BASIC ACCOUNTING CON CEPTS

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CHAPTER 2

BASIC ACCOUNTING CON CEPTS

CLASS DISCUSSION QUE STIONS

• The basic elements of a financial accounting

system include (1) a set of rules for deter- mining what, when, and the amount that should be recorded; (2) a framework for preparing financial statements; and (3) one or more controls to determine whether errors may have occurred in the recording process.These elements apply to all businesses, from a local restaurant to Google Inc. All businesses require a financial reporting sys- tem so that financial statements can be pro- vided to stakeholders.

• Purchase of land for cash affects only

assets.

• Payment of a liability affects assets and

liabilities; receipt of cash for fees earned affects assets and stockholders’ equity.

• Incurring an expense that is partially

paid in cash decreases assets, increas- es liabilities, and decreases stockhold- ers’ equity (retained earnings). For ex- ample, assume that a business hires a lawyer for $10,000 to draft and file the necessary documents to start and incor- porate the business. The business pays the lawyer $4,000 and agrees to pay the remaining $6,000 over the next several months. This transaction would decrease assets ($4,000), increase liabilities ($6,000), and decrease stockholders’ eq- uity (retained earnings) $10,000. The ex- pense is an organizational expense.Likewise, a new business might hire a new chief operating officer by agreeing to pay a nonrefundable, noncancellable signing bonus of $50,000, with $30,000 due at signing and the remainder due in four installments. This transaction would decrease assets ($30,000), increase li- abilities ($20,000), and decrease stock- holders’ equity (retained earnings) $50,000. The expense is salary expense or bonus expense.

• Out of balance. Assets are correct, but re-

tained earnings (utilities expense) should have been decreased by $1,200 rather than $2,100. Thus, retained earnings is under- stated by $900, and total liabilities plus stockholders’ equity would be less than total assets by $900.

• Out of balance. Assets are overstated

by $27,000 ($85,000 – $58,000), and thus, total assets would exceed total lia- bilities plus stockholders’ equity by

$27,000.

• In balance. Even though liabilities and

stockholders’ equity are incorrect, the accounting equation balances. For this error, liabilities are overstated by $7,000, and retained earnings (fees earned) are understated by $7,000; thus, the over- and understatements off- set each other, and the accounting equation balances.

• A primary control for determining the accu-

racy of record keeping is the equality of the accounting equation. The accounting equa- tion must balance.

6. Total assets are increased by $175,000: an

increase in cash of $375,000 and a de- crease in land of $200,000. Stockholders’ equity (retained earnings) is increased by $175,000, the gain on the sale of the land.

• The payment of $15,000 of dividends

decreases total assets (decrease in cash) and decreases stockholders’ equity (decrease in retained earnings).

• Net income is not affected by the pay-

ment of dividends. Dividends are a dis- tribution of income to stockholders and are not an expense.

• The equality of the accounting equation

would not be affected. That is, the ac- counting equation would still balance.

• On the income statement, total operat-

ing expenses (salary expense) would be overstated by $30,000, and net income would be understated by $30,000. On the retained earnings statement, the be- ginning and ending retained earnings would be correct. However, net income and dividends would be understated by $30,000. These understatements offset one another, and thus, ending retained earnings is correct. The balance sheet is not affected by the error. On the state- ment of cash flows, net cash flows from operating activities is understated, since cash paid for salary expense is over- stated. In addition, net cash flows from Survey of Accounting 7th Edition Warren Solutions Manual Visit TestBankDeal.com to get complete for all chapters

32 © 2015 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.financing activities is overstated, since cash paid for dividends is understated.The understatement of net cash flows from operating activities is offset by the overstatement of net cash flows from financing activities, and thus, the net increase or decrease in cash for the period is correct, as is the ending cash balance.

• The equality of the accounting equation

would not be affected. That is, the ac- counting equation would still balance.

• On the income statement, revenues

(fees earned) would be overstated by $75,000, and net income would be overstated by $75,000. On the retained earnings statement, the beginning re- tained earnings would be correct. How- ever, net income and ending retained earnings would be overstated by $75,000. The balance sheet total assets is correct. However, liabilities (notes payable) is understated by $75,000, and stockholders’ equity (retained earnings) is overstated by $75,000. The under- statement of liabilities is offset by the overstatement of stockholders’ equity, and thus, total liabilities and stockhold- ers’ equity is correct. On the statement of cash flows, net cash flows from oper- ating activities is overstated, since cash received from fees earned is overstated.In addition, net cash flows from financ- ing activities is understated, since cash received from borrowing (notes payable) is understated. The overstatement of net cash flows from operating activities is offset by the understatement of net cash flows from financing activities, and thus, the net increase or decrease in cash for the period is correct, as is the ending cash balance.

• a. $350,000 ($500,000 – $150,000)
• Stockholders’ equity as of

December 31, 20Y8 ........ $400,000 Less stockholders’ equity as of January 1, 20Y8 .............. 350,000 Net income ........................... $ 50,000

• Change in stockholders’ equity

(see Question 10) ................ $50,000 Plus dividends ............................ 18,000 Net income ........................... $68,000

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EXERCISES

E2–1

• $1,000,000 ($250,000 + $750,000)

• $350,000 ($480,000 – $130,000)

• $107,500 ($115,000 – $7,500)

E2–2

• $37,385 ($72,124 – $34,739)

• $400 increase ($2,774 – $2,374)

• Total assets = $74,898 ($72,124 + $2,774)

Total liabilities = $35,139 ($34,739 + $400) Total stockholders’ equity = $39,759 ($37,385 + $2,374)

• Yes. [$74,898 (total assets) = $35,139 (total liabilities) + $39,759 (total stock-

holders’ equity)]

E2–3

• $1,088 ($6,862 – $5,774)

• $190 decrease ($332 – $142)

• Total assets = $6,530 ($6,862 – $332)

Total liabilities = $5,632 ($5,774 – $142) Total stockholders’ equity = $898 ($1,088 – $190)

• Yes. [$6,530 (total assets) = $5,632 (total liabilities) + $898 (total stockholders’

equity)]

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E2–4

(a) $11,610 ($14,429 – $2,819)

(b) $46,241 ($57,851 – $11,610)

(c) $72,574 ($57,851 + $14,723)

(d) $58,145 ($72,574 – $14,429) or ($46,241 + $11,904)

(e) $220,005 ($230,461 – $10,456) or ($86,912 + $133,093)

(f) $133,093 ($144,553 – $11,460) or ($220,005 – $86,912)

(g) $10,456 ($11,460 – $1,004)

(h) $(1,004) ($85,908 – $86,912)

(i) $144,553 ($230,461 – $85,908)

E2–5

• $550,000 ($750,000 – $200,000)

• $635,000 ($550,000 + $125,000 – $40,000)

• $434,000 ($550,000 – $80,000 – $36,000)

• $715,000 ($550,000 + $140,000 + $25,000)

e. Net income: $130,000 ($950,000 – $270,000 – $550,000)