Solution Manual for Fundamentals of Financial Accounting, 5th Edition

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Instructor’s Resource Manual, Chapter 11-1CHAPTER1BUSINESS DECISIONSANDFINANCIAL ACCOUNTINGStudent Learning Objectives and Related Assignment MaterialsStudent Learning ObjectivesMini-ExercisesExercisesCoachedProblemsProblems(GroupsA & B)SkillsDevelopmentCasesContinuingCaseLO1-1Describe variousorganizational formsand business decisionmakers.21*, 2, 3LO1-2Describe thepurpose, structure, andcontent of the four basicfinancial statements.2, 3, 4, 5,6, 7, 8, 9,10, 11,12*, 13,14, 15^,161,2, 3*,4, 5, 6*,7, 8*, 9,10, 11,121, 3A1, A3,B1, B31*,2, 3, 4,6, 71†LO1-3Explain howfinancial statements areused by decisionmakers.163*, 4, 6*,9, 102, 4A2, A4,B2, B41*, 2, 3, 4,61†LO1-4Describe factorsthatcontribute to usefulfinancialinformation.1, 2,34, 5, 6*Animated solution included in the PowerPoint Slides.^Particularly challenging;requiresstudents to combine multiple concepts in order to advance to thenext level of accounting knowledge.†Continuing Case1-1 introducesNicole Mackisey, who is thinking of forming her own spa business,Nicole’s Getaway Spa. This casefocuses on preparinga(forecasted)income statement, statement ofretained earnings, and balance sheet for the business.The case will be extended in future chapters.OverviewA real entrepreneur meets with his local CPA, who walks him through the decisions he must make whenplanning his business.Students discover the role of accounting, with an emphasis on financial statement reporting and use.

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1-2Fundamentals of Financial Accounting, 5/eSynopsis of Chapter Revisions•Newcontemporary focus company: replaced pizza company withSonicGateway—a private companythat develops game apps for smartphones and tablets•Newdescription of financial statement users, with new illustration (Exhibit 1.2)•Revision to account names to match streamlined chart of accounts•Updated IFRS map in Spotlight on the World•Expanded discussion of conceptual framework, with new illustration (Exhibit 1.9)•Updated demonstration case featuringUnder Armour•Reviewed and updated all end-of-chapter material, including new exercise and problem formats toexpand number of algorithmic online problemsPowerPoint SlidesStudent Learning ObjectivePowerPoint® SlidesLO1-1 Describe various organizational forms and business decision makers.1-3through1-6LO1-2 Describe the purpose, structure, and content of the four basic financialstatements.1-7 through 1-22LO1-3 Explain how financial statements are used by decision makers.1-23 through 1-24LO1-4 Describe factors that contribute to useful financial information.1-25 through 1-28LO1-S1 Accounting Careers1-29 through 1-30Animated Builds and Animated SolutionsPowerPoint® SlidesMini-Exercise 1-121-32 through 1-33Exercise 1-31-34 through 1-35Exercise 1-61-36 through 1-38Exercise 1-81-39 through 1-40Skills Development Case 1-6 (Requirement 1)1-41 through 1-42

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Instructor’s Resource Manual, Chapter 11-3Chapter SummaryLO1-1 Describe various organizational forms and business decision makers.•Sole proprietorships are owned by one individual, are relativelyinexpensive to form, and are nottreated legally as separate from their owners. Thus, all profits or losses become part of the taxableincome to the owner,who is also responsible personally for all debts of the business.•Partnerships are businesses similar legally to proprietorships, but with two or more owners.•Corporations are separate legal entities (thus, corporations pay taxes) thatissueshares of stock toinvestors (stockholders) and are more costly to establish. Stockholders cannot be held liable formore than their investment in the corporation. Private corporationsissuestock to a few individualswhile public corporationsissuestock in the stock market.•Business decision makers include creditors (banks, suppliers), investors (stockholders), customers,governments, and other external users.LO1-2 Describe the purpose, structure, and content of the four basic financial statements.•Theincome statementreports the net amount that a business earned (net income) over a period oftime by subtracting the costs of running the business (expenses) from the total amount earned(revenues).•Thestatement of retained earningsexplains changes in theRetainedEarningsaccount over aperiod of time by considering increases (from net income) and decreases (from dividends tostockholders).•Thebalance sheetreports what the business owns (reported as assets) at a particular point in timeand whether the financing for these assets came from creditors (reported as liabilities) orstockholders (reported as stockholders’ equity).•Thestatement of cash flowsexplains changes in the cash account over a period of time byreporting inflows and outflows of cash from the business’s operating, investing, and financingactivities.LO1-3 Explain how financial statements areused by decision makers.•Creditors are mainly interested in assessing whether the company (1) is generating enough cash tomake payments on its loan, and (2) has enough assets to cover its liabilities. Answers to thesequestions are indicated by the statement of cash flows and the balance sheet.•Investors look closely at the income statement for information about a company’s ability togenerate profits, and at the statement of retained earnings for information about a company’sdividend distributions.LO1-4 Describe factors thatcontribute to useful financial information.•Companies generate usefulfinancialinformation byapplyingGenerallyAcceptedAccountingPrinciples(GAAP) or International Financial Reporting Standards (IFRS) in an ethicalbusinessenvironment.•To be useful, information must be relevant and a faithful representation of reality. Information ismore useful when it is comparable, verifiable, timely, and understandable.

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1-4Fundamentals of Financial Accounting, 5/eChapter OutlineTeachingNotesProvide alearning strategyOverview the textbook:You Should Know(marginal boxes)Coach’s Tip (marginalboxes)Review the Chapter—DemonstrationCaseChapterSummaryKeyTermsHighlightand demo thestudent edition of thetextbook websiteatwww.mhhe.com/phillips4e:Practice QuizzesNarrated slidesiPod ContentI.Understand the BusinessLO1-1 Describe various organizational forms and business decision makers.A.Organizational Forms:1.Sole proprietorship—Abusiness owned(and usuallyoperated)by one individual.2.Partnership—Similar to a sole proprietorship, except thatprofits, taxes, and legal liability are the responsibility oftwo or more owners instead of just one.3.Corporation—Aseparate entity from both a legal andaccounting perspective. The corporation, not its owners,islegallyresponsible for its own taxes and debts. Thus,owners cannot lose more than their investment in thecorporation.This textbookfocuses oncorporations.4.Other—Other organizational forms exist, such as alimited liability company (LLC), which combinescharacteristics of a partnership and a corporation.B.Accounting for Business Decisions1.Most companies exist to earn profitsfor theirstockholders; profits are earned by selling goods orservices to customers for more than they cost to produce.2.Accounting—System ofanalyzing, recording, andsummarizing the results ofa business’s activities andthenreporting the results todecisionmakers.3.Business people talk about their companies usingaccounting terms; accounting is the “language ofbusiness.”4.Every organization needs accountants to assist inreporting financial information fordecision making andto help itsowners understand the financial effects of thosebusinessdecisions.

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Instructor’s Resource Manual, Chapter 11-5Chapter OutlineTeaching Notes5.The accounting system produces two kinds of reports:a.Managerial accounting reports—Include detailedfinancial plans and continually updated reports aboutthe financial performance of the company. Thesereports are made available only to employees of thecompany so that they can make business decisions.b.Financial accounting reports—Calledfinancialstatements:i.Prepared periodically to provide information topeople not employed by the business.ii.External financial statement users aren’t givenaccess to detailed internal records of the company,so they relyextensively on the financial statements6.Users of financial information:Illustrated in Exhibit 1.2a.Creditors—Suppliers, banks, and anyone to whommoney is owed.b.Investors—Existing and potential future stockholders.c.Directors—Members of a company’s board ofdirectors; electedby stockholders to oversee thecompany’s managers.c.Government agencies—Include the Securities andExchange Commission and Internal Revenue Service.II.Studythe Accounting MethodsLO1-2Describe the purpose, structure, and content of the four basic financial statements.A.TheBasicAccounting EquationAssets = Liabilities + Stockholders’ EquityDescribe as “what acompany owns must equal1.Separateentity assumption—Thefinancial reports of abusiness areassumed to include the results ofonly thatbusiness’s activities.what a company owes to itscreditors and stockholders.”2.Asset—Economicresource presently controlled by thecompany; it has measureable value and is expected tobenefit the company by producing cash inflows orreducing cash outflows in the future.To decide:Does companyown/have legal rights to it? Ifyes, will it have benefitbeyond the end of the current3.Liabilities—Measurable amounts thatthe company owesto creditors.month? Ifso,it’s an asset.4.Stockholders’ Equity—Represents theowners’ claims onthe business; claims arise for two reasons:a.First, the owners have a claim on amounts theycontributed directly tothe businessin exchange for itsstock(CommonStock).b.Second, the owners have a claim on amounts thecompany has earned through profitable businessoperations (RetainedEarnings).

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1-6Fundamentals of Financial Accounting, 5/eChapter OutlineTeaching Notesc.Profits are generated when the totalamount earnedfrom selling goods and services(revenues) is greaterthan all the costs incurred to generate those sales(expenses).i.Revenues—Earned by selling goods or services tocustomers.ii.Expenses—All costs of doing business that arenecessary to earn revenues.iii.Net Income(orprofit)—Revenuesminus expenses(net loss if revenues are less than expenses); netincomeincreases stockholders’ equity.iv.Dividends—Distribution of a company’s profits toits stockholders;not an expense incurred togenerate earnings.B.Financial Statements✓Supplemental Enrichment1.Reports prepared at any time during year.Activity(Activity)#1a.Most commonly monthly, quarterly, and annuallyusing calendar year or fiscal year (a 12-month periodending on a day other than December 31).b.Eachfinancial statementhas a heading(name ofcompany, name of statement, and time period).c.Each major caption has an underlined subtotal;“bottom line” amount has a double underline.d.Adollar sign appears at the topand bottom ofeachcolumn of numbers.2.There are four basic financial statements:Summarized inExhibit1.8a.Income statement—Reportsthe amount of revenueslessexpenses for a period of time.i.Unit of measure assumption—Resultsof businessactivities shouldbe reported in an appropriatemonetary unit.ii.Accounts—Accumulate andreport the effects ofeachdifferent business activity.iii.Whenlisting the accounts on the income statement,revenues are on top(largest, most relevant revenuelisted first), thenexpenses are subtracted, fromlargest to smallest(except that Income TaxExpense is the last expense listed).Illustrated in Exhibit 1.3Other income statementformats are possible, asexplained in Chapter 6.iv.Revenues–Expenses = Net Income (or Net Loss)b.Statement of retained earnings—Reports the waythat net income and the distribution of dividendsaffected thefinancial position during the period.Illustrated in Exhibit 1.4i.Retained earningsare profits that haveaccumulated over a period of time.ii.Beginning balance of retained earnings+ Netincome (or–Net loss)–Dividends =Endingbalance of retained earnings

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Instructor’s Resource Manual, Chapter 11-7Chapter OutlineTeaching Notesc.Balance sheet—Reports the amount of assets,liabilities, and stockholders’ equity of a business at aspecificpoint in time; it “balances.”Illustrated in Exhibit 1.5✓Activity #2i.Assets =Liabilities +Stockholders’ equityii.Assets listed in order of how soon they are to beused or converted into cash; liabilities in order ofhow soon each is to be paid or settled.d.Statement of cash flows—Reportsthe operating,investing,and financing activities thatcausedincreases and decreasesin cash during the period.Illustrated in Exhibit 1.6✓Activity #3i.Operating—Activities directly related to runningthe business to earn profit.ii.Investing—Activities involving buying and sellingproductive resources with long lives, purchasinginvestments, and lending to others.iii.Financing—Any borrowing from banks, repayingbank loans, receiving cash from stockholders forcompany stock, or paying dividends tostockholders.e.Notesto the Financial Statements(footnotes)—Helpfinancial statement users understand how the amountswere derived and what other information may affecttheir decisions.3.The four basic financial statements connect to oneanother:✓Activity #4a.Net income, fromthe income statement,is acomponent in determining endingRetainedEarningson the statement ofretainedearnings.Illustrated inExhibit 1.7b.Ending RetainedEarnings is then reported on thebalance sheet.c.Cash on the balance sheet is equal to the ending Cashreported on the statement of cash flows.III.EvaluatetheResultsLO1-3 Explain how financial statements areused by decision makers.A.UsingFinancial Statements1.Creditors—Interested in assessing two things:a.Is thecompany generating enough cash to makepayments on its loans?Answers come from statementof cash flows.b.Does the company have assets to cover its liabilities?Answers come fromcomparing assets and liabilitiesreported on thebalancesheet.

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1-8Fundamentals of Financial Accounting, 5/eChapter OutlineTeaching Notes2.Investors—Expect a return on their contribution to thecompany:a.Return may be immediate(through dividends)or long-term (through selling stock certificates at a pricehigher than their original cost).b.Looks closely at theincome statement (and statementof retained earnings)for information about thecompany’s ability to generate profits (and distributedividends).LO1-4 Describe factors thatcontribute to useful financial information.B.UsefulFinancial Information1.Generally Accepted Accounting Principles (GAAP)—Rules of accounting createdby the Financial AccountingStandards Board foruse in theUnited States.a.Financial Accounting Standards Board (FASB)—Currently hasprimary responsibility for setting theunderlying rules of accounting.b.Accounting rules in U.S. are similar to those usedelsewhere, with someimportant differences; FASBworks alongside International Accounting StandardsBoard (IASB) to eliminate differences.2.Main goal of GAAP and IFRS is to ensure companiesproduce financialinformation that is useful to existingand potentialinvestors, lenders, and othercreditors inmaking decisions about providing resources to thecompanies.3.Forfinancial information to be judged useful, it mustpossess two fundamental characteristics:Illustrated inExhibit 1.9a.Relevance—Information makes adifference indecision making.b.Faithful representation—Informationfully depicts theeconomic substance of business activities.4.Usefulness is enhanced when it is:a.Timely—If it is available in time to influence decisionmakers.b.Verifiable—If others, such as external auditors, reachsimilar values using similar methods.c.Comparable—If the same accounting principles areused over time and across companies.d.Understandable—If reasonably informed users cancomprehend and interpret it.

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Instructor’s Resource Manual, Chapter 11-9Chapter OutlineTeaching Notes5.Ethical Conduct✓Activity #5a.Ethics—Thestandards of conduct for judging rightfrom wrong, honest from dishonest,and fair fromunfair.b.Intentional financialmisreporting is both unethical andillegal.c.The American Institute of Certified PublicAccountants (AICPA) requires allits members toadhere toa Code of Professional Conduct tohelpensure these decisions are made in aprofessional andethicalmanner.d.Regardless of the above, some individuals have beeninvolved in accounting scandals and fraud.e.Sarbanes-Oxley Act(SOX)—A set of lawsestablished tostrengthen corporate reportingin theUnited States; it requires top managers of publiccompanies to:i.Sign a report certifying their responsibilitiesforthe financial statements,ii.Maintain an audited system of internal controls toensure accuracy in the accounting reports,andIii.Maintain an independent committee toensurethatmanagers cooperate with auditors.f.Ethical conduct is just as important for small privatebusinesses as it is for large public companies.g.When facedwith an ethical dilemma, follow athree-step process:The “Stoplight on Ethics”featuresummarizes recenti.Identify who will benefit from the situation (oftenthe manager or employee)and how others will beharmed (other employees, the company’sreputation, owners,creditors, and the public ingeneral).scandals.ii.Identify thealternative courses of action.iii.Choose the alternative that is the most ethical;thatyou would be proud tohave reported in the news.IV.Supplement1A–Careers That Dependon AccountingKnowledgeOverviewed in Exhibit 1S.1

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1-10Fundamentals of Financial Accounting, 5/eSupplemental Enrichment ActivitiesNote: These activities would be suitable for individual or group activities.1.Handout 1–1Usethis handout for an in-class activity designed to review the classification of various accounts,elements, or transactionson the financial statements. The solutionfollows the handout master.2.Handout 1–2Usethis handout for an in-class activity designed to review the classification of various accountnames on the balance sheet. The solutionfollows the handout master.3.Handout 1–3Usethis handout for an in-class activity designed to review the classification of various transactionson the statement of cash flows. The solutionfollows the handout master.4.Handout 1–4Usethis handout for an in-class activity designed to review the individual financial statements and therelationships among the financial statements.The solutionfollows the handout master.5.Consider showing the first segment ofthefollowing video in class; most students will be able toidentify with the “fraudster.” Lively discussion of the manner in which the fraud was perpetrated willfollow.The Association of Certified Fraud Examiners produced a video in 1991 called“Cooking the Books:What Every Accountant Should Knowabout Fraud.”It can be ordered by calling1-800-245-3321 orvisiting the ACFEweb site atwww.cfenet.com.(Consider joining as an educator to obtain adiscounted rate.)Three frauds are overviewed: ZZZZ Best Carpet, Regina Vacuum Cleaner Company, and ESMGroup, Inc. (ESM Government Securities). ZZZZ Best Carpet might be the best one to use.BarryMinkow, the CEO and major stockholder, is interviewed in prison. The video segment discussesrevenue overstatements, deferred costs, asset valuations, inadequate disclosures, and horizontal andvertical analysis. It is very well done.(Note that the discussion of ratio analysis and trends wouldalso be appropriate for Chapter 13—Measuring and EvaluatingFinancial Performance.).

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Instructor’s Resource Manual, Chapter 11-11HANDOUT 1–1COMPONENTS OFFINANCIALSTATEMENTSMatch eachaccount, element, or transactionto the financial statement(s) on which it would be reported.Accountor ElementIncomeStatementStatement ofRetainedEarningsBalance SheetStatement ofCash Flowsa.The amount of cashpaid for equipmentb.Cashc.Notes Payabled.Common Stocke.Suppliesf.The amount of cashcollected fromcustomersg.AccountsReceivableh.Notes Payablei.Salaries and WagesExpensej.Equipmentk.Dividends paid tostockholdersl.Net Income

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1-12Fundamentals of Financial Accounting, 5/eHANDOUT 1–1 SOLUTIONCOMPONENTS OFFINANCIAL STATEMENTSMatch eachaccount, element, or transactionto the financial statement(s) on which it would be reported.Accountor ElementIncomeStatementStatement ofRetainedEarningsBalance SheetStatement ofCash Flowsa.The amount of cashpaid for equipmentXb.CashXc.Notes PayableXd.Common StockXe.SuppliesXf.The amount of cashcollected fromcustomersXg.AccountsReceivableXh.Notes PayableXi.Salaries and WagesExpenseXj.EquipmentXk.Dividends paid tostockholdersXXl.Net IncomeXX

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Instructor’s Resource Manual, Chapter 11-13HANDOUT1–2BASIC BALANCE SHEET ELEMENTSMatch eachaccountto its classification on the balance sheet.AccountAssetLiabilityStockholders’Equitya.Notes Payableb.Cashc.Common Stockd.Suppliese.Accounts Receivablef.Accounts Payableg.Equipmenth.Notes Payablei.Retained Earnings

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1-14Fundamentals of Financial Accounting, 5/eHANDOUT1–2SOLUTIONBASIC BALANCE SHEET ELEMENTSMatch eachaccountto its classification on the balance sheet.AccountAssetLiabilityStockholders’Equitya.Notes PayableXb.CashXc.Common StockXd.SuppliesXe.Accounts ReceivableXf.Accounts PayableXg.EquipmentXh.Notes PayableXi.Retained EarningsX

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Instructor’s Resource Manual, Chapter 11-15HANDOUT1–3STATEMENT OF CASH FLOWSMatch eachactivityto its classification on thestatement of cash flows.ActivityOperatingInvestingFinancinga.Cash paid to employeesand suppliersb.Cashused to buyequipment and softwarec.Cash dividendspaid tostockholdersd.Cashreceivedfromcustomerse.Cash received fromselling equipmentf.Cashborrowed from thebank

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1-16Fundamentals of Financial Accounting, 5/eHANDOUT1–3SOLUTIONSTATEMENT OF CASH FLOWSMatch eachactivityto its classification on thestatement of cash flows.ActivityOperatingInvestingFinancinga.Cash paid to employeesand suppliersXb.Cash used to buyequipment and softwareXc.Cash dividends paid tostockholdersXd.Cash received fromcustomersXe.Cash received fromselling equipmentXf.Cash borrowed from thebankX

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Instructor’s Resource Manual, Chapter 11-17HANDOUT1–4TEAM PROJECT—OVERVIEW OF FINANCIAL STATMENTSComplete the following table.Financial StatementPurposeEquationIncome StatementStatement of RetainedEarningsBalance SheetStatement of Cash FlowsRELATIONSHIPS AMONG FINANCIAL STATEMENTSThen,answer the following questions.1.How doestheincome statement tie to thestatementofretained earnings?2.How does the statement ofretainedearnings tie to the balance sheet?3.How does the balance sheet tie to the statement of cash flows?

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1-18Fundamentals of Financial Accounting, 5/eHANDOUT1–4 SOLUTIONTEAM PROJECT—OVERVIEW OF FINANCIALSTATEMENTSComplete the following table.Financial StatementPurposeEquationIncome StatementThe financial performance ofthe businessduring thecurrentaccounting period.Revenues–Expenses=Net IncomeStatement of RetainedEarningsThe accumulation of earningsretained in the businessduring thecurrent accountingperiod with thatof priorperiods.Beginning RetainedEarnings+Net Income (this period)–Dividends (this period)=Ending Retained EarningsBalance SheetThe financial position of abusiness at a point in time.Assets= Liabilities+Stockholders’EquityStatement of Cash FlowsInflows(receipts) andoutflows(payments) of cashduring thecurrent accountingperiod.+/–Cash Flows fromOperating Activities+/–Cash Flows fromInvesting Activities+/–Cash FlowsfromFinancing Activities=Change in Cash+Beginning Cash=Ending CashRELATIONSHIPS AMONG FINANCIAL STATEMENTSThen,answer the following questions.1.How does the income statement tie to the statement of retained earnings?Net income, from the income statement,is a component in determining ending retained earnings onthe statement ofRetainedEarnings.2.How does the statement of retained earnings tie to the balance sheet?Ending retainedearningson the statement of retained earningsisreportedin the stockholders’ equitysection ofthe balance sheet.3.How does the balance sheet tie to the statement of cash flows?Cash on the balance sheet is equal to the ending Cash reported on the statement of cash flows.

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Instructor’s Resource Manual, Chapter 22-1CHAPTER2THE BALANCE SHEETStudent Learning Objectives and Related Assignment MaterialsStudent Learning ObjectivesMini-ExercisesExercisesCoachedProblemsProblems(GroupsA & B)SkillsDevelopmentCasesContinuingCaseLO 2-1Identify financialeffects of commonbusinessactivitiesthataffect the balance sheet.4, 5, 61, 2, 3, 4*,5, 9, 11,13, 141, 2, 3, 4, 5,61†LO 2-2Apply transactionanalysis toaccountingtransactions.3, 7, 8, 91, 2, 4*, 5,8, 9, 10,11,12, 13,15^1, 2, 3A1, A2,A3, B1,B2, B34, 71†LO 2-3Use journal entriesand T-accounts to showhow transactions affectthe balance sheet.1, 2, 3, 5,6,10, 11,13*, 14,15*, 16,17*, 18,19*^, 201,3, 6*, 7,8,10,12,13, 15^2, 3A2, A3,B2, B31†LO 2-4Prepareatrialbalance anda classifiedbalance sheet.4, 5, 6, 12,21, 223, 9, 10,12, 152, 3A2, A3,B2, B31, 2,3,61†LO 2-5Interpret the balancesheet using the currentratioand anunderstanding of relatedconcepts.3,22, 23,24^, 25^1, 2,5,7,8, 11, 14,15^1, 2, 3A1, A2,A3, B1,B2, B31, 2, 3, 4, 5,61†*Animated solution included in the PowerPoint Slides.^Particularly challenging;requiresstudents to combine multiple concepts in order to advance to thenext level of accounting knowledge.†Continuing Case2-1builds on the story ofNicole’s Getaway Spa, introduced in chapter 1. This casefocuses onanalyzing transactions, preparing and recording journal entries, posting to T-accounts,preparing a classified balance sheet, and interpreting the current ratio.This case will be extended infuture chapters.OverviewThe entrepreneur from chapter 1 organizes his business as a corporation and completesbusinesstransactions to establish the business.Students learn how to analyze and recordbusiness transactions that affect the balance sheet andthenprepare and interpret a classified balance sheet.

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2-2Fundamentals of Financial Accounting, 5/eSynopsis of Chapter Revisions•New contemporary focus company: replaced pizza company with SonicGateway, thereby replacingpeculiar Cookware account with contemporary intangible accounts such as Software and Trademarks•New margin illustration of accounting cycle•Expanded learning objectives to include trial balance preparation•Revised illustration of T-accounts to include normal balance (Exhibit 2.7)•Updated analysis of current ratios in Exhibit 2.14 and Spotlight on Financial Reporting to focus ontechnology companies, including Apple, Expedia, Electronic Arts, Facebook, and LinkedIn•Reviewed and updated all end-of-chapter material, including new problem formats that automaticallypost journal entries to T-accounts and prepare trial balancesPowerPoint SlidesStudent Learning ObjectivePowerPoint® SlidesLO 2-1 Identify financial effects of common business activities that affect thebalance sheet.2-2 through 2-6LO 2-2 Apply transaction analysis to accounting transactions.2-7 through 2-19LO 2-3 Use journalentries and T-accounts to show how transactions affect thebalance sheet.2-20through 2-34LO 2-4 Prepareatrial balance anda classified balance sheet.2-35through 2-37LO 2-5 Interpret the balance sheet using the current ratio and an understandingof related concepts.2-38through 2-40Animated Builds and Animated SolutionsPowerPoint® SlidesMini-Exercise 2-132-42through 2-43Mini-Exercise 2-152-44through 2-45Mini-Exercise 2-172-46through 2-47Mini-Exercise 2-192-48through 2-49Exercise 2-42-50Exercise 2-62-51through 2-52

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Instructor’s Resource Manual, Chapter 22-3Chapter SummaryLO2-1Identify financial effects ofcommon business activities that affect the balance sheet.•Financing activities involve debt transactions with lenders (e.g.,Notes Payable) or equitytransactions with investors (e.g.,Common Stock)•Investing activities involve buying and selling long-term assets (e.g., Buildings, Equipment).•Operating activities involve day-to-day transactions with suppliers, employees, and customers, andtypically affect current assets and current liabilities.LO2-2Apply transaction analysis toaccountingtransactions.•Transactions include external exchanges and internal events.•Transaction analysis is based on the duality of effects and the basic accounting equation.Dualityof effectsmeans that every transaction affects at least two accounts.•Transaction analysis follows a systematic approach of picturing the documented businessactivity;naming theexchangedasset,liability,andstockholders’ equityaccounts;andanalyzing thefinancial effects on the basic accounting equation.LO2-3Use journal entries and T-accounts to show how transactions affect the balancesheet.•Debit means left and credit means right.•Debits increase assets and decrease liabilities and stockholders’ equity.•Credits decrease assets and increase liabilities and stockholders’ equity.•Journal entries express, in debits-equal-credits form, the effects of a transaction on variousasset,liability, and stockholders’ equity accounts. Journal entries are used to record financialinformation in the accounting system, which is later summarized by accounts in the ledger(T-accounts).•T-accounts are a simplified version of the ledger, which summarizes transaction effects foreachaccount. T-accounts show increases on the left (debit) side for assets, which are on theleft side ofthe accounting equation. T-accounts show increases on the right (credit) side forliabilities andstockholders’ equity, which are on the right side of the accounting equation.LO2-4Prepareatrial balance anda classified balance sheet.•A trial balance checks on the equality of debit and credit balances.•Aclassified balance sheetseparately classifies assets as current if they will be used up or turnedinto cash within one year. Liabilities are classified as current if they will be paid, settled, orfulfilled within one year.LO2-5Interpret the balance sheet using thecurrent ratio and an understanding ofrelatedconcepts.•The current ratio divides current assets by current liabilities to determine the extent towhichcurrent assets are likely to be sufficient for paying current liabilities.•Because accounting is transaction-based, the balance sheet does not necessarily representthecurrent value of a business.Some assets are not recorded because they do not arise fromtransactions.•The amounts recorded for assets and liabilities may not represent current values becauseunder thecost principle they generally are recorded at cost, using the exchange amountsestablished at thetime of the initial transaction.Accounting DecisionToolsCurrent Ratio = Current Assets ÷ Current Liabilities•It tells you whether current assets are sufficient topay current liabilities.

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2-4Fundamentals of Financial Accounting, 5/e•A higher ratio means better ability to pay.

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Instructor’s Resource Manual, Chapter 22-5Chapter OutlineTeachingNotesI.Understand theBusinessLO2-1Identify financial effects ofcommon business activities that affect the balancesheet.A.Building aBalance Sheet1.Asset––Resources presentlyowned by a business thatgenerate future economicbenefits.In this chapter,the Retained2.Liabilities––Amountspresently owed by a businessEarningsaccounthas a zero3.Stockholders’ equity––Amount invested andreinvestedin a company by itsstockholders.balancebecause there havebeen nooperating4.Key activity for any start-up company is to obtainfinancing.transactionsa.Equity financing––Money obtainedthrough owners’contributions and reinvestments of profit; business isnot legally obligated to repay.b.Debt financing––Money obtainedthrough loans;business is legally obligated to repay.5.After obtaining initial financing, company will startinvesting in assets that will be used when business opens.6.Featuresimportant for understanding how accountingworks; acompany always:a.Documents its activities.b.Receives something and gives something(basicfeature of all business activities).c.Determines a dollar amount for each exchange basedon value of items given and exchanged.i.Exchange is either to earn a profit immediately orobtain resources that will allow it to earn a profitlater.Fundamental idea of businessisto create value throughexchange.ii.Any exchange that affects company’s assets,liabilities, or stockholders’ equity must be capturedin and reported by the accounting system.iii.Adollar amount is determined for each exchangebased on the value (cost) of items given andreceived.iv.Cost principle––At the time of a transaction,assets and liabilities should berecorded at theiroriginal costto the company.7.Accounting for business activities:Illustrated in Exhibit 2.3a.Picture the documented activity.b.Name what’s exchangedUltimate goal––capturec.Analyzethe financial affects––Building on the laststep, show how the costs cause elementsof theaccounting equation to increase and/ordecrease.financial effects so that theycan be reported in financialstatements.

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2-6Fundamentals of Financial Accounting, 5/eChapter OutlineTeaching NotesB.Transactions and Other Activities1.Transaction––An event or activity that hasa direct andmeasurable financial effect on the assets, liabilities, orstockholders’ equity of a business.2.Transactions include two types of events:a.External exchanges––Exchanges involving assets,liabilities, and/or stockholders’ equity that you can seebetween the company and someone else.b.Internal events––Events that do not involve exchangeswith others outside the business, but rather occurwithin the company itself.3.Exchange ofonly promises is not an accountingtransaction.a.Documents are created to indicate activities occurred.b.Later, when promises result in actually receiving orgiving an asset or services, they will becometransactions captured by theaccounting system.II.Study the Accounting MethodsLO2-2 Apply transaction analysis toaccountingtransactions.A.Step 1––AnalyzeTransactions1.A systematic accounting process is used to capture andreport the financial effects of acompany’s activities.a.Process is called the accounting cycle; repeats itselfover and over.b.Steps include: analyze, record, summarize, preparetrial balance, and report financial statements.2.Once a transaction is identified, it must beanalyzedcarefully to determine its financial effects; two simpleideas are used when analyzing transactions:Analyze transactions from thestandpoint of the business,not its owners.a.Duality of effects––Every transaction has at least twoeffects on the basic accounting equation.b.The dollar amount for assets must always equal thatfor liabilities plus stockholders’ equity for everyaccounting transaction. A = L + SE.c.As part oftransactionanalysis, name (or account title)is given to each item exchanged.d.Chart of accounts––A summary of all accountnames(and correspondingaccount numbers) used torecordfinancial results in theaccounting system.Illustrated in Exhibit 2.4.Chart of accounts shown inChapter 2includes onlyi.Ensures account titles are used consistently.balance sheet accounts.ii.Tailored to each company’s business.iii.Many account titles are common across allcompanies; others may be used only by a particularcompany.

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Instructor’s Resource Manual, Chapter 22-7Chapter OutlineTeaching Notes3.SonicGateway’sBusinessActivitiesStressthat students should(a) Issue Stock to Owners––Scott incorporatesSonicGatewayand the company issuescommonstocktoScott and Angusas evidence oftheir contribution of$10,000cash, which is deposited in the company’sbankaccount.not skip this sectionwith theplanof coming back to itlater;the next part ofthechapter builds on this part.•Name:SonicGateway has received $10,000 cash.SonicGatewayissues$10,000 ofcommonstock.•Analyze:Assets = Liabilities + Stockholders’ EquityCash (A)+10,000=Common Stock(SE) +10,000(b)Invest in Equipment––SonicGatewaypays $300 cashfor the company’s logo.•Name:SonicGatewayhas receiveda logocosting $300.SonicGatewaygave $300 cash.•Analyze:Assets = Liabilities + Stockholders’ EquityCash(A)−300+Logo/Trademarks(A) +300= 0(c)Obtain Loan from Bank––SonicGatewayborrows$20,000 from a bank, depositing those funds in itsbank account and signing a formal agreement to repaythe loan in two years(on September 1, 2017).Notes payable are likeaccountspayable exceptthat they:(a) charge interest,•Name:SonicGatewayhas received $20,000 cash.SonicGatewaygave a note, payable to the bank for$20,000.(b) canbe outstanding forperiodslonger than oneyear, and(c)are documented using•Analyze:Assets = Liabilities + Stockholders’ EquityCash (A) +20,000= Note Payable(L)+20,000formaldocuments callednotes.(d)Invest in Equipment––SonicGatewaypurchasesandreceives $9,600 in computers, printers, and desks,signing a purchase order to indicate itspromise to pay$9,600 at the end of the month.•Name:SonicGatewayhas received$9,600of equipment.SonicGatewaygave a promise to pay$9,600onaccount.•Analyze:Assets = Liabilities + Stockholders’ EquityEquipment (A) +9,600 =Accounts Payable+9,600

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2-8Fundamentals of Financial Accounting, 5/eChapter OutlineTeaching Notes(e) Pay Supplier––SonicGatewaypays $5,000of itspromiseto the equipment supplier in (d).Stress that the companywould typically wait until the•Name:SonicGatewayhas received back its $5,000promise to pay on account.SonicGatewaygave$5,000 cash.end of the month to pay theamount owed to the supplier.•Analyze:Assets = Liabilities + Stockholders’ EquityCash–5,000=Accounts Payable–5,000(f)Order Software for App––SonicGatewaysigns acontract with a programmer for program code for theStatic Charge game app for $9,000. No code has beenreceived yet.•Name:An exchange of only promises is not a transaction.This does not affect the accounting equation.Not all business activitiesareconsidered accountingtransactions.•Analyze:Assets = Liabilities + Stockholders’ EquityNo change = Nochange(g)ReceiveSoftware––SonicGatewayreceivesthe$9,000 of app game codeordered in (f); pays $4,000cash,and promises to paythe remaining $5,000nextmonth.•Name:SonicGatewayhas received software costing$9,000.SonicGatewaygave$4,000 cash andapromise to pay $5,000on account.•Analyze:Assets = Liabilities + Stockholders’ EquityCash (A)–4,000 + Software (A) +9,000 =Accounts Payable (L) +5,000✓Supplemental EnrichmentActivity (Activity) #1✓Activity #2(h)ReceiveSupplies––SonicGatewayreceivessuppliescosting $600 on account.•Name:SonicGateway has received suppliescosting $600.SonicGatewaygavea promise to pay $600onaccount.•Analyze:Assets = Liabilities + Stockholders’ EquitySupplies (A) +600= Accounts Payable (L) +600

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Instructor’s Resource Manual, Chapter 22-9Chapter OutlineTeaching NotesB.Steps 2and 3: Recordand Summarize1.One method for recording and summarizing the financialeffects of accounting transactions is to prepare aspreadsheet.Illustrated in Exhibit 2.5a.By summing each spreadsheet column, the newbalances can be computed at the end of the month andreported on a balance sheet.b.Thismethod is impracticalfor most largeorganizations.2.Most companies use computerized accounting systems,which can handle a largenumber of transactions.a.These systems follow the accounting cycle,which isrepeated month-after-month and year-after-year.Illustrated inExhibit 2.6b.Three-step analyze-record-summarize process isapplied to daily transactions, as well asadjustmentsatthe end of each month, before preparing a trial balanceand financial statements; same three steps are part ofthe closingprocessesthat occursat the end of eachyear.Focushereis on applying thethree-step process during theperiod to activities that affectonly balance sheet accounts.3.Transactions areanalyzed, and their financial effects areentered into journalseach day they occur. Later, thesejournal entries are summarized in ledger accounts thatkeep track of the financial effects on each account.a.Journal––Used to recordthe effects ofeach day’stransactions; organized by date.b.Ledger––Used to summarize the effectsof journalentries on eachaccount; organized by account.LO2-3 Use journal entries and T-accounts to show how transactions affect the balance sheet.C.TheDebit/Credit Framework✓Activity #31.The accounting equation (A = L + SE) can be thought ofas a scale that tips at the equals sign; assets are put on theleft side of the scaleand liabilities and stockholders’equity accounts are put on the right.✓Activity #42.Eachindividual account has two sides, with one side usedfor increases and the other for decreases.3.Accounts increase on the same side as they appear in A =L + SE(decreases are the opposite):a.Assets increase on the leftside of the account.b.Liabilities increase on the right side of the account.c.Stockholders’ equity accounts increase on the rightside of the account.4.Debit(dr)––The left side of anaccount, or the act ofenteringan amount into the leftside ofan account.5.Credit(cr)––Theright side of anaccount, or the act ofenteringan amount into the right sideof an account.

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2-10Fundamentals of Financial Accounting, 5/eChapter OutlineTeaching Notes6. When combined with how increases and decreases areentered intoaccounts, the following rules emerge:a.Use debits for increases in assets (and for decreases inliabilities and stockholders’ equity accounts).Illustrated in Exhibit 2.7b.Use credits for increases in liabilities andstockholders’ equity accounts (and for decreases inassets).7.Normal balance––the side on which an account increases.a.Assets accounts normally have debit balances.b.Liabilities and stockholders’ equity accounts normallyhave credit balances.8.In addition to requiring thatA = L + SE, the double-entrysystemalso requires that debits=credits.a.Step 1: Analyzing Transactions––The debit/creditframework does not change this step.b.Step 2: Recording Journal Entries––The financialeffects of transactions are entered into a journal usinga debits-equal-credits format.9.Journal entries––Indicate the effects of each day’stransactions in a debits-equal-credits format.Illustrated inExhibit 2.8a.A date is included for each transaction.b.Debits appear first; credits are written below the debitsand are indented to the right (words and amounts).c.Total debits must equal total credits.d.Dollar signs are not used.e.The reference column (Ref.) will be used later(in step3) to indicate when thejournal entry has beensummarized in the ledger accounts.f.Abrief explanationof the transaction is writtenbelowthe debits and credits.g.The line after the description is left blank.D.Step 3: Summarizingin Ledger Accounts:1.After journal entries have been recorded (in step 2), theirdollar amounts are copied (“posted”) to each ledgeraccount affected by the transaction so that accountbalances can be computed.Illustrated inExhibit 2.92.The posting of journal entries to general ledger accountsis kept track of by writing the account number in the Ref.column of the journal and the journal page number in theRef. column of the ledger.✓Activity #53.T-account––Simplified version of a ledger account usedfor summarizing the effects of journal entries.Illustrated inExhibit 2.10a.Every account starts with a beginning balancenormally on the side where increases are summarized.b.Dollar signs are not needed.c.Each amount is accompanied by a reference to therelated journal entry, which makes it easy to traceback to the original transaction should errors occur.

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Instructor’s Resource Manual, Chapter 22-11Chapter OutlineTeaching Notesd.To find ending account balance,express the T-accountas equations:Start with beginning balanceAdd “+” sideSubtract “–” sideEquals ending balance“Spotlight on FinancialReporting” feature addressesthe impact of needing extratime to prepare financialstatementse.Endingbalance is double underscored to distinguish it.E.SonicGateway’s Accounting Records(a) Issue Stock to Owners––Scott incorporatesSonicGatewayand thecompany issuescommonstocktoScott and Angusas evidence oftheir contribution of$10,000cash, which is deposited in the company’s bankaccount.1.Analyze:Assets = Liabilities + Stockholders’ EquityCash (A)+10,000= Common Stock (SE) +10,000Refer to illustrations oftransactions (a) through (g)2.Record:intextbook for Step 3—DebitCreditCash (+A)10,000Common Stock(+SE)10,000Summarize (which includesposting to T-accounts).(b)Invest in Equipment––SonicGatewaypays $300cashforthe company’s logo.1.Analyze: Assets = Liabilities + Stockholders’ EquityCash(A)–300;Logo and Trademarks(A) +300= 02.Record:DebitCreditLogo and Trademarks(+A)300Cash (–A)300(c)Obtain Loan from Bank––SonicGatewayborrows$20,000 from a bankand signsa formal agreement torepay the loan in twoyears(on September 1, 2017).1.Analyze: Assets = Liabilities + Stockholders’ EquityCash (A) +20,000 = NotePayable (long-term)(L)+20,0002.Record:DebitCreditCash (+A)20,000Note Payable (long-term) (+L)20,000(d)Invest inEquipment––SonicGatewaypurchasesandreceives $9,600 in computers, printers, and desks,signinga purchase order to indicate itspromise to pay $9,600 atthe end of the month.1.Analyze: Assets = Liabilities + Stockholders’ EquityEquipment (A) +9,600 =Accounts Payable+9,6002.Record:DebitCreditEquipment(+A)9,600Accounts Payable(+L)9,600

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2-12Fundamentals of Financial Accounting, 5/eChapter OutlineTeaching Notes(e) Pay Supplier––SonicGatewaypays $5,000 to theequipment supplier in (d).1.Analyze:Assets = Liabilities + Stockholders’ EquityCash–5,000=Accounts Payable–5,0002.Record:DebitCreditAccounts Payable (–L)5,000Cash (–A)5,000(f) Order Software for App––SonicGatewaysigns a contractwith a programmer for program code for the StaticCharge game app for $9,000. No code has been receivedyet.1.Analyze: Assets = Liabilities + Stockholders’ EquityNo change = Nochange2.Record––No journal entry is needed.(g)ReceiveSoftware––SonicGatewayreceivesthe $9,000 ofapp game codeordered in (f); pays $4,000 cash,andpromises to paythe remaining $5,000next month.1.Analyze: Assets = Liabilities + Stockholders’ EquityCash (A)–4,000 + Software (A) +9,000= AccountsPayable (L) +5,0002.Record:DebitCreditSoftware(+A)9,000Cash (–A)4,000Accounts Payable(+L)5,000(h)ReceiveSupplies––SonicGatewayreceivessuppliescosting $600 on account.1.Analyze:Assets =Liabilities + Stockholders’ EquitySupplies (A) +600= Accounts Payable (L) +6002.Record:DebitCreditSupplies(+A)600Accounts Payable(+L)600LO2-4Prepareatrial balance anda classified balance sheet.F.Preparing aTrial Balance and aBalance Sheet✓Activity #61.The trialbalance lists the ending balance in every T-account and then computes total debits and total credits;when the column totals are equal, a balance sheet can beprepared.2.Classified balance sheet––A balance sheet thatshows asubtotal for currentassets and current liabilities.a.Current assets––Tobe used up orconverted into cashwithin 12months of the balance sheet date.

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