Introduction to Financial Accounting, 11th Edition Class Notes

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1-1CHAPTER 1Accounting:The Language of BusinessLEARNING OBJECTIVESAfter studying this chapter you should be able to:1.Explain how accounting information assists in making decisions.2.Describe the components of the balance sheet.3.Analyze business transactions and relate them to changes in the balance sheet.4.Prepare a balance sheet from transactions data.5.Compare the features ofsoleproprietorships, partnerships, and corporations.6.Identify how the owners’ equity section in a corporate balance sheet differs from that in a soleproprietorship or a partnership.7.Explain the regulation of financial reporting, including differences between U.S. GAAP and IFRS.8.Describe auditing and how it enhances the value offinancial information.9.Evaluate the role of ethics in the accounting process.10.Recognize career opportunities in accounting, and understand that accounting is important to both for-profit and nonprofit organizations.Chapter 1 provides a glimpse of the entire field of accounting. It describes the nature of accounting and itsrole in providing useful information for a wide variety of decisions. In addition, the balance sheet equation isintroduced: Assets = Liabilities +Owners’equity.An introduction to the basic terms accountants use—the accounting vocabulary—is an overall theme ofthe chapter.Transaction analysis is introduced as well as the effect of a transaction on the balance sheetequation. The chapter also looks at types of business organizations.The chapter concludes with a discussionof the accounting profession, regulation,the auditing function, andprofessional ethics.

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1-2Accountingis the language of business andis the process ofidentifying, recording,andsummarizingeconomic information to decisionmakers.An organization’saccounting systemis the series of steps it uses to record financialdataandconvert them into informative financial statements.Learning Objective 1.Explain how accounting information assists in making decisions.Accounting information is useful to anyone making decisions that have economic consequences.Financial accountingservesexternal decisionmakers (stockholders, suppliers, banks andgovernment agencies)whilemanagementaccountingserves internal decisionmakers(topexecutives, department heads, college deans,and hospital administrators).A common source of financial information used by investors and others outside the company istheannual report.It is prepared by management to informcurrent and potentialinvestors aboutthe company’s past performance and future prospects.It contains financial statementsand otherinformation about the corporation, such asa letter from corporate management, a discussion andanalysis by management of recent economic events, footnotes to the financial statements,auditor’s report, and statements by management and the authors on the company’s internalcontrols.Financial statements also appear inForm 10-K,filed annually with theSecurities and ExchangeCommission (SEC), the government agency responsible for regulating capital markets in theUnitedStates. U.S.companies withpublicly traded stock(companies that sell shares intheir ownership tothe public) must file Form 10-K and other forms with the SEC.DO MULTIPLE CHOICE 1, 2and3.Learning Objective2.Describe the components of the balance sheet.Thebalance sheet(also called thestatement of financial position)shows the financial status ofan organizationat a particular instant in time.The balancesheet has two counterbalancing sections. One section lists the resources of the firmand the other the claims against the resources. The two sections form thebalance sheetequation:Assets = Liabilities + Owners’ equity.Assetsare economicresourcesthat the company expects to generate future cash inflows orreduce or prevent future cash outflows.Examples are cash, inventory, and equipment.Liabilitiesare economic obligations of the organization to outsiders, or claims against itsassets by outsiders such as a debt to the bank.Notes payabledescribe the existence ofpromissory notes that are signed when a company takes out a bank loan.Owners’equityisthe owners’ claims on the organization’s assets and is equal to totalassets less total liabilities. The termnet assetsalso refers to assets less liabilities.DO MULTIPLE CHOICE4and 5.DO EXERCISES 1 and2.

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1-3Learning Objective3.Analyze business transactions and relate them to changes in thebalance sheet(SeeEXHIBIT 1-2).Anentityis an organization or a section of an organization that standsapart from otherorganizations and individuals as a separate economic unit.Atransactionis any event that affectsthe financial position of an entity and can be reliably recorded in monetary terms.Every transaction affects the balance sheet. When accountants record transactions they alwaysmake at least two entries(i.e., double-entry accounting system)so that the total assets alwaysequal the total liabilities and owners’equity. The balance sheet equation always must remain inbalance.Accountants record transactions in an organization’saccounts. Anaccountis a summary recordof the changes in a particular asset, liability,or owners’equity category, and the account balanceis the total of all entries to the account up to a particular date.Transaction analysis determines which specific accounts are affected,whether the accountbalances are increased or decreased, andthe amount of the change in each account balance.Forexample, if the company borrows money from the bank, an asset (cash) increases, and a liability(notes payable) increases.Inventoryrefers to goods held by the company for the purpose of sale to customers. Anaccountpayableis a liability that results from a purchase of goods or services onopen account(i.e., oncredit).When inventory is purchased on account, both assets and liabilities are increased(ifpurchased for cash,one asset will increase and another asset will decrease).Acompound entryaffects more than two balance sheet accounts. Acreditoris one to whom the company owesmoney.DO MULTIPLE CHOICE 6 and 7.Learning Objective4.Prepare a balance sheetfrom transactions data(SeeEXHIBIT 1-3)Transactions data can be used to compute a cumulative total for each account at any date. Notethat a balance sheet represents the financial impact of all transactions up to a specific point intime.The account titles are listed with their respective balances on the specific date noted in the headerof the balance sheet. Each account is listed under the category that it belongs to—assets, liabilities,or owner’s equity.Examples of actual corporate balance sheets can be found inEXHIBIT1-5.Although a new balance sheet could be prepared after each transaction, companies usually producebalance sheets only when needed by managers and at the end of each quarter for reporting to thepublic.LearningObjective5.Compare the features ofsoleproprietorships, partnerships, andcorporations.Asoleproprietorshipis abusinesswith a single owner.Sole proprietorships tend to be smallbusinesses such as local stores or restaurants.

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1-4Apartnershipis aform of organization that joins two or more individuals together as co-owners.Each partnership is an individual entity that is separate from the personal activities of eachpartner.Corporationsare organizations created under state law in the United States with an unlimitednumber of owners. Owners of a corporation havelimited liability(i.e., corporation creditorsordinarily have claims against the corporate assets only, not against the personal assets of theowners).Apublicly ownedcorporation is one in which shares of ownershipare sold to the public.Purchasers or shares areidentified as shareholders or stockholders.Aprivately owned(closely held, unlisted)corporation is owned bya family, a smallgroup of shareholders, ora single individual.Advantages of the corporate form of ownershipincludeeaseof transfer of ownership(thecorporation issuesstock certificatesas formal evidence of ownership), easeofraising ownershipcapital, and continuityof existence.Tax laws may favor a sole proprietorship, a partnership, or a corporation, depending on thepersonal tax situations of the owners.Learning Objective6.Identify how the owners’ equity section in a corporatebalance sheet differs from that in a sole proprietorship or apartnership.All business entities account for assets and liabilities similarly(SeeEXHIBIT1-8).a.Owners’equities for proprietorshipsand partnershipsare identified as capital.b.Owners’equities for the corporation are calledstockholders’equityorshareholders’equity.In a corporation, capital investment by the owners,known aspaid-in capital,is recorded in twoparts:common stock at par value and paid-in capital in excess of par value.Par valueorstated valueis the dollar amount printed on the stock certificates, andpaid-incapital in excess of parvalueoradditional paid-in capitalis the differencebetween the total amount received for the stock and the par value.Common stockrepresentsthe par value purchased by the common stockholders of thecorporation. (SeeEXHIBIT 1-9).Common stockholdershave a “residual” ownership in thecorporation.DO MULTIPLE CHOICE8and9.In corporations, the ultimateresponsibility for management is delegated by the stockholders totheboardof directors.One of the duties of the board of directors is to appoint and monitormanagers.Thechief executive officer (CEO)is the top manager in an organization andsometimesserves as the chairman of the board.

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1-5Learning Objective7.Explain the regulation of financial reporting, including differencesbetween U.S. GAAP and IFRS.Generally accepted accounting principles (GAAP)consist ofallthebroad concepts anddetailed practices to be followed in preparing and distributing financial statements.Companiesreporting in more than 100 countries useInternational Financial Reporting Standards (IFRS)while U.S.companies useFinancial Accounting Standards.TheFinancial Accounting StandardsBoardis responsible for establishing U.S. GAAP. In2009 it compiled all standards and other elements of U.S. GAAP into theFASB AccountingStandards Codification.The U. S. Congress has charged theSecurities and Exchange Commission (SEC)with theultimate responsibility for authorizing GAAP for companies whose stock is held by the generalinvesting public. However, the SEC has informally delegated much rule-making power to theFASB. Congress can, however, overrule both the SEC and the FASB.TheInternational Accounting Standards Board(IASB)was established to“develop, in thepublic interest, a single set of high quality, understandable,and enforceable global accountingstandards.”The IASB sets International Financial Reporting Standards (IFRS).The IASB has 16members who represent a diversity of geographic and professional backgrounds.DO MULTIPLE CHOICE 10.Learning Objective8.Describe auditing andhow it enhances the value of financialinformation.The credibility of financial statements is the ultimate responsibility of the managers who areentrusted with the resources of the entity under their command.Third-party assurance about the credibility of financial statements gave rise to the CPAprofession.Anauditorexamines the information that managers use to prepare the financialstatements and provides assurances about the credibility of those statements.The desire for third-party assurance about the credibility of financial statements created theprofession ofpublic accountants–accountants who offer services to the general public on a feebasis.Acertified public accountant(CPA)in the U.S.earns this designation bymeetingstandards of knowledge and integrity set by a State Board of Accountancy.To assess management’s financial disclosures, CPAs conduct anaudit,anexamination ofacompany’stransactions andthe resultingfinancial statements.The audit is conducted by anindependent CPA to lend credibility to management’s financialstatements and is described in the auditor’s opinion (seeEXHIBIT1-10).Anauditor’s opinion(also called anindependent opinion) describes the scope and results of the audit, and companiesinclude the opinion with the financial statements in their annual reportsand 10K filings.DO MULTIPLE CHOICE 11.Accountantswhodo not offer services to the general public are known asprivate accountants.Theywork for businesses, governmental agencies, and other nonprofit organizations.

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1-6TheAmerican Institute of Certified Public Accountants (AICPA)is the principal professionalassociation of CPAs.TheInternational Auditing and Assurance Standards Board (IAASB),established by the International Federation of Accountants, is working to standardize audit regulationaround the globe, but regulation of auditing continues to differ significantly across countries.In 2002, the U.S. Congress passed theSarbanes-Oxley Act, which gave the government a largerrole in regulating the audit profession. Among its regulations were:a.theestablishment of thePublic Company Accounting Oversight Board(PCAOB)withpowers to regulate many aspects of public accounting and to set standards for auditprocedures,b.prohibitingpublic accounting firms from providing to audit clients certain nonauditservices,andc.requiringrotation every five years of the lead audit or coordinating partner and thereviewing partner on an audit.All accounting firms that audit companies with publicly traded stock in the U.S. must registerwith the PCAOB, and they are referred to asregistered public accounting firms.Additionally,the PCAOB issuesGenerally AcceptedAuditing Standards (GAAS)that prescribe theminimum steps that an auditor must take inexamining the transactions and financial statementsand issuing an auditor’s opinion.

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1-7Learning Objective9.Evaluate the role of ethics in the accounting process.Members of the AICPA, as well as members of the Institute of ManagementAccountantsand the Association of Government Accountants, must abide by codesof professional conduct, whichareespecially concerned with integrity andindependence. Professional accounting organizations have procedures for reviewingbehavior alleged as not being consistent with the codes of professional conduct(seeEXHIBIT1-11).DO MULTIPLE CHOICE 12 and 13.Learning Objective 10.Recognize career opportunities in accounting, andunderstand that accounting is important to both for-profit andnonprofit organizations.Accounting is provides an excellent background for almost any manager and is especiallyimportant for finance professionals.Additionally, anyone who wants to move up in the management structure of a companyneeds to know accounting.Companies often rely on accountants to safeguard the ethics of a company. Therefore,accountants have a special responsibility to ensure that managers act with integrity andthat information provided by the company is accurate.Although this textbook focuses on profit-seeking organizations, accounting principlesalso apply to nonprofit organizations such as hospitals, universities, and governmentagencies.Chapter 1 QuizMultipleChoice1.Financial accounting focuses onthe specific needs of decisionmakers external to theorganization. Which of the following wouldnotbe an external user?a.Stockholdersb.Internal Revenue Servicec.Vice President—Marketingd.Banks2.The correct version of theaccounting equation is

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1-8a.assets = liabilities–owners’ equityb.assets = liabilities + owners’ equityc.liabilities = assets + owners’ equityd.owners’ equity = assets + liabilities3.The annual report does not includea.a report from the independent auditors.b.footnotes.c.statements on the company’s internal controls.d.a letter from the board of directors.4.Another term for owners’ equity isa.assets.b.liabilities.c.net assets.d.net liabilities.5.The balancesheet shows the financial status of a companya.at a particular point in time.b.for a period of a month, quarter, or year.c.from the beginning of a period to the end of the period.d.only at the end of the year.6.A loan from the banka.increases assets and owner’s equity.b.increases assets and liabilities.c.increases liabilities and owner’s equity.d.has no effect on total assets.7.The purchase of inventory by paying cash causesa.an increase in one asset andadecrease in another.b.an increase in owner’s equity andadecrease in an asset.c.an increase in an asset and an increase in a liability.d.none of the above8.If the owners’(stockholders’) equity section of the balance sheet includes“AdditionalPaid-in-Capital,”the type of organization isaa.nonprofit.b.partnership.c.corporation.d.governmentalentity.9.Which of the following is a disadvantage of the corporate form of ownership?

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1-9a.Separationof ownership and managementb.Continuityof existencec.Unlimitedliabilityd.Easeof raising capitale.Both c anddf.Noneof the above10.Which organization has the responsibility toestablishU.S. GAAP?a.The FASBb.TheIASBc.TheSECd.Management11.An audit opiniona.is provided bythe audited company’s president.b.is provided by private accountants.c.is provided by an independent CPA.d.allof the above12.A certified public accountant (CPA)in the U.S.earns certification througha.being an accounting major in college.b.having sufficientexperience.c.meeting Board of Accountancy standards of knowledge and integrity.d.all of the above13.The overall concern of the AICPA’s Code of Professional Conduct iswhich of thefollowing?a.Whether theCPA is an officer in the corporation being auditedb.Whether theCPA owns stock in the corporation being auditedc.Whether theCPA is independent and acts with integrity and objectivityd.Whether theCPA’s father is the controller of the corporation being auditedExercises1.If total assets are $85,000 and total liabilities are $45,000,what is total owner’sequity?2.If a company purchases $50,000 of equipment on credit,how much did total owners’equity increase?

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1-10Chapter 1 Quiz SolutionsMultipleChoice1.c6.b11.c2.b7.a12.f3.d8.c13.c4.c9.f5.a10.aExercises1.The balancesheet equation holds that Total Assets equal Total Liabilities plus TotalOwner’s Equity. This means that $85,000 = $45,000 + x and x =$40,000, the TotalOwner’s Equity balance.2.“0”:Assets increase and liabilities increase.

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2-1CHAPTER 2Measuring Income toAssess PerformanceLEARNING OBJECTIVESAfter studying this chapter you should be able to:1.Explain how accountants measure income.2.Determine when a company should record revenue from a sale.3.Use theconceptofmatchingto recordtheexpensesfor a period.4.Prepare an income statement and show how it is related to a balance sheet.5.Account for cash dividends and prepare a statement ofstockholders’ equity.6.Compute and explain earnings per share, price-earnings ratio, dividend-yield ratio, and dividend-payoutratio.7.Explain how the conceptual framework guides the standard setting process and how accountingregulators trade off relevance and faithful representation in setting accounting standards.8.Explain how the following concepts affect financial statements: entity, going concern, materiality, stablemonetary unit,periodicity,andreliability.Chapter 2 presents the rudiments of measuring income, including adiscussion of revenues andexpenses. It introduces accrual accounting and what it means to recognize revenues when they are earned andrealized.The matching concept is then explained as to how expenses are assigned to a period in which thepertinent goods and services are either used or appear to have no future benefit.Other basic financial statements—the income statementand the statement ofstockholders’ equity—areintroduced in more detail.The chapter discusses four financial ratios that decision makers use to analyze theperformance and prospects of a business entity.The chapter concludeswithdiscussion of important conceptsand conventions and their effect on financial statements.

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2-2Learning Objective 1.Explain howaccountants measure income.The accounting measurement of income is the major means for evaluating a business entity’sperformance.Generally Accepted Accounting Principles (GAAP)specify rules that governincome measurement so that investors can compare one companytoanother.Theoperating cycle(cash cycle) is the timeelapsing between the acquisition ofgoods andservices,in exchange for cash, and the subsequent sale of products to customers who in turn payfor their purchases in cash.Accounting time periods are imposed on a business to enable periodic reports of performance.a.The calendar year is the most popular time period for measuring income or profits,although a business may adopt afiscalyearthat differs from the calendar year.b.Interim periodsare the time spans established for accounting purposes that are lessthan a year.Revenues(sales, sales revenue) are increases innet assets resulting from selling products orservices to customers.Expensesare decreases innet assets as a result of consuming or giving up resources in theprocess of providing products or services to a customer.Income(profits,earnings) is the excess of revenues over expenses.DO MULTIPLE CHOICE1 and2.Retained earnings(retained income) istotal cumulativeowners’equitythat isgenerated byincome or profits (seeEXHIBIT2-3).Accounts receivable(trade receivables,receivables) are amounts owed to a company bycustomers as a result of the company’s delivering goods or services and extending credit in theordinary course of business.Cost of goods soldexpense (cost of sales,cost of revenue) is the original acquisition cost of theinventory that a company sells to customers during the reporting period.Theaccrual basisrecordsrevenuewhenthe company earns it andexpenseswhenthe companyincurs them.Under thecash basis,revenues and expensesare recordedonly when cash isreceived or paid.

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2-3Learning Objective 2.Determine when a company should recordrevenue from a sale.To measure income on an accrual basis, accountants use aset ofrevenue recognitioncriteriatodetermine whether revenues should be recorded in the financial statements of a given period.Both U.S. GAAP and IFRS userevenue recognitioncriteria, although thecriteriadiffer slightly.To be recognizedunder U.S. GAAP, revenues must meet two criteria:a.They must beearned. Goods or services are fully rendered, usually delivered to thecustomer.b.They must berealizedorrealizable. Revenues are realized whencashor claims to cashare receivedin the exchange of goods or services.Revenues are realizable when thecompany receives assets that are easily converted into cash or claims to cash.(If cash isnot received directly, the eventualcollectabilityof cash must be reasonably assured.)DO MULTIPLE CHOICE 3.Learning Objective 3.Use the concept of matching to record the expenses for a period.There aretwo typesof expenses in every accounting period:a.Thosedirectlylinkedtothegeneration ofrevenues earned that period—product costs(costs that are linked with revenues and charged as expenses when the related revenueis recognized).b.Those linkedtothetimeperiod itself—period costs(costssupporting a company’soperations for a given periodthat are charged to expense in the time period in whichthe costs are incurred).Matchingis theconcept ofrecording expenses in the same time period as therelated revenuesare recognized.DO MULTIPLE CHOICE 4.Some purchases of goods or services areinitiallyrecorded as assetsin order to match the costswith revenues of future periods. For example, a firm might pay rentin advancefor the entire yearand record the payment in the asset accountPrepaidRent. Each month the firm reduces theprepaid rent accountand increases rent expense.The same matching concept applies torecognition ofdepreciation,the systematic allocation ofthe acquisition cost of long-lived or fixed assetsto the expense accountsof particularaccountingperiods that benefit from the use of the assets.Inbothcases(prepaid rent and depreciation), the business purchased an asset that gradually woreout or was used.

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2-4Learning Objective4.Prepare an income statement and show how it is related to abalance sheet.Anincome statement(statement of earnings,statementofoperations) is a report of allrevenues and expenses pertaining to a specific time period.Net income(netearnings) is the remainder after all expenseshave been deducted from revenue.If expensesexceedrevenues,a company has anet loss.The income statement shows how an entity’s operations for theperiod have increased net assetsthrough revenues and decreased net assets through expenses.The income statement is the major link between two balance sheets and shows the activities of anentitybetween the two balance sheet dates.DO EXERCISES 1 and2.Learning Objective 5.Account for cash dividends and prepare a statement ofstockholders’ equity.Retainedearningsincreasebythe amount ofnet incomereported during the period(or decreasebythe amount ofnet loss).DO MULTIPLE CHOICE5and6.Cash dividendsare distributions ofcash to shareholders that reduce retained earnings.Cash dividends are not expenses, and, therefore, not deducted from revenues on the incomestatement.Cash dividendsaredeclared by the board of directors of a companyon the declaration date,arepayable to those stockholders on record as owning stock on a second date (record date), andarepaid on a third date (payment date).Retainedearningsand cash are two separate accounts. Cash is needed to pay the declareddividend.Thestatement ofstockholders’ equity(statement of shareholders’equity)showsall changesduring the year in each stockholders’ equity account. (SeeEXHIBIT 2-8.)Changes in stockholders’ equity arise from three main sources:a.A period’s net income (or net loss) increases(decreases) the balanceinthe retainedearnings portion of stockholders’ equity.b.Transactions with shareholders such as the payment of dividends and purchase or sale ofshares of stock.c.Other comprehensive income(OCI)-specific changes in stockholders’ equity that donot result from net income ortransactions with shareholders.Companies accumulatethese items in a stockholders’ equity account entitledAccumulated othercomprehensive income(AOCI).

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2-5Negative Retained Earnings is known asAccumulated Deficit.DO MULTIPLE CHOICE7and8.Learning Objective 6.Compute and explain earnings per share, price-earnings ratio,dividend-yield ratio, anddividend-payout ratio.1.Basicearnings per share (EPS)is net income divided bytheweighted-averagenumber ofcommon sharesoutstandingduring the period over which the net income is measured.Net incomeEarnings per share = Weighted-Average Number of Common Shares Outstanding2.Price-Earning(P-E)Ratio(earnings multiple): measures how much the investing public iswilling to pay for a chance to share in a company’s potential earnings.Market Price per Share of Common StockP – EEarnings per Share of Common Stock3.Dividend-Yield Ratio:common dividends per share divided by market price per shareDividend–Yield =Common Dividends per shareMarket Price per Share4.Dividend-Payout Ratio:common dividends per share divided by earnings per shareCommon Dividends per ShareDividend – PayoutEarnings per ShareDO MULTIPLE CHOICE9, 10,and11.Learning Objective7.Explain how theconceptual framework guides the standard settingprocess and how accounting regulators trade off relevance andfaithful representation in setting accounting standards.When the FASB and the IASB are setting standards, theybegin withtheObjective of FinancialReporting-to provide information that is useful to present and potential investors and creditorsand others in making investment, credit, and similar resource allocation decisionsRelevanceandfaithfulrepresentationare the two main qualities that make accountinginformation useful for decision making (seeEXHIBIT2-9).Relevanceis the capability of the information to make a difference to the decision makerand ischaracterized by the following:a.Predictive valuehelpsusersform their expectations about the future.b.Confirmatoryvaluehelps confirm or contradict existing expectations.Faithful Representationmeans that the information truly captures the economic substance ofthetransactions, events,or circumstances it describes.It requires information to be:

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2-6a.Completeb.Neutralc.Free from material errorsRelevance and faithful representation arebothenhanced by the following characteristics:a.Comparabilitymeans that companies use similar concepts and measurements and usethem consistentlyfrom period to period.b.Verifiabilitymeans that information can be checked to make sure it is correct.c.Timelinessmeans that information reaches decision makers while itcan still influencetheir decisions.d.Understandabilityrequiresinformationto bepresented clearly and concisely.Thecost-effectiveness constraintis a requirement that standard setting bodies choose ruleswhosedecision-making benefits exceed the cost of the information.Learning Objective8.Explain how the following concepts affect financial statements:entity, going concern, materiality, and stable monetary unit,periodicity, and reliability.There are a number of concepts and conventions thatare implicit in all financial statements.Theentity concept–an accounting entity stands apartfromother organizations andindividuals as a separate economic unit.Thegoing concern(continuity)conventionassertsthat the entity willpersistindefinitely.Themateriality conventionstates that an item should be included inafinancialstatement, if its omission or misstatement would tend to mislead the readerof the financialstatement under consideration.Thestable monetary unitisa monetary unit that isnot expected to change significantlyover time.Theperiodicity conventionrequires that a company break up its economic activity intoartificial time periods that will provide timely information to users.Thereliability conceptassures decision makers that the information presented capturesthe conditions or events it purports to represent.

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2-7Chapter 2 QuizMultiple Choice1.A fiscal yeara.ends onDecember 31.b.always ends at the end of the month.c.endson June 30.d.is any12consecutive months.2.The key components in measuring income area.revenue and assets.b.assets and liabilities.c.revenue and expenses.d.retained earnings andexpenses.e.revenue and liabilities.f.expenses and assets.3.Which of the following help(s) determine when a sale should be included in the income statement?a.Recognitionprincipleb.Costrecovery principlec.Matchingprincipled.Both a and c4.The recording of expenses in the same time period as the related revenues is calleda.matching.b.recognition.c.allocation.d.accuracy.5.Given the following information at the end of the year, what was the balance in retained earnings atthe beginning of the year?Total Assets=$190,000Total Liabilities=110,000Contributed Capital=30,000Revenues=85,000Expenses=70,000a.$25,000b.$35,000c.$45,000d.$80,000

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2-86.Which of the following accounts is not anexpense?a.depreciationb.salariesc.dividendsd.delivery expense7.Given the following information at the end of the year, how much was net income for the year?Beginning retained earnings=$54,000Dividends=$20,000Ending retained earnings=$69,000a.$(5,000)b.$15,000c.$35,000d.$40,0008.Declarationof dividends to stockholdersa.increasespaid-in capital.b.decreasespaid-in capital.c.increasesretainedearnings.d.decreasesretainedearnings.e.increasesassets.f.increasesliabilities.9.The ratio that is sometimes referred to as the earnings multiple is thea.earnings-per-share ratio.b.dividend-yield ratio.c.price-earnings ratio.d.dividend-payment ratio.10.The only financial ratiorequired to be a part of the financial statements isa.price-earnings.b.earnings per share.c.dividend-yield.d.dividend-payout.11.Which of the following formulas is used to calculate dividend-yield ratio?a.Netincome / average number ofshares outstandingb.Commondividends per share / market price per sharec.Marketprice per share / gross profit per shared.Revenue/ average number of shares outstanding

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2-9Exercises1.Calculate net income using the following data:Interest expense$ 3,100Revenue$110,000Rent expense3,000Wages expense80,000Suppliesexpense4,000Interestincome7,1002.The income statements for four different firms are shownnext. Some of the account balances andtotals have been omitted and a letter substituted.Determine the omitted amounts.Revenue from Operations$3,600ce3,000Operating ExpensesRent Expense400650200400Wages Expense700330200265Advertising Expense600df300Total Expensesa1,200580gNet Income (Loss)b(210)1,000h

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2-10Chapter 2 Quiz SolutionsMultiple Choice1.d6.c11.b2.c7.c3.a8.d4.a9.c5.b10.b

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2-11Exercises1.Sales Revenue$110,000Interest Income7,100Expenses:Interest3,100Rent3,000Supplies4,000Wages80,00090,100Net Income$27,0002.a =$1,700b = $1,900c = $990d = $220e = $1,580f = $180g = $965h =$2,035

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3-1CHAPTER 3Recording TransactionsLEARNING OBJECTIVESAfter studying this chapter you should be able to:1.Use double-entry accounting.2.Describe the five steps in the recording process.3.Analyze and journalize transactions and post journal entries to the ledgers.4.Prepare and use a trial balance.5.Close revenue and expense accounts and update retained earnings.6.Correct erroneous journal entries and describe how errors affect accounts.7.Explain how computers have transformedtheprocessing of accounting data.Chapter 3 introduces the accounting recording process,concentrating on thegeneraljournal andgeneral ledger. The terms debit and credit are introduced and explained. Journal entries are illustrated.Recording transactions in thegeneraljournal andgeneralledger is explained.Analysis of transactions is discussed. Included in the discussion are the effects of errors in therecords and the methods for creating entries from incomplete files and data sources.Trial balances are introduced and their purpose is discussed.Closing revenue and expense accountsto retained earnings is demonstrated.Lastly, the importance of computers in data processing is discussed.

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3-2Learning Objective 1.Use double-entry accounting.In thedouble-entry system,at least two accounts are affectedbyeverytransaction. After atransaction is recorded, thebalance sheetequationAssets = Liabilities + Stockholders’Equitymust remain in balance.Thegeneral journalis a complete chronological record of an organization’s transactions,including how eachtransactionaffects the balances of the organization’s accounts.Thegeneral ledgeris a collection ofall ledgeraccounts thatsupportthe major financialstatements.Aledger accountis a listing of all increases and decreases in a particular account.DO MULTIPLE CHOICE 1.a.Accountsare used to appropriately categorize transactions.b.T-accountsare used to portray the individual accounts in the generalledgerandresemble the letter T.For example,CashLeft sideRight sideIncreasesDecreasesAbalanceisthe net result of all activity that has been recordedin an account as ofa particularpoint intime. In a T-account the balanceis the difference between the total left-side and totalright-side amounts in theT-account.The balance in a general ledger account at the end of anaccounting period is computed as the beginning balance in the account, plus the amount of theincreases in the account during the period, minus the amount of the decreases.Assetsandexpenses usually have left-side balances, while liabilities, equity, andrevenues haveright-side balances.The worddebitmeansan entry or balance on theleftside of any account.The wordcreditmeansan entry or balance on therightside of any account. The word“charge”issometimesused instead of debit.DO MULTIPLE CHOICE2 and3.

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3-3Learning Objective 2.Describe the five steps in the recording process.Recording transactions consists of the following steps:Transaction DocumentationJournalLedgerTrial BalanceFinancial StatementsStep 1: The recording process begins with source documents,whicharethe original recordssupporting any transaction.Step 2: An analysis of the transaction, based on the course documents,is recorded in the generaljournal (also known as thebook of original entry).Step 3: Enter transactions into the ledger accounts.Step 4: Prepare thetrial balance-a list of all of the accounts in the general ledger with theirbalances.Step 5: Closing the books and preparing the financial statements.DO MULTIPLE CHOICE 4 and 5.Learning Objective 3.Analyze and journalize transactions and post journal entries to theledgers.Journalizingis the process of entering transactions intothegeneral journal.Ajournal entryisan analysis of the effectsof a transactionon thevariousaccounts—(seeEXHIBIT 3-1)andis recordedas follows:a.Thetitle of account(s) to be debited is placed left,b.thetitle of account(s) to be credited is indented,c.a brief explanation of the transaction is usually included,andd.theaccount numbercolumn refers to the number of the account in the ledger.Accountants use account numbers as a shorthandwayto identify the accounts.Theledger accountnumberis found in thechart of accounts(a numbered or coded list ofall account titles).

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3-4DO MULTIPLE CHOICE 6.“Posting”isthetransferringofamounts from thegeneraljournal to the appropriate accounts inthegeneralledger (seeEXHIBITS 3-1 and3-2for examples).Theprocess of using numbering,dating, and/or some other form of identification to relate each ledger posting to the appropriatejournal entryis known ascross-referencing.Analyzing a transaction for the journal and ledger requiresa.the accountsaffectedby the transaction to be identified,b.deciding if the accounts should be decreased or increased,andc.deciding if the accounts should be debited or credited.Simple entriesare for transactions that affect only two accounts.Compound entriesare fortransactions that affect more than two accounts.a.Assetsandexpenses normally have left-side (debit) balances. They are increased byentries on the left side and decreased by the entries on the right side.b.Liabilities and owners’equity (including revenue) accounts have right-side (credit)balances. They are increased by entries on the right side and decreased by the entrieson the left side(seeEXHIBIT 3-3).Revenue and expenses are summarized as net income (net loss) on the income statement.Withregard to the balance sheet, revenues serve to increase retained earnings and expenses serve todecrease retained earnings.When recording depreciation expense on an asset, accumulated depreciation is credited.Accumulated depreciationis acontra account(a separate but related account that is an offsetor a deduction from acompanion account). It is the cumulative sum of all depreciationrecognized since the date of acquisition ofalong-term asset.Accumulated depreciationis acontra assetbecause its companion account is an asset.Acontra accountalways has a companion account and ithas a balance on the opposite side fromthe companion account. Thebook value(net book value, carrying amount,orcarryingvalue) is the balance of an account shown on the books, net of anyassociatedcontra accounts.EXHIBITS3-4and3-5illustrate the general journal and general ledgerfor Biwheels Company.

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3-5Learning Objective 4.Prepare and use a trial balance.Thetrial balance(seeEXHIBIT 3-6) is a list of all accounts with their balances. Its purpose is toa.help check on the accuracy of posting by proving whether the total debits equal thetotal creditsin the general ledger, andb.establish a convenient summary of balances in all accounts for the preparation offormal financial statements.DO MULTIPLE CHOICE7and8.DO EXERCISE 1.Financial statements are derived from the trial balance (seeEXHIBIT 3-7).In the trial balance, all balance sheet accounts except Retained Earnings show their balances asof the date of the trial balance. Retained Earnings show the balance at the beginning of theperiod because any changes to Retained Earnings during the period are reflected in the balancesof the Revenue and Expense accounts.Learning Objective 5.Close revenue and expense accounts and update retainedearnings.The last step in the process is toclose thebooks.The closing processtransfersthebalances inallrevenue and expense accountstoRetainedEarnings.Closing entriesperform this transfer.There are two procedures that may be used to close the books.1.Alternative #1 is a two-step process.a.Transfer the amounts in each revenue and expense account to a “temporary” IncomeSummary account.The Income Summaryaccountisused only for the closing processand iscredited to closea company’s revenues, and isdebited tocloseacompany’sexpenses.b.Transfer the balance in the Income Summary account to Retained Earnings.2.Alternative #2 is a single-step process, which transfers the amounts in the revenue andexpense accounts directly into the Retained Earnings account, bypassing the need for theIncome Summary account.Either way, the revenue and expense account balances are“reset”to zero and the net income (netloss) generated during the period increases (decreases) retained earnings(seeEXHIBIT 3-8).DO MULTIPLE CHOICE9and10.

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3-6Learning Objective 6.Correct erroneous journal entries and describe how errors affectaccounts.When a journal entry contains an error, the entry can be erased or crossed out and corrected—ifthe error is discovered immediately.If the error is detected later, typically after posting to ledger accounts,thenthe accountant makesacorrecting entry(one that cancels an erroneous journal entryand adds the correct amounts tothe correct accounts), as distinguished from aregularentry.Some errors in recording revenues and expenses aretemporary in nature and arecounterbalanced by offsetting errors in the ordinary bookkeeping process in the next period.Such errors misstate net income in both periods; they also affect the balance sheet of the firstperiod but not the second.DO MULTIPLE CHOICE 11and12.Other errors may not be counterbalanced in the ordinary bookkeeping process. Until specificcorrecting entries are made, all subsequent balance sheets will be in error.Accountants must sometimes construct financial statements from incomplete data (for example,documents can be stolen, destroyed, or lost).T-accountshelp organize an accountant’s thinking and aid the discovery of unknown amounts.a.Enter all known items into the key T-account.b.Find the unknown. Simple arithmetic will often suffice.Learning Objective 7.Explain how computers have transformedtheprocessing ofaccounting data.Data processing and computers are used by almost all organizations toprocesstransactionsefficiently. An accounting information system is adata processing system, which records,analyzes, stores, and reports on an entity’s business transactions.eXtensibleBusinessReportingLanguage(XBRL)is a computer language that can be used forfinancial reporting and allows for easy comparisons across companies.

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3-7Chapter 3 QuizMultipleChoice1.Thegeneralledgera.should always have a credit balance.b.is a collection of accounts that support the financial statements.c.is the book of original entry.d.compiles all source documents.2.Which of the following is a group of accounts that all normally have a debit balance?a.Cash, MortgagePayable, and Inventoryb.Land, Cost ofGoodsSold, and Paid-inCapitalc.AccountsReceivable, SalariesExpense, andInventoryd.PrepaidRent, Building, and NotesPayable3.The term credit meansa.to increase.b.to decrease.c.the left side of an account.d.the right side of an account.4.Source documents area.supporting original records of financial transactions.b.journal entries.c.ledger accounts.d.increases on the left side of an account.5.What is the correct order oftheaccounting process?a.Ledger, journal, trial balance, balance sheet, income statementb.Journal, trial balance, ledger, balance sheet, income statementc.Trial balance, journal, ledger,income statement,balance sheetd.Journal, ledger, trial balance, income statement, balance sheet6.To find an explanation of a transaction, one would look at thea.journal.b.ledger.c.chart of accounts.d.trial balance.

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3-87.The trial balance isa.the listing of all accounts.b.a listing of all accounts with their balances.c.a place where a running balance of an account is kept.d.the book of original entry.8.The trial balance makes sure thata.the proper accounts areaffected.b.each account has the appropriate dollar amount balance.c.the debits equal the credits in the journal.d.the debits equal the credits in the ledger.e.Noneof the above9.When the financial statements are completed, the Income Summary account is found on whichfinancial statement?a.Balancesheetb.Incomestatementc.Statementof cash flowsd.Noneof the above10.If the company ends the year with a net income, the balance in the Income Summary accountimmediately preceding its closing will have aa.debit balance.b.credit balance(usually).c.both a and bd.credit balance(always).11.If the bookkeeper (in20X2) expenses the entire cost of a truck that normally would be used for threeyears, thena.net income will be understated for 20X2 and overstated for the years 20X3 and 20X4.b.total assets will not equal liabilities plus owners’equity.c.net income will be overstated for20X2and understated for the years20X3and20X4.d.assets will be overstated for20X2.12.If the bookkeeper fails to make a revenue entry for20X2,a.both20X2’sand20X3’snet income will be overstated.b.only20X2’snet income will be overstated.c.net income for20X2would be understated.d.assets will be overstated for20X2and20X3.

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3-9Exercise1.DateDescriptionDebitCreditMarch 2Cash3,000.00Paid-in Capital3,000.00Issued 100 shares of $30 par valueMarch31Salary Expense500.00SalaryPayable500.00Accrued wages owed to employeesApril 1Supplies900.00Cash900.00Paid cash for suppliesRequired:a.Classify each account and indicate its normal balance.b.Show how these transactions would be posted to the Cash account using a T-account format. Assume the Cash account had a $10,000 balance on March 1.c.What balance would appear in the Cash account following these transactions?

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