “Ten-Minute Quiz” questions 5 and 6 to reinforce the learning concepts.

Learning Unit 24-2: How Operating Expenses Are Broken Down by Departments Summary: Direct Expenses are operating expenses that can be traced and identified directly to separate departments. The operating expenses that cannot be identified with a specific department but are incurred on behalf of the company are called indirect expenses. The income statement and net income is determined by the allocation of the direct and indirect expenses per department. (see Figure 24.5 as an example of direct and indirect expenses by department) Key Concepts: Direct expenses, indirect expenses.

Lecture Outline: 1. Expenses can be categorized as: a. Direct Expenses – expenses directly traceable to a specific department. b. Indirect Expenses – expenses are not traceable to a specific department.

2. Sales Salaries – expenses that can be identified and traced directly to the individual departments.

.

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3. Building Expense – an indirect expense allocated on the basis of square footage (square footage per department divided by total square feet).

4. Delivery Expense – an expense that can be directly traceable to each department.

5. Advertising Expenses: a. The direct part of the expense is traced to the department. b. The indirect part of the expense needs to be allocated – one method is based on the gross sales of each department (gross sales by department divided by total gross sales).

6. Depreciation Expense – an indirect expense that needs to be allocated to each department. The allocation method is selected by management. Some common allocation methods are: a. Square footage per department divided by total square feet b. Equipment cost per department divided by total equipment cost 7. Administrative Expense – an indirect expense that needs to be allocated to each department. The allocation method is selected by management and a common method is to allocate costs by gross sales (gross sales per department divided total gross sales.)

Teaching Tips/Strategy: Develop a step-by-step process utilizing Concept Checks 1 and 2 to teach the allocation concept. After the concepts are discussed, group the students in pairs (pair/share) and assign four different Exercises (24A-1, 24A-2, 24B-1, and 24B-2). After all groups are finished, the students can share the findings with the other groups. Use Problems 24A-2 and 24B-2 to review the concept objectives.

Use the “Ten-Minute Quiz” questions 1 through 4 and 7 to reinforce the learning concepts.

Learning Unit 24-3: Contribution Margin on the Income Statement Summary: The Contribution Margin approach (Figure 24.6 is an example of and income statement showing departmental contribution margins) lists direct departmental expenses and the contribution each department makes to cover indirect expenses. The contribution margin can also be defined as the gross profit of a department minus its direct expenses. This approach charges to a department only those expenses that are directly traceable to it. Supporters of this approach think indirect expenses are not controlled by the department manager and, thus, should not be used in evaluating departmental performance.

Key Concepts: Contribution margin Lecture Outline: 1. Contribution Margin Approach – financial statement illustration of a department’s contribution margin used to cover indirect expenses.

2. Contribution Margin = gross profit less direct expenses.

3. This approach theorizes indirect expenses are not controlled by the department manager and should not be used in evaluating departmental performance.

4. Departmental evaluation considers expansion or reduction and needs to consider: a. The effect dropping a department would have in terms of loss of its contribution margin.

For example, would closing a jewelry department in a clothing store reduce the store’s total administrative expenses? b. The effect one department has in drawing customers to other departments. Do customers who come into the store to look at jewelry go on to look at dresses in another department?

.

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c. Trends in the industry. Even though a certain department is not doing well, all the competing stores have such a department. The answer may be to cut down the size of the department rather than eliminate it. d. Ability of supplies to meet increasing demand for items. For example, it would not be a good idea to open a pastry shop in Diamond’s until one had lined up a number of good reliable suppliers. e. The text example illustrates how eliminating a department that has a net loss may in fact cause an even greater loss in the overall net income for the company.

Teaching Tips/Strategy: Use the Success Coach LU 24-3and Concept Check #5 as classroom discussion/ practice. The Exercise 24A-5 and Problem 24A-4 are excellent for classroom discussion and step-by-step practice.

Use the “Ten-Minute Quiz” question 8 through 10 to reinforce the entire chapter’s learning concepts.

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Name

Date

Section

CHAPTER 24 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Assigning indirect costs to a specific department is called: a. cost tracing b. cost allocation c. cost assignment d. cost directing 2.

Assigning direct costs to a specific department is called: a. cost tracing b. cost allocation c. cost assignment d. cost directing

3.

Costs identifiable with a specific department are: a. product costs b. period costs c. direct costs d. indirect costs

4.

Costs not identifiable with a specific department are: a. product costs b. period costs c. direct costs d. indirect costs

5.

A profit center: a. holds each department accountable for revenue and expenses b. holds each department accountable for the company's net income c. holds each department responsible for revenue d. holds each department responsible for expenses

6.

A cost center: a. holds each department accountable for revenue and expenses b. holds each department accountable for the company's net income c. holds each department responsible for revenue d. holds each department responsible for expenses

7.

Which is the best method for allocating depreciation? a. percentage of sales b. percentage of square footage c. percentage of sales salaries d. percentage of delivery costs

8.

A company's record shows the following: Pennsylvania Stores Oregon Stores Total Sales $530,000 $270,000 $800,000 Building Expense $320,000 Square feet 2,500 1,500 Sales Salaries $120,000 Delivery costs $30,000 If a company uses square footage to allocate costs, how much of building expenses should be allocated to the Pennsylvania stores? a. $1,500 b. $2,500 c. $120,000 .

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d. $200,000 9.

A company's record shows the following: Pennsylvania Stores Oregon Stores Total Sales $530,000 $270,000 $800,000 Building Expense $320,000 Square feet 2,500 1,500 Sales Salaries $120,000 Delivery costs $30,000 If a company uses sales to allocate costs, how much of delivery costs should be allocated to the Oregon stores? a. $10,125 b. $19,875 c. $270,000 d. $530,000

10.

A company's record shows the following: Pennsylvania Stores Oregon Stores Total Sales $530,000 $270,000 $800,000 Building Expense $320,000 Square feet 2,500 1,500 Sales Salaries $120,000 Delivery costs $30,000 If a company uses sales to allocate costs, how much of sales salaries should be allocated to the Oregon stores? a. $40,500 b. $79,500 c. $270,000 d. $530,000

Answer Key to Chapter 24 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

b a c d a d b d a a

.

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Chapter 25 Manufacturing Accounting Chapter Overview This chapter introduces the specialized accounting concepts and techniques required to properly record, report, and control the operations of a manufacturing company. The financial accounting procedures discussed in earlier chapters are still valid in a manufacturing company, but they are supplemented by the accounting needed to prepare the reports presented in this chapter. The first report covered in this chapter is the cost of goods manufactured schedule. Manufacturing expenses are divided into raw materials or materials directly traceable to the finished product, direct labor (the labor directly traceable to the finished product), and overhead or other costs not considered raw materials or direct labor. Raw materials, direct labor, and overhead combine to manufacture the products sold, and the different stages of product development each have their own type of inventory: raw material inventory, work-in-process inventory, and finished goods inventory.

This chapter illustrates the flow of goods from raw materials through work-in-process inventory to finished goods inventory. There are several source documents necessary to accurately record the flow of goods and the allocation of overhead to the correct product. Finally, the worksheet explained in earlier chapters is expanded to develop a statement of goods manufactured schedule.

Learning Objectives After studying Chapter 25, your students should gain proficiency in the following: 1. Calculate Statement of Cost of Goods Manufactured.

2. Journalize Entries to Record Flow of Manufacturing Costs.

3. Prepare a Worksheet for a Manufacturing Company.

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Chapter 25 Assignment Grid Learning Objective(s)

Assignment Topic(s)

Discussion Questions and Critical Thinking/Ethical Case 1 Manufacturing Costs 1 2 Direct Labor 1 3 Inventory Categories 1 4 Cost of Goods Manufactured 1 5 Receiving Reports 2 6 Flow of Inventory Goods and Costs 1 7 Source Document: Bill of Lading 2 8 Flow of Manufacturing Costs (Diagram) 2 9 Overhead Application 2 10 Worksheet (Merchandising versus Manufacturing) 3 11 Ethical Case 1 Concept Checks 1 Classification of Manufacturing Costs 1 2 Raw Materials 1 3 Calculating Total Manufacturing Costs 1 4 Manufacturing Journal Entries 2 5 Worksheet 3 Exercises (Set A) 25A-1 Classifying Manufacturing Costs 1 25A-2 Calculating Raw Materials Costs 1 25A-3 Calculating Manufacturing Costs 1 25A-4 Manufacturing Journal Entries 2 25A-5 Worksheet for a Manufacturer 3 Exercises (Set B) 25B-1 Classifying Manufacturing Costs 1 25B-2 Calculating Raw Materials 1 25B-3 Calculating Manufacturing Costs 1 25B-4 Manufacturing Journal Entries 2 25B-5 Worksheet for a Manufacturer 3 Problems (Set A) 25A-1 Cost of Goods Manufactured Statement 1 25A-2 Manufacturing Journal Entries 2 25A-3 Worksheet for a Manufacturer 3 Problems (Set B) 25B-1 Cost of Goods Manufactured Statement 1 25B-2 Manufacturing Journal Entries 2 25B-3 Worksheet for a Manufacturer 3 Financial Report Problem Reading Amazon’s Annual Report/ Internet Project

.

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1

Estimated Time in Minutes

Level of Difficulty

5 5 5 5 5 5 5 5 5 5 10

Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy Easy

10 10 15 15 10

Easy Easy Easy Easy Easy

10 10 20 25 30

Easy Easy Medium Medium Medium

10 10 20 25 30

Easy Easy Medium Medium Medium

30 50 60

Medium Hard Hard

30 50 60

Medium Hard Hard

10

Easy

Learning Unit 25-1: Cost of Goods Manufactured and the Income Statement Summary: In a manufacturing environment it is necessary to separate the manufacturing costs from selling and administrative expenses. Manufacturing costs such as the cost of raw materials, direct labor, and overhead are incurred because of the manufacturing process. In addition, it is necessary to allocate a portion of the nonmanufacturing costs such as accounting, personnel, purchasing, and data processing departments each month based on their contribution to manufacturing. The manufacturing costs are divided into three elements: raw material, direct labor, and manufacturing overhead.

Raw material (or direct material) includes all the items of prime material that will become a part of the product. Direct labor includes the wages of those personnel whose efforts directly change the quality or characteristics of the products. Manufacturing overhead consists of all other manufacturing costs not included in raw material or direct labor. Manufacturing overhead includes many diverse items such as indirect labor, maintenance, engineering, manufacturing supervision, and supplies. A manufacturing firm tracks three major inventories: raw material, work-in-process, and finished goods. The raw material inventory consists only of the cost of the items of raw material being held for production plus the freight cost to bring the material in. The acquisition of raw material is recorded as purchases, the account reserved for the purchase of raw material.

The work-in-process inventory represents the cost of the products being processed (the step before becoming finished goods) and includes the raw material, direct labor, and the manufacturing overhead costs incurred at the time of the inventory.

The finished goods inventory consists of the manufacturing cost of the products that have been completed and are awaiting shipment to customers.

The schedule of cost of goods manufactured (Figure 25.2) is the calculation of all the costs associated with the production of the finished goods.

• The first step in preparing the cost of goods manufactured is the calculation of the raw material cost for the month. If the accounting department has its records on a computer, the raw material cost may be readily available. If it is not, the cost must be calculated as shown by adding purchases to the beginning raw material inventory and then subtracting the ending inventory.

• The direct labor cost is usually a single amount found on the payroll or the labor distribution report.

• The overhead costs are then totaled and added to the raw material and direct labor to arrive at the total costs for the month. Manufacturing overhead includes indirect materials and indirect labor as part of the overhead costs.

• The final step is to add the beginning work-in-process inventory and subtract the ending work-inprocess inventory. Keep in mind that we subtract work-in-process ending inventory because it is not part of the cost of goods manufactured (not yet).

Key Concepts: Raw material, direct labor, manufacturing overhead.

Lecture Outline: 1. Elements of manufacturing costs: a. Raw Materials – materials that will become a part of the product or will change the quality or characteristics of the product. b. Direct Labor – the wages of the individuals whose efforts directly change the quality or characteristics of the products.

.

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c. Manufacturing Overhead – all other manufacturing costs not included in raw material or direct labor.

Some of the most common manufacturing overhead costs are maintenance wages and supplies, production supervision and expenses, depreciation expense of manufacturing assets, rent expense for buildings or machinery, electricity for manufacturing, insurance expense for manufacturing, indirect labor (material handlers), and manufacturing clerical wages.

2. Three manufacturing inventories: Raw Materials, Work-in-Process, and Finished Goods. a. Raw Materials Inventory is the cost of the items of raw material being held for production plus the freight costs.

Raw Material (RM) Beginning RM Inventory + Net Purchases + Transportation In - Ending RM Inventory = Cost of Raw Materials used b. Work-in-Process Inventory: the cost of the products being processed and includes raw material used, direct labor, and estimated overhead costs. .

Cost of raw material used + Direct Labor + Factory Overhead = Work-in-Process Inventory c. Finished Goods Inventory consists of the manufacturing cost of the products that have been completed and are awaiting shipment to consumers.

3. Cost of goods sold: Merchandising Company Manufacturing Company Beginning Merchandise Inventory Beginning Finished Goods Inventory + Net Purchases + Cost of Goods Manufactured* = Cost of Merchandise Available for Sale = Cost of Goods Available for Sale - Ending Merchandise Inventory - - Ending Finished Goods Inventory = Cost of Goods Sold = Cost of Goods Sold 4. The Cost of Goods Manufactured “replaces” the purchases of the merchandise company statement and is calculated separately (See Figure 25.2) Cost of Goods Manufactured: Cost of Raw Materials: Beginning Raw Materials Inventory $XX + Net Purchases $XX – Ending Raw Materials Inventory $XX = Cost of Raw Materials or Direct Materials Used $XX

.

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Total Manufacturing Costs: Cost of Direct Material used (DM) + Direct labor (DL) + Manufacturing Overhead (OH) Total manufacturing costs** + Beginning Work-in-Process Inventory - Ending Work-in-Process Inventory = Cost of Goods Manufactured*

$XX XX XX $XX XX XX $XX

*The Cost of Goods Manufactured includes the Total Manufacturing Costs PLUS the Beginning Workin-Process and deducts the Ending Work-in-Process . **Total Manufacturing Costs include ONLY the current period Direct Material, Direct Labor, and Manufacturing Overhead. It does NOT include the Work-in-Process. The Total Manufacturing Cost is NOT the same as Cost of Goods Manufactured!

Teaching Tips/Strategy: Use Discussion Questions 1 through 3 to distinguish between a service or retail business and a manufacturing business. Illustrate or/and demonstrate the differences between the total manufacturing cost and the cost of goods manufacturing calculations. Exercises 25A-1 through 25A-3 are excellent for class discussion or group presentations. Review the Success Coach LU 25-1 to reinforce the concepts on the cost of goods manufactured and cost of goods sold. While lecturing you can demonstrate the following topics: calculation of raw materials (Concept Check 2), calculation of total manufacturing costs (Concept Check 3), and preparation of a Cost of Goods Manufactured Statement using Problem 25A1.

Use the “Ten-Minute Quiz” questions 1, 2, 3, 4, and 5 to reinforce the learning concepts.

Learning Unit 25-2: Journalizing the Flow of Costs for a Manufacturing Company Summary: As the raw material, direct labor, and overhead are charged into the manufacturing process, they must be recorded in the journal entry. The issuance of material from the warehouse, the assignment of labor to departments, and the movement of the products through the process must be reported to the cost accountants as the basis for journal entries. The supporting documents are: • Receiving reports are prepared by the receiving department to acknowledge receipt of all material and supplies from vendors. (Figure 25.4 is an example of a Receiving Report) The accounting copy becomes a part of the vendor payment voucher, along with the purchase order and the vendor invoice.

• Material requisitions are the documents initiated by the manufacturing personnel, or other users, to request material from the inventory warehouse. The requisition (Figure 25.5 is an example of a Material Requisition document) is presented to the storekeeper as the materials are issued. Copies of the requisitions are kept in accounting as a basis for charging material to production.

• A clock card is a card used by each hourly employee to clock in and out of the factory each day (see Figure 25.6 for an example of a Clock Card). The cards are collected each week by the payroll department and become a basis for the payroll check and for charging labor to production.

• Lot tickets, or move tickets, are documents that are written by departmental managers to reflect the movement of products, or parts of products, from one department to another. The department

.

24-5

• •

receiving the products must verify the quantity and quality of the products. These tickets become the basis for transferring costs between departments and to finished goods inventory. (Figure 25.7) A labor distribution report is a by-product of the payroll that has been allocated to the categories of direct labor, maintenance labor, and so forth. Based on this report, the cost accountants charge labor to the appropriate departments (Figure 25.8 is an example of a Labor Distribution Report).

Bills of lading are documents that show the shipment of products to customers. The cost accounting copies of the bills become the basis for recording the transfer of the cost of the products from the finished goods inventory to the cost of goods sold. (Figure 25.9 is an example of a Bill of Lading).

The Overhead Application is an estimate of the application necessary to produce an item. Some overhead accounts, such as electricity, supervision, and depreciation, are not known until the end of the month. For this reason, an overhead rate must be established as a basis for applying the overhead. Several methods help to determine a rate, depending on the type of operation of the company. The most common and practical methods are based on direct labor or machine hours. A rate can be developed from the annual budget of the overhead costs and the direct labor dollars (wages of those persons whose efforts directly affect the characteristics of the products manufactured) as follows: Annual Manufacturing Overhead ÷ Annual Direct Labor Dollars = Overhead Application rate Key Concepts: Receiving report, material requisition, clock card, lot ticket, labor distribution report, bill of lading.

Lecture Outline: Review the Flow of Costs (Figure 25.10 is a diagram of the flow of manufacturing costs) and Journal Entries (Figure 25-11) Source documents – the required data submitted to the cost accountants through various source documents to create required journal entries.

1. Receiving report: (Figure 25.4) a. prepared by the receiving department, b. acknowledges receipt of material/supplies from vendors.

2. Material requisitions (documents): (Figure 25.5) a. initiated by the manufacturing personnel, b. request material from the inventory warehouse. c. Journal entry for Direct Material: Dr. Work in process XX Cr. Raw Material Inventory XX d. Journal entry for Indirect Material: Dr. Material Overhead-Control XX Cr. Supplies Inventory XX 3. Clock card: (Figure 25.6) a. a card used by each hourly employee to clock in and out, b. track the hours worked each day.

4. Lot tickets: (Figure 25.7) a. Also known as move tickets b. documents are prepared to show the movement of materials or products between departments. c. Journal Entry: Dr. Finish Goods Inventory XX Cr. Work-in-Process Inventory XX 5. Labor distribution report: (Figure 25.8) .

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a. a report issued by the payroll department to categorize employees, b. includes all types of labor incurred during the week. c. Journal entry for Direct Labor: Dr. Work-in-Process Inventory XX Cr. Payroll Payable XX d. Journal entry for Indirect Labor: Dr. Manufacturing Overhead-Control XX Cr. Payroll Payable XX 6. Bill of lading: (Figure 25.9) a. formal document issued to the carrier of the finished product, b. the basis for charging the cost of the products from the finished goods inventory to the cost of goods sold. c. Journal Entry: Dr. Cost of Goods Sold XX Cr. Finished Goods Inventory XX 7. Overhead Application: a. overhead application is based on machine hours, direct labor hours or direct labor cost, b. overhead accumulated needs to be applied to the work-in-process inventory. The allocation method selected by management should be one that most accurately reflects the cost apportionment. c. Journal entry for the application: Dr. Work-in-Process Inventory XX Cr. Manufacturing Overhead – Applied XX 8. The flow of manufacturing costs (Figure 25.10) a. illustrates the movement of material, labor, and overhead through the operation.

Teaching Tips/Strategy: Analyze and compare all three inventory accounts, Contrast the difference on each account. Use Discussion Question #3 to explain the accounts characteristics and their impact on the flow of goods. Consider demonstrating the flow of materials on a factory floor by explaining via graph the movement of each item as it flows on the manufacturing line. A video/visit/group activity of a manufacturing line can help students experiment and learn to understand the flow of goods through all the inventory accounts. Recreate a manufacturing line with Legos®, Tinker toys®, etc. The Exercises 25A-2, 25A-3, 25B-2, and 25B-3 are excellent to practice the construction of the schedule of cost of goods manufactured. Exercises 25A-4 or 25B-4 are excellent to integrate a full set of journal entries into the chapter’s material.

Use the “Ten-Minute Quiz” questions 6, 7, 8, 9, and 10 to reinforce the learning concepts.

Learning Unit 25-3: Preparing a Worksheet for a Manufacturing Company Summary: In past chapters we viewed worksheets for a service company and a merchandising company.

We now examine and explain the preparation of a worksheet for a manufacturing company (Figure 25.15 shows an example of a worksheet for a manufacturing company). The calculations and theory are the same as that for the worksheets of a service or merchandising companies but some accounts are different.

Key Concepts: None Lecture Outline: The formula for cost of goods manufactured: beginning inventory + purchases – ending inventory is a .

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constant in manufacturing accounting. With income being a credit balance, placing the ending inventory in the credit column and placing the beginning inventory in the debit column has the effect of adding ending inventory and subtracting beginning inventory.

1. Key points to look at on the worksheet (Figure 25.15) a. New set of columns for the statement of cost of goods manufactured. b. Raw materials inventory and work-in-process inventory. i) Beginning balances are listed in the debit column of the statement of cost of goods manufactured. ii) Ending balances are listed in the credit column of the statement of cost of goods manufactured. c. Finished goods inventory is not listed on the statement of cost of goods manufactured. i) Beginning balance is listed in the debit column of the income statement. ii) Ending balance is listed in the credit column of the income statement. d. Operating expenses are not part of the cost of goods manufactured and not listed in this statement.

2. Reports prepared from the worksheet: a. Cost of Goods Manufactured (See Figure 25.16) b. Income Statement (See Figure 25.17) c. Balance Sheet (See Figure 25.18) – note: raw materials, work-in-process, and finished goods inventories are listed as current assets Teaching Tips/Strategy: The optimal way to integrate the concept and maintain the retention of the material is to assign, group or individual, an exercise for a worksheet completion. Both Problems 25A-3 and 25B-3 are excellent to successfully execute the worksheet and required objectives.

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Name

Date

Section

CHAPTER 25 TEN-MINUTE QUIZ Circle the letter of the best response.

1.

Both direct materials and indirect materials are included in: a. raw materials inventory c. work-in-process inventory

b. manufacturing overhead d. overhead allocation

2.

Manufacturing employees whose work can be physically traced to the finished product have their labor classified as: a. manufacturing overhead b. indirect materials c. direct labor d. indirect labor

3.

Which of the following is not manufacturing overhead? a. direct labor b. indirect labor c. indirect materials d. depreciation

4.

Manufacturing costs include: a. raw materials and overhead c. direct labor and overhead

b. raw materials, direct labor, and overhead d. direct labor and raw materials

Which of the following is not a direct material? a. plastic used in windshield wipers c. wooden pegs in a chair assembly

b. glass used in a mirror d. oil used to lubricate parts

5.

6.

7.

A company has the following information: Beginning work-in-process inventory Beginning raw materials inventory Net purchases of raw materials Ending raw materials inventory Direct labor Overhead Ending work-in-process inventory What is the cost of raw materials used? a. $118,000 c. $188,000 A company has the following information: Beginning work-in-process inventory Beginning raw materials inventory Net purchases of raw materials Ending raw materials inventory Direct labor Overhead Ending work-in-process inventory How much is the total manufacturing cost? a. $118,000 b. $177,000 .

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$ 75,000 33,000 120,000 35,000 37,000 22,000 70,000 b. $177,000 d. $172,000

$75,000 33,000 120,000 35,000 37,000 22,000 70,000

c. $188,000 d. $172,000 8.

A company has the following information: Beginning work-in-process inventory Beginning raw materials inventory Net purchases of raw materials Ending raw materials inventory Direct labor Overhead Ending work-in-process inventory How much is the cost of goods manufactured? a. $118,000 c. $188,000

$75,000 33,000 120,000 35,000 37,000 22,000 70,000

b. $177,000 d. $182,000

9.

What is the entry to allocate $25,000 of labor to overhead? a. Payroll expense XX Overhead - Control XX b. Payroll expense XX Work-in-process XX c. Overhead - Control XX Payroll expense XX d. Work-in-process inv.

XX Overhead - Control XX

10.

What is the entry to allocate $25,000 of overhead to inventory? a. Payroll expense XX Overhead - Control XX b. Payroll expense XX Work-in-process XX c. Overhead - Control XX Payroll expense XX d. Work-in-process inv.

XX Overhead - Control XX

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Answer Key to Chapter 25 Quiz 1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

c c a b d a b d c d

.

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Part 1: Journal Entries Part 2: Post to the Ledger Part 3: Prepare the Unadjusted Trial Balance Part 4: Adjusting Entries Part 5: Post Adjusting Entries Part 6: Adjusted Trial Balance Part 7: Financial Statements Part 8: Closting Entries Part 9: Post and Close All Accounts Part 10: Post-Closing Trial Balance

Account Number

Account

Basic Account Type Asset

Expanded Account Type Asset

101

Cash

105 115

Accounts Receivable Office Supplies

Asset

Asset

Asset

Asset

120

Prepaid Insurance

Asset

Asset

155

Furniture

Asset

Asset

156

Accumulated Depreciation - Furniture

Asset

Asset

201

Accounts Payable

Liability

Liability

210 235

Salaries Payable Unearned Revenue

Liability

Liability

Liability

Liability

305

Miller, Capital

Equity

Owner, Capital

320

Miller, Withdrawals

Equity

Owner, Withdrawals

325

Income Summary

410

Service Revenue

Equity

Revenue

510

Depreciation Expense - Furniture

Equity

Expense

520

Insurance Expense

Equity

Expense

540 545

Rent Expense Salaries Expense

Equity

Expense

Equity

Expense

550

Supplies Expense

Equity

Expense

555

Utilities Expense

Equity

Expense

Normal Balance Debit

Used in Adjustments? (Blue Y denotes specific account for adjusting)

Permanent or Temporary Permanent

Debit

Y

Permanent

Debit

Y

Permanent

Debit

Permanent

Debit

Permanent

Credit

Y

Credit

Permanent Permanent

Credit

Y

Permanent

Credit

Y

Permanent

Credit

Permanent

Debit

Temporary

Dependent upon Net Income or Net Loss

Temporary

Credit

Temporary

Debit

Temporary

Debit

Temporary

Debit

Y

Temporary

Debit

Y Y

Temporary

Debit Debit

Temporary Temporary

Income Statement or Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet Balance Sheet N/A N/A Income Statement Income Statement Income Statement Income Statement Income Statement Income Statement Income Statement

INSTRUCTIONS: Smart Touch Learning began operations on December 1. Record the business' transactions for the month of December. Explanations are not required.

Refer to the Chart of Accounts for account titles.

EXAMPLE OF LAYOUT FOR STUDENT (students get all transactions, but only 3 provided here as example)

Smart Touch Learning began operations by receiving $$$ cash and furniture of a fair value of $$$ from James Miller. The busin gave Miller capital in exchange for this contribution.

Date

Accounts

Debit

Credit

December 1: Paid $$$ cash for a four-month insurance policy. The policy begins December 1.

Date

Accounts

Debit

Credit

Debit

Credit

December 4: Paid $$$ cash for office supplies.

Date

Accounts

FULL TRANSACTION LIST WITH ANSWERS (Each instance will have different values) Smart Touch Learning began operations by receiving $10,000 cash and furniture of a fair value of $15,000 from James Miller. The business gave Miller capital in exchange for this contribution.

Date Dec. 1

Accounts Cash Furniture Miller, Capital

Debit

Credit 10,000 15,000 25,000

Paid $1,000 cash for a four-month insurance policy. The policy begins December 1.

Date Dec. 1

Accounts Prepaid Insurance Cash

Debit

Credit 1,000 1,000

Paid $500 cash for office supplies.

Date Dec. 4

Accounts Office Supplies Cash

Debit

Credit 500 500

Performed services for a customer and received $2,000 cash.

Date Dec. 12

Accounts Cash Service Revenue

Debit

Credit 2,000 2,000

Completed a large job, billed the customer, $2,500, and received a promise to collect the remaining amount within a week.

Date Dec. 15

Accounts Accounts Receivable Service Revenue

Debit

Credit 2,500 2,500

Paid employee salary, $1,000.

Date Dec. 18

Accounts Salaries Expense Cash

Debit

Credit 1,000 1,000

Received $15,000 cash for performing services.

Date Dec. 20

Accounts Cash Service Revenue

Debit

Credit 15,000 15,000

Collected $800 in advance for a service to be performed later.

Date Dec. 22

Accounts Cash Unearned Revenue

Debit

Credit 800 800

Collected $2,500 cash from customer on account.

Date Dec. 25

Accounts Cash Accounts Receivable

Debit

Credit 2,500 2,500

Paid a utility bill of $300 on account.

Date Dec. 27

Accounts Utilities Expense Accounts Payable

Debit

Credit 300 300

Performed services on account, $700.

Date Dec. 28

Accounts Accounts Receivable Service Revenue

Debit

Credit 700 700

Paid office rent, $1,600, for the month of December.

Date Dec. 29

Accounts Rent Expense Cash

Debit

Credit 1,600 1,600

Paid $300 on account.

Date Dec. 30

Accounts Accounts Payable Cash

Miller withdrew $2,400 cash.

Debit

Credit 300 300

Date Dec. 31

Accounts Miller, Withdrawals Cash

Debit

Credit 2,400 2,400

TRANSACTION LIST:

ctions for the month of

provided here as example)

12/1/2016 1 4

value of $$$ from James Miller. The business 12 Date dropdown - include all possible dates as options in chronological order.

15

Fill in - account name (keyword/grouping)

18

Fill in - numerical value

20 22 25 27 28 29 30 31

ANSACTION LIST: Smart Touch Learning began operations by receiving $10,000 cash and furniture of a fair value of $15,000 from James Miller. The business gave Miller capital in exchange for this contribution.

Paid $1,000 cash for a four-month insurance policy. The policy begins December 1.

Paid $500 cash for office supplies.

Performed services for a customer and received $2,000 cash.

Completed a large job, billed the customer, $2,500, and received a promise to collect the remaining amount within a week.

Paid employee salary, $1,000.

Received $15,000 cash for performing services.

Collected $800 in advance for a service to be performed later.

Collected $2,500 cash from customer on account.

Paid a utility bill of $300 on account.

Performed services on account, $700.

Paid office rent, $1,600, for the month of December.

Paid $300 on account.

Miller withdrew $2,400 cash.

INSTRUCTIONS Post all transactions to the t-accounts and calculate ending balances. Make sure you post all transactions in chronological order.

EXAMPLE OF LAYOUT FOR STUDENT Student gets snippets and blank t-accounts, with given account names already displayed.

INFO student filled out in Part 1 (Values will differ per student): Date

Accounts

Dec. 1

Cash

10,000

Furniture Miller, Capital

15,000

Date

Accounts

Dec. 1

Prepaid Insurance

Date

Cash Accounts

Dec. 4

Office Supplies

Debit

Credit

25,000 Debit

Credit 1,000 1,000 Credit

Debit 500

Cash Date

Accounts

Dec. 12

Cash

Date

Service Revenue Accounts

Dec. 15

Accounts Receivable

Date

Service Revenue Accounts

Dec. 18 Date Dec. 20 Date Dec. 22 Date Dec. 25 Date Dec. 27 Date Dec. 28 Date Dec. 29 Date Dec. 30

Salaries Expense Cash Accounts Cash Service Revenue Accounts Cash Unearned Revenue Accounts Cash Accounts Receivable Accounts Utilities Expense Accounts Payable Accounts Accounts Receivable Service Revenue Accounts Rent Expense Cash Accounts Accounts Payable

500 Debit

Credit 2,000 2,000 Credit

Debit 2,500

2,500 Credit

Debit 1,000 Debit 15,000

1,000 Credit 15,000 Credit

Debit 800

800 Debit

Credit 2,500 2,500 Credit

Debit 300

300 Debit

Credit 700 700

Debit

Credit 1,600 1,600 Credit

Debit 300

Date Dec. 31

Cash Accounts Miller, Withdrawals Cash

300 Debit

Credit 2,400 2,400

Student starts with blank t-accounts, which they must fill in using the information carried from Part 1. The students "w corrected before they are brought over, so student is not penalized twice.

DATE/BAL dropdown

FILL IN - numerical Cash

Acc

Une

Accounts Receivable

M

Office Supplies

Mill

Prepaid Insurance

Furniture

This is what student will produce.

Cash Dec. 1 Dec. 12 Dec. 20 Dec. 22

Cash 10,000 2,000 15,000 800

Acc 1,000 Dec. 1 500 Dec. 4 1,000 Dec. 18 1,600 Dec. 29

Dec. 30

Dec. 25

2,500

Bal.

23,500

Dec. 15 Dec. 28 Bal.

Accounts Receivable 2,500 700 700

Dec. 4

Office Supplies 500

300 Dec. 30 2,400 Dec. 31

Une

2,500 Dec. 25

M

Mill Dec. 31

Bal.

500 Bal.

Dec. 1

Prepaid Insurance 1,000

Bal.

1,000

Dec. 1

Furniture 15,000

Bal.

15,000

art 1. The students "wrong" answers from Part 1, will be

Accounts Payable

Service Revenue

Unearned Revenue

Salaries Expense Miller, Capital

Utilities Expense Miller, Withdrawals

Rent Expense

Accounts Payable 300

Service Revenue 300 Dec. 27 0 Bal.

Unearned Revenue 800 Dec. 22 800 Bal.

Miller, Capital

Dec. 18

Salaries Expense 1,000

25,000 Dec. 1 Dec. 18

1,000

25,000 Bal. Miller, Withdrawals 2,400

Dec. 27 Dec. 27

Utitilies Expense 300 300

2,400 Dec. 29

Rent Expense 1,600

Bal.

1,600

Service Revenue

Salaries Expense

Utilities Expense

Rent Expense

Service Revenue 2,000 Dec. 12 2,500 Dec. 15 15,000 Dec. 20 700 Dec. 28

20,200 Bal. Salaries Expense

Utitilies Expense

Rent Expense

INSTRUCTIONS Prepare the Unadjusted Trial Balance for Smart Touch Learning for December.

EXAMPLE OF LAYOUT FOR STUDENT Student gets list of accounts (in alphabetical order and values) and a blank Trial Balance, and must fill in headers, accounts and values.

INFO student filled out in Part 2 (Values will differ per student):

ACCOUNT Accounts Receivable Cash Miller, Capital Miller, Withdrawals Utilities Expense Office Supplies Prepaid Insurance Rent Expense Salaries Expense Service Revenue Furniture Unearned Revenue

Dec. 27 700 23,500 25,000 2,400 300 500 1,000 1,600 1,000 20,200

15,000 800

Miller, Capital Miller, Withdrawals Service Revenue Salaries Expense Utilities Expense Rent Expense Total

ember.

nk Trial Balance, and must fill in headers,

Dropdown options Smart Touch Learning Smart Books Learning

Account Title

Unadjusted Trial Balance

Debit

Credit

December 31, 2016 Month ended December 31, 2016

Fill in - account name Fill in - numerical value

Total

Answer: colors identify groups

SMART TOUCH LEARNING Unadjusted Trial Balance December 31, 2016

Account Title Cash Accounts Receivable Office Supplies Prepaid Insurance Furniture Unearned Revenue

Balance Debit Credit $23,500 700 500 1,000 15,000 $800

Miller, Capital Miller, Withdrawals Service Revenue Salaries Expense Utilities Expense Rent Expense Total

25,000 2,400 20,200 1,000 300 1,600 $46,000

$46,000

INSTRUCTIONS Record the adjusting entries for the month of December. Explanations are not required.

Refer to the Chart of Accounts for account titles.

EXAMPLE OF LAYOUT FOR STUDENT (students get all transactions, but only 3 provided here as example) Accrued Salaries Expense, $1,000.

Date

Accounts

Debit

Credit

Debit

Credit

Depreciation was recorded on the furniture, $400.

Date

Accounts

Prepaid Insurance for the month has expired. Remember a four month insurance policy of [PREPAID INSURANCE VALUE] was paid for on December 1.

Date

Accounts

Debit

Credit

FULL TRANSACTION LIST WITH ANSWERS (Each instance will have different values) Accrued Salaries Expense, $1,000.

Date Dec. 31

Accounts Salaries Expense Salaries Payable

Debit

Credit 1,000 1,000

Depreciation was recorded on the furniture, $400.

Date Dec. 31

Accounts Depreciation Expense—Furniture Accumulated Depreciation—Furniture

Debit

Credit 400 400

Prepaid Insurance for the month has expired. Remember a four month insurance policy of [PREPAID INSURANCE VALUE] was paid for on December 1.

Date Dec. 31

Accounts Insurance Expense Prepaid Insurance

Debit

Credit 250 250

Office Supplies on hand, $100.

Date Dec. 31

Accounts Supplies Expense Office Supplies

Debit

Credit 100 100

Unearned Revenue earned during the month, $300.

Date Dec. 31

Accounts Unearned Revenue Service Revenue

Debit

Credit 300 300

Accrued Service Revenue, $650.

Date Dec. 31

Accounts Accounts Receivable Service Revenue

Debit

Credit 650 650

here as example)

Date dropdown - include Nov. 30, Dec 1. Dec. 15, and Dec. 31 as options.

Fill in - account name Fill in - numerical value

TRANSACTION LIST Accrued Salaries Expense, $1,000.

Depreciation was recorded on the furniture, $400.

Prepaid Insurance for the month has expired. Remember a four month insurance policy of [PREPAID INSURANCE VALUE] was paid for on December 1.

Office Supplies on hand, $100.

Unearned Revenue earned during the month, $300.

Accrued Service Revenue, $650.

INSTRUCTIONS Post all adjusting entries to the t-accounts and calculate ending balances.

EXAMPLE OF LAYOUT FOR STUDENT

Student gets snippets and blank t-accounts, with given account names already displayed.

Date Dec. 31

Date Dec. 31

Date Dec. 31

Date Dec. 31

Date Dec. 31

Date Dec. 31

Accounts Salaries Expense Salaries Payable

Credit 1,000

Credit 1,000

Accounts Debit Depreciation Expense—Furniture 400 Accumulated Depreciation—Furniture

Credit

Accounts Insurance Expense Prepaid Insurance

Debit 250

Credit

Accounts Supplies Expense Office Supplies

Debit 100

Accounts Unearned Revenue Service Revenue

Debit 300

Accounts Accounts Receivable Service Revenue

Debit 650

400

250

Credit 100

Credit 300

Credit 650

Bal. Bal.

Bal. Bal.

Student will be presented with t-accounts with just the balances displayed. The Adj. + letter and Balance options will b DATE/BAL dropdown

FILL IN - numerical

Sala

Bal.

Accounts Receivable 700

Unear

Bal.

Office Supplies 500

Bal.

Prepaid Insurance 1,000

Accumulated Depreciation—Furniture 0 Bal.

ANSWER

Accounts Receivable Bal. Dec. 31 Bal.

Salaries Payable 700 650 1,350

Office Supplies Bal.

500

Bal.

400

Prepaid Insurance Bal. Bal.

1,000

100 Dec. 31

250 Dec. 31

750

Accumulated Depreciation—Furniture 0 Bal. 400 Dec. 31 400 Bal.

Unearned Revenue Dec. 31

Service Revenue

r and Balance options will be a dropdown.

Salaries Payable 0 Bal.

Unearned Revenue $800 Bal.

Salaries Expense Bal.

1,000

Depreciation Expense—Furniture Bal. 0 #REF!

Insurance Expense Bal.

0 0

Supplies Expense Bal.

0 #REF!

Service Revenue

Salaries Payable 0 Bal. 1,000 Dec. 31 1,000 Bal.

Salaries Expense Bal. Dec. 31 Bal.

1,000 1,000 2,000

Unearned Revenue 300

$800 Bal. $500 Bal.

Depreciation Expense—Furniture Bal. 0 Dec. 31 400 Bal. 400

Insurance Expense Bal. Dec. 31 Bal.

0 250 250

Supplies Expense Bal. Dec. 31 Bal.

0 100 100

20,200 Bal. 0

—Furniture

20,200 Bal. 300 Dec. 31 650 Dec. 31 21,150 Bal.

—Furniture

INSTRUCTIONS Prepare the Adjusted Trial Balance for Smart Touch Learning for December.

EXAMPLE OF LAYOUT FOR STUDENT Student gets list of accounts (in alphabetical order) and values and a blank Trial Balance

ACCOUNT Accounts Receivable Accumulated Depreciation—Furniture Cash Miller, Capital Depreciation Expense—Furniture Miller, Withdrawals Utilities Expense Insurance Expense Office Supplies Prepaid Insurance Rent Expense Salaries Expense Salaries Payable Service Revenue Supplies Expense Furniture Unearned Revenue

VALUE 1,350 400 $23,500 25,000 400 2,400 300 250 400 750 1,600 2,000 1,000 21,150 100 15,000 $500

FROM Part 5 Part 5 Part 3 Part 3 Part 5 Part 3 Part 3 Part 5 Part 5 Part 5 Part 3 Part 5 Part 5 Part 5 Part 5 Part 3 Part 5

Salaries Payable Unearned Revenue Miller, Capital Miller, Withdrawals Service Revenue Salaries Expense Depreciation Expens Insurance Expense Utilities Expense Rent Expense Supplies Expense Total

Balance

Account Title Debit

Credit

Total

Answer: colors identify groups

SMART TOUCH LEARNING Adjusted Trial Balance 12/31/2016 Balance Account Title Debit Credit $23,500 Cash 1,350 Accounts Receivable 400 Office Supplies 750 Prepaid Insurance 15,000 Furniture $400 Accumulated Depreciation—Furniture

Salaries Payable Unearned Revenue Miller, Capital Miller, Withdrawals Service Revenue Salaries Expense Depreciation Expense—Truck Insurance Expense Utilities Expense Rent Expense Supplies Expense Total

1,000 $500 25,000 2,400 21,150 2,000 400 250 300 1,600 100 $48,050

$48,050

Dropdown options Smart Touch Learning Smart Books Learning Unadjusted Trial Balance December 31, 2016 Month ended December 31, 2016 Adjusted Trial Balance

Fill in - account name (keyword/grouping) Fill in - numerical value

INSTRUCTIONS Prepare the financial statements for Smart Touch Learning for the month of December.

Remember that the business started operations this month so all beginning balances were 0.

Enter any decreases with a negative sign or parentheses.

EXAMPLE OF LAYOUT FOR STUDENT Snippet of adjusted trial balance from Part 6 and blank financial statements.

SMART TOUCH LEARNING Adjusted Trial Balance 12/31/2016 Balance

Account Title Cash Accounts Receivable Office Supplies Prepaid Insurance Furniture Accumulated Depreciation—Furniture Salaries Payable Unearned Revenue Miller, Capital Miller, Withdrawals Service Revenue Salaries Expense Depreciation Expense—Furniture Insurance Expense Utilities Expense Rent Expense Supplies Expense Total

Debit $23,500 $1,350 $400 $750 $15,000

Credit

$400 $1,000 $500 $25,000 2,400 21,150 2,000 400 250 300 1,600 100 $48,050

Assets

$48,050

Total Assets

ANSWER: Colored sections are groups

SMART TOUCH LEARNING Income Statement Month Ended December 31, 2016 Revenues: Service Revenue Expenses: Salaries Expense Rent Expense Depreciation Expense—Furniture Utilities Expense Insurance Expense Supplies Expense Total Expenses Net Income SMART TOUCH LEARNING Statement of Owner's Equity Month Ended December 31, 2016 Miller, Capital, December 1, 2016

$21,150 $2,000 $1,600 $400 $300 $250 $100 4,650 $16,500

$0

Owner Contribution

$25,000

Net income for the month

16,500 41,500 -2,400 $39,100

Owner withdrawal Miller, Capital, December 31, 2016

SMART TO Bala 12 Assets Cash

Accounts Receivable Office Supplies Prepaid Insurance Furniture Less: Accumulated Depreciation—Furniture Total Assets

15,000 -$400

Revenues: Expenses:

Total Expenses Net Income

Dropdown options Miller, Capital, December 1, 2016 Miller, Capital, December 31, 2016 Owner withdrawal Net income for the month

Liabilities

Total Liabilities Stockholders’ Equity Total Stockholders’ Equity Total Liabilities and Stockholders’ Equity

SMART TOUCH LEARNING Balance Sheet 12/31/2016 Liabilities $23,500

Salaries Payable

$1,350 $400 $750

Unearned Revenue Total Liabilities Owner's Equity

14,600 $40,600

Miller, Capital Total Owner's Equity Total Liabilities and Owner’s Equity

Dropdown options (For all three statements) Smart Touch Learning Smart Books Learning Income Statement

Statement of Owner's Equity Balance Sheet Adjusted Trial Balance December 31, 2016 Month ended December 31, 2016 Fill in - keywords Numerical value

wn options Capital, December 1, 2016 Capital, December 31, 2016

r withdrawal come for the month

Liabilities

Stockholders’ Equity

ckholders’ Equity

Liabilities $1,000

wner’s Equity

$500 1,500 Owner's Equity 39,100 39,100 $40,600

INSTRUCTIONS Journalize Smart Touch Learning's closing entries for the month of December.

EXAMPLE OF LAYOUT FOR STUDENT Snippet of adjusted trial balance from Part 6 and blank financial statements.

SMART TOUCH LEARNING Adjusted Trial Balance 12/31/2016 Account Title Cash Accounts Receivable Office Supplies Prepaid Insurance Furniture Accumulated Depreciation—Furniture Salaries Payable Unearned Revenue Miller, Capital Miller, Withdrawals Service Revenue Salaries Expense Depreciation Expense—Furniture Insurance Expense Utilities Expense Rent Expense Supplies Expense Total

Balance Debit $23,500 $1,350 $400 $750 $15,000

$0

$400 $1,000 $500 $25,000 2,400 21,150 2,000 400 250 300 1,600 100 $48,050

$48,050

12/31/2016

12/31/2016

Date

Accounts

Debit

Credit

Date

Accounts

Debit

Credit

Date

Accounts

Debit

Credit

Date

Accounts

Debit

Credit

Debit

Credit

ANSWER: Colored sections are groups

Date Accounts 12/31/2016 Service Revenue Income Summary 12/31/2016 Income Summary Salaries Expense Depreciation Expense—Furniture Insurance Expense Utilities Expense Rent Expense Supplies Expense

21,150 21,150 4,650 2,000 400 250 300 1,600 100

12/31/2016 Income Summary Miller, Capital

16,500

12/31/2016 Miller, Capital Miller, Withdrawals

2,400

16,500

2,400

Date dropdown options Nov. 15 Nov. 30 Dec. 15 Dec. 31

Fill in - account name Fill in - number

INSTRUCTIONS T-accounts have been opened using the balances from the adjusted trial balance. Post the closing entries to the t-accounts and calculate ending balances for all accounts. For accounts that have a zero balance, enter the zero on the normal balance side. Use the acronym for closing entries (REIW) as post references and include Bal. references where appropriate. For the Income Summary account, calculate and enter the Balance (Bal.) before posting the entry to close out the account.

Post any closing entries to the accounts and then calculate the​ post-closing balance​ ("Bal.") of each account​ (including those that were not​ closed).

EXAMPLE OF LAYOUT FOR STUDENT

Date Accounts 12/31/2016 Service Revenue Income Summary

Debit 21,150

Date Accounts 12/31/2016 Income Summary Salaries Expense Depreciation Expense—Furniture Insurance Expense Utilities Expense Rent Expense Supplies Expense

Debit 4,650

Date Accounts 12/31/2016 Income Summary Miller, Capital

Debit 16,500

Date Accounts 12/31/2016 Miller, Capital Miller, Withdrawals

Debit 2,400

21,150

W

Miller, Withdrawals

Credit 2,000 400 250 300 1,600 100 Credit 16,500 Credit 2,400

ANSWERS

Miller, Capital 2,400

Credit

$25,000 Bal. 16,500 I 39,100 Bal.

Bal. Bal.

2,400 0

E

Income Summary 4,650

I

16,500

2,400 W

21,150 R 16,500 Bal. 0 Bal.

R

Service Revenue 21,150

Bal. Bal.

Cash 23,500 23,500

Bal. Bal.

Accounts Receivable 1,350 1,350

Bal. Bal.

Office Supplies $400 $400

Bal. Bal.

Prepaid Insurance $750 $750

Bal. Bal.

Furniture 15,000 15,000

21,150 Bal. 0 Bal.

Accumulated Depreciation—Furniture $400 Bal. $400 Bal.

Starting tables - just a few examples Dropdown with options: R, E, I, D, Bal. FILL IN - numerical

Starting data Miller, Capital

Salaries Expe $25,000 Bal.

Bal.

Depreciation Expense Bal.

Miller, Withdrawals 2,400

Bal.

Income Summary

Insurance Exp Bal. Bal.

Bal. Bal.

Salaries Expense 2,000 0

Bal.

Depreciation Expense—Furniture 400 400 E

2,000 E

Bal.

0

Bal. Bal.

Insurance Expense 250 0

250 E

Bal. Bal.

Utilities Expense 300 0

300 E

Bal. Bal.

Rent Expense 1,600 0

1,600 E

Bal. Bal.

Supplies Expense 100 0

100 E

Salaries Payable 1,000 Bal. 1,000 Bal.

Unearned Revenue $500 Bal. $500 Bal.

Salaries Expense 2,000

Depreciation Expense—Furniture 400

Insurance Expense 250

INSTRUCTIONS Prepare the Post-Closing Trial Balance for Smart Touch Learning for December.

EXAMPLE OF LAYOUT FOR STUDENT Student gets list of accounts (in alphabetical order and values) and a blank Trial Balance

ACCOUNT Accounts Receivable Accumulated Depreciation—Furniture Cash Miller, Capital Office Supplies Prepaid Insurance Salaries Payable Furniture Unearned Revenue

$1,350 $400

23,500

39,100 $400 $750 1,000 15,000 $500

Account Title

Balance Debit

Credit

Total

Answer: colors identify groups

SMART TOUCH LEARNING Post-Closing Trial Balance 12/31/2016 Account Title Cash Accounts Receivable Office Supplies Prepaid Insurance Furniture Accumulated Depreciation—Furniture Salaries Payable Unearned Revenue Miller, Capital Total

Balance Debit Credit $23,500 1,350 $400 $750 15,000 $400 1,000 $500 39,100 $41,000 $41,000

Dropdown options (in alphabetical order) Smart Touch Learning Smart Books Learning Unadjusted Trial Balance December 31, 2016 Month ended December 31, 2016 Adjusted Trial Balance Post-Closing Trial Balance

Fill in - account name (keyword/grouping) Fill in - numerical value