To Joan, Scott, Mary, Susie, Cathy, Liz, Garth, Jens, Laura, Dawn, Jesse, and Duncan

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2 To Joan, Scott, Mary, Susie, Cathy, Liz, Garth, Jens, Laura, Dawn, Jesse, and Duncan VP/Editorial Director: Sally Yagan AVP/Editor in Chief: Donna Battista Acquisitions Editor: Julie Broich Senior International Acquisitions Editor: Laura Dent Director of Editorial Services: Ashley Santora Senior Editorial Project Manager: Karen Kirincich Editorial Assistant: Brian Reilly International Editorial Assistant: Emily Jones Exec. Director of Digital Development: Lisa Strite Editorial Media Project Manager: Allison Longley VP/Director of Marketing: Patrice Lumumba Jones International Marketing Manager: Dean Erasmus Marketing Assistant: Ian Gold Sr. Managing Editor, Production: Cynthia Zonneveld Production Manager: Carol O Rourke Sr. Operations Specialist: Diane Peirano Sr. Art Director: Jon Boylan Interior Design: Lisa Delgado Cover Design: Jodi Notowitz Art Studio: GEX Publishing Services Pearson Education Limited Edinburgh Gate Harlow Essex CM20 2JE England and Associated Companies throughout the world Visit us on the World Wide Web at: Pearson Education Limited 2012 The right of Charles T. Horngren, Gary L. Sundem, John A. Elliott, and Donna Philbrick to be identified as authors of this work has been asserted by them in accordance with the Copyright, Designs and Patents Act Authorised adaptation from the United States edition, entitled Introduction to Financial Accounting, 10th Edition, ISBN by Charles T. Horngren, Gary L. Sundem, John A. Elliott, and Donna Philbrick, published by Pearson Education, publishing as Prentice Hall All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6 10 Kirby Street, London EC1N 8TS. All trademarks used herein are the property of their respective owners. The use of any trademark in this text does not vest in the author or publisher any trademark ownership rights in such trademarks, nor does the use of such trademarks imply any affiliation with or endorsement of this book by such owners. Credits and acknowledgments borrowed from other sources and reproduced, with permission, in this textbook appear on appropriate page within text (or on page PC1). ISBN: British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library Typeset in 10/12 Times Roman by GEX Publishing Services Printed and bound by Courier Kendaville in the United States of America The publisher s policy is to use paper manufactured from sustainable forests.

3 ASSIGNMENT MATERIAL 181 salaries expense was erroneously classified as a nonoperating expense. One of your co-workers argues that the error need not be corrected because the net income number is not affected by the misclassification. You disagree. Defend your position Accounting for Supplies A company began business on July 1 and purchased $1,000 in supplies including paper, pens, paper clips, and so on. On December 31, as financial statements were being prepared, the accounting clerk asked how to treat the $1,000 that appeared in the Supplies Inventory account. What should the clerk do? Exercises 4-21 True or False Use T or F to indicate whether each of the following statements is true or false: 1. Retained Earnings should be accounted for as a noncurrent liability item. 2. Deferred Revenue will appear on the income statement. 3. Machinery used in the business should be recorded as a noncurrent asset item. 4. A company that employs cash-basis accounting cannot have a Prepaid Expense account on the balance sheet. 5. From a single balance sheet, you can find stockholders equity for a period of time but not for a specific day. 6. It is not possible to determine changes in the financial condition of a business from a single balance sheet Tenant and Landlord The Trucano Company, a retail hardware store, pays quarterly rent on its store at the beginning of each quarter. The rent per quarter is $21,000. The owner of the building in which the store is located is the Resing Corporation. By using the balance sheet equation format, analyze the effects of the following on the tenant s and the landlord s financial position: 1. Trucano pays $21,000 rent on July Adjustment for July. 3. Adjustment for August. 4. Adjustment for September. Also prepare the journal entries for Trucano and Resing for September Customer and Airline Kimberly Clark (KC), maker of Scott paper products, decided to hold a managers meeting in Hawaii in February. To take advantage of special fares, KC purchased airline tickets in advance from Alaska Airlines at a total cost of $50,000. These were acquired on December 1 for cash. By using the balance sheet equation format, analyze the impact of the December payment and the February travel on the financial position of both KC and Alaska. Also prepare journal entries for February for both companies Accrual of Wages Consider the following calendar: September S M T W T F S

4 182 CHAPTER 4 ACCRUAL ACCOUNTING AND FINANCIAL STATEMENTS The Golden Rule Department Store commenced business on September 1. It is open every day except Sunday. Its total payroll for all employees is $8,000 per day. Payments are made each Tuesday for the preceding week s work through Saturday. By using the balance sheet equation format, analyze the financial impact on the Golden Rule of the following: 1. Disbursements for wages on September 8, 15, 22, and Adjustment for wages on September 30. Also prepare the journal entry required on September Accrued Vacation Pay As of December 31, 2008, Delta Airlines had the following account listed as a current liability on its balance sheet: Accrued salaries and related benefits $972,000,000 The related benefits include the liability for vacation pay. Under the accrual basis of accounting, vacation pay is ordinarily accrued throughout the year as workers perform service and earn vacation. For example, suppose a Delta baggage handler earns $1,250 per week for 50 weeks and also gets paid $2,500 for 2 weeks vacation each year. Accrual accounting requires that the obligation for the $2,500 be recognized as it is earned instead of when the payment is disbursed. Thus, in each of the 50 work weeks, Delta would recognize a wage expense (or vacation pay expense) of $2,500/50 = $ Prepare Delta s weekly adjusting journal entry called for by the $50 example. 2. Prepare the entry for the $2,500 payment of vacation pay Placement of Interest in Income Statement Two companies have the following balance sheets as of December 31, 20X8: Jupiter Company Cash $ 50,000 Note payable* $100,000 Other assets 150,000 Stockholders equity 100,000 Total $200,000 Total $200,000 * 9% annual interest. Saturn Company Cash $ 50,000 Stockholders equity $200,000 Other assets 150,000 Total $200,000 In 20X9, each company had sales of $700,000 and operating expenses of $600,000. Jupiter had not repaid the $100,000 Note Payable as of December 31, 20X9. Neither company incurred any new interest-bearing debt in 20X9. Ignore income taxes. Did the two companies earn the same net income and the same operating income? Explain, showing computations of operating income and net income Effects of Interest on Lenders and Borrowers Bank of America lent Miller Paint Company $1,500,000 on April 1, 20X0. The loan plus interest of 8% is payable on April 1, 20X1. 1. By using the balance sheet equation format, prepare an analysis of the impact of the transaction on both Bank of America s and Miller s financial position on April 1, 20X0. Show the summary adjustments on December 31, 20X0, for the period April 1 to December 31. Prepare an analysis of the transaction that takes place on April 1, 20X1, when Miller repays its obligation. 2. Prepare adjusting journal entries for Bank of America and Miller on December 31, 20X0. 3. Prepare the entries that Bank of America and Miller would make on April 1, 20X1 when the loan and interest is repaid. These entries should include interest that accumulates between January 1, 20X1, and April 1, 20X1.

5 ASSIGNMENT MATERIAL Identification of Transactions Valenzuela Corporation s financial position is represented by the nine balances shown on the first line of the following schedule ($ in thousands). Assume that a single transaction took place for each of the following lines, and describe what you think happened, using one short sentence for each line. Cash Accounts Receivable Inventory Equipment Accounts Payable Accrued Wages Payable Unearned Rent Revenue Paid-in Capital Retained Earnings Bal. $19 $32 $54 $ 0 $29 $0 $0 $55 $21 (1) (2) (3) (4A) (4B) (5) (6) (7) (8) (9) (10) Effects on Balance Sheet Equation Following is a list of effects of accounting transactions on the balance sheet equation: Assets = Liabilities + Stockholders equity. a. Increase in assets, decrease in liabilities b. Increase in assets, increase in liabilities c. Decrease in assets, decrease in stockholders equity d. Decrease in assets, decrease in liabilities e. Increase in assets, decrease in assets f. Increase in liabilities, decrease in stockholders equity g. Decrease in assets, increase in liabilities h. Decrease in liabilities, increase in stockholders equity i. Increase in assets, increase in stockholders equity j. None of these Required Which of the relationships previously identified by letter defines the accounting effect of each of the following transactions? 1. The adjusting entry to recognize periodic depreciation. 2. The adjusting entry to record Accrued Salaries. 3. The adjusting entry to record Accrued Interest Receivable. 4. The collection of interest previously accrued. 5. The settlement of an Account Payable by the issuance of a Note Payable. 6. The recognition of an expense that had been paid for previously. A prepaid account was increased on payment. 7. The earning of revenue previously collected. Unearned Revenue was increased when collection was made in advance Effects of Errors in Adjustments What will be the effect understated (u), overstated (o), or no effect (n) on the income of the present and future periods if the following errors were made? In all cases, assume that amounts carried over into 20X1 would affect 20X1 operations via the routine accounting entries of 20X1.

6 184 CHAPTER 4 ACCRUAL ACCOUNTING AND FINANCIAL STATEMENTS 1. Revenue has been collected in advance, but earned amounts have not been recognized at the end of 20X0. Instead, all revenue was recognized as earned in 20X1. 2. Revenue for services rendered has been earned, but the unbilled amounts have not been recognized at the end of 20X0. 3. Accrued wages payable have not been recognized at the end of 20X0. 4. Prepaid rent has been paid (in late 20X0), but no adjustment for rent used in 20X0 was made. The payments have been debited to prepaid rent. They were transferred to expense in mid-20x1. Period 20X0 20X Effects of Adjustments and Corrections Listed here are a series of accounts that are numbered for identification. 1. Cash 2. Accounts Receivable 3. Notes Receivable 4. Inventory 5. Accrued Interest Receivable 6. Accrued Rent Receivable 7. Fuel on Hand 8. Prepaid Rent 9. Prepaid Insurance 10. Prepaid Repairs and Maintenance 11. Land 12. Buildings 13. Machinery and Equipment 14. Long-Term Debt 15. Notes Payable 16. Accrued Wages and Salaries Payable 17. Accrued Interest Payable 18. Unearned Subscription Revenue 19. Capital Stock 20. Sales 21. Fuel Expense 22. Salaries and Wages 23. Insurance Expense 24. Repairs and Maintenance Expense 25. Rent Expense 26. Rent Revenue 27. Subscription Revenue 28. Interest Revenue 29. Interest Expense Required All accounts needed to answer this question are listed previously. The same account may be used in several answers. Prepare any necessary adjusting or correcting entries called for by the following situations, which were discovered at the end of the calendar year. With respect to each situation, assume that no entries have been made concerning the situation other than those specifically described (i.e., no monthly adjustments have been made during the year). Consider each situation separately. These transactions were not necessarily conducted by one firm. Amounts are in thousands of dollars. a. A $5,000 purchase of equipment on December 30 was erroneously debited to Long-Term Debt. The credit was correctly made to Cash. b. A business made several purchases of fuel oil. Some purchases ($900) were debited to Fuel Expense, whereas others ($1,100) were charged to an asset account. An oil gauge revealed $300 of fuel on hand at the end of the year. There was no fuel on hand at the beginning of the year. What adjustment was necessary on December 31? c. On April 1, a business took out a fire insurance policy. The policy was for 2 years, and the full premium of $2,400 was paid on April 1. The payment was debited to Insurance Expense on April 1. What adjustment was necessary on December 31? d. On December 1, $6,000 was paid in advance to the landlord for 5 months rent. The tenant debited Prepaid Rent for $6,000 on December 1. What adjustment is necessary on December 31 on the tenant s books? e. Machinery is repaired and maintained by an outside maintenance company on an annual fee basis, payable in advance. The $1,800 fee for the year beginning October 1 was paid on October 1 and charged to Repairs and Maintenance Expense. What adjustment is necessary on December 31?

7 ASSIGNMENT MATERIAL 185 f. On November 16, $800 of machinery was purchased, $200 cash was paid down, and a 90-day, 5% note payable was signed for the balance. The November 16 transaction was properly recorded. Prepare the adjustment for the interest. g. A publisher sells subscriptions to magazines. Customers pay in advance. Receipts are originally credited to Unearned Subscription Revenue. On June 1, $24,000 in 1-year subscriptions (all beginning on June 1) were collected and recorded. What adjustment was necessary on December 31? h. On December 30, certain merchandise inventory was purchased for $1,500 on open account. The bookkeeper debited Machinery and Equipment and credited Accounts Payable for $1,500. Prepare a correcting entry. i. A 120-day, 8%, $15,000 cash loan was made to a customer on November 1. The November 1 transaction was recorded correctly. What adjustment is necessary on December 31? 4-32 Working Capital and Current Ratio Using the Columbia Sportswear balance sheet in Exhibit 4-6 on page 168, compute Columbia s working capital, current ratio, and quick ratio for Compute the quick ratio as (current assets inventories) current liabilities Profitability Ratios The Nestlé Group, the Swiss chocolate company, sells many other food items in addition to various types of chocolates. Sales in 2008 were CHF 109,908 million (where CHF means Swiss francs), cost of goods sold was CHF 47,339 million, net income was CHF 18,039 million, average common stockholders equity was CHF 54,846 million, and average total assets were CHF 110,788 million. Compute Nestlé s gross profit percentage, return on sales, return on average common stockholders equity, and return on average total assets Impact of Adjusting Entries on Ratios Exercise 4-31 asked you to write adjusting/correcting entries for transactions (a) through (i). In this problem, consider the effect on the current ratio and return on sales if the adjusting/ correcting entries were not made. Indicate whether the failure to record the adjusting/correcting entry will result in these ratios being understated (u), overstated (o), or no effect (n). If additional information is necessary before you can provide the correct response, indicate with (i). Prior to the adjusting entry, the current ratio exceeds 1.0 and the company operated at a profit. (a) (b) (c) (d) (e) (f) (g) (h) (i) Current Ratio Return on Sales Problems 4-35 Adjusting Entries (Alternates are 4-37 through 4-39.) Amber Marshall, certified public accountant, had the following transactions (among others) during 20X0: a. For accurate measurement of performance and position, Marshall uses the accrual basis of accounting. On August 1, she acquired office supplies for $2,000. Office Supplies Inventory was increased, and Cash was decreased by $2,000 on Marshall s books. On December 31, her inventory of office supplies was $900. b. On September 1, a client gave Marshall a retainer fee of $36,000 cash for monthly services to be rendered over the following 12 months. Marshall increased Cash and Unearned Fee Revenue.