BASIC ACCOUNTING SYSTEMS: CASH BASIS

33 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

CHAPTER 2

BASIC ACCOUNTING SYSTEMS: CASH BASIS

CLASS DISCUSSION QUESTIONS

• The basic elements of a financial ac-

counting system include the following:

(1) a set of rules for determining what, when, and how much 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 Alphabet (Google), Inc. All businesses require a financial reporting system so financial statements can be provided to stake- holders.

• 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 partially paid

in cash decreases assets increases liabilities and decreases stockhold- ers’ equity (retained earnings). For example, assume a business hires a lawyer for $10,000 to draft and file the necessary documents to start and incorporate 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’ equity (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 sign- ing and the remainder due in four installments. This transaction would decrease assets ($30,000), increase liabilities ($20,000), and decrease stockholders’ equity (retained earn- ings) $50,000. The expense is sala- ry expense or bonus expense.

• Out of balance. Assets are correct, but

retained earnings (utilities expense) should have been decreased by $1,200 rather than $2,100. Thus, retained earnings is unders- tated by $900, and total liabilities plus stock- holders’ 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 liabilities plus stockholders’ equity by $27,000.

• In balance. Even though liabilities and

stockholders’ equity are incorrect, the ac- counting equation balances. For this error, liabilities are overstated by $7,000, and re- tained earnings (fees earned) are unders- tated by $7,000; thus, the over- and unders- tatements offset each other, and the accounting equation balances.

• A primary control for determining the accuracy of

record keeping is the equality of the accounting equation. The accounting equation must balance.

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

crease in cash of $375,000 and a decrease 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 de-

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

• Net income is not affected by the payment of

dividends. Dividends are a distribution of in- come to stockholders and are not an ex- pense.

• The equality of the accounting equation

would not be affected. That is, the account- ing equation would still balance.

• On the income statement, total operating

expenses (salary expense) would be over- stated by $30,000, and net income would be understated by $30,000. On the statement of stockholders’ equity, the beginning and ending retained earnings would be correct.However, net income and dividends would be understated by $30,000. These understate- ments offset one another, and thus, ending retained earnings is correct. The balance sheet is not affected by the error. On the statement of cash flows, net cash flows from operating activities is understated since Survey of Accounting 8th Edition Warren Solutions Manual Visit TestBankDeal.com to get complete for all chapters

34 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.cash paid for salary expense is overstated. In addition, net cash flows from financing activities is overstated since cash paid for dividends is understated. The understatement of net cash flows from operating activi- ties is offset by the overstatement of net cash flows from financing activi- ties, 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 equa-

tion would not be affected. That is, the accounting 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 statement of stockholders’ equity, the beginning retained earnings would be correct. However, net income and ending retained earnings would be overstated by $75,000. The total assets reported on the balance sheet is correct. However, liabilities (notes payable) are understated by $75,000, and stockholders’ equity (retained earnings) is overstated by $75,000. The understatement of liabilities is offset by the overstatement of stockholders’ equity, and thus, total liabilities and stock- holders’ equity is correct. On the statement of cash flows, net cash flows from operating activities is overstated since cash received from fees earned is overstated. In addition, net cash flows from financing 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 unders- tatement 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

35 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

EXERCISES

E2–1

• $1,900,000 ($715,000 + $1,185,000)

• $90,000 ($600,000 – $510,000)

• $88,650 ($112,400 – $23,750)

E2–2

• $44,958 ($84,141 – $39,183)

• $4,474 increase ($4,041 + $433)

• Total assets = $88,182 ($84,141 + $4,041)

Total liabilities = $43,657 ($39,183 + $4,474) Total stockholders’ equity = $44,525 ($44,958 – $433)

• Yes. [$88,182 (total assets) = $43,657 (total liabilities) + $44,525 (total stock-

holders’ equity)]

E2–3

• $1,615 ($8,113 – $6,498)

• $235 decrease ($24 + $211)

• Total assets = $8,089 ($8,113 – $24)

Total liabilities = $6,709 ($6,498 + $211) Total stockholders’ equity = $1,380 ($1,615 – $235)

• Yes. [$8,089 (total assets) = $6,709 (total liabilities) + $1,380 (total stockhold-

ers’ equity)]

36 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

E2–4

(a) $120,292 ($171,124 – $50,832)

(b) $111,547 ($231,839 – $120,292)

(c) $290,479 ($231,839 + $58,640)

(d) $119,355 ($290,479 – $171,124) or ($111,547 + $7,808)

(e) $274,098 ($232,708 + $41,390) or ($38,836 + $235,262)

(f) $235,262 ($220,410 + $14,852) or ($274,098 – $38,836)

(g) $(41,390) ($14,852 + $26,538)

(h) $(26,538) ($12,298 – $38,836)

(i) $220,410 ($232,708 – $12,298)

E2–5

• $825,000 ($1,200,000 – $375,000)

• $895,000 ($825,000 + $150,000 – $80,000)

• $525,000 ($825,000 – $200,000 – $100,000)

• $1,300,000 ($825,000 + $400,000 + $75,000)

e. Net income: $160,000 ($1,275,000 – $290,000 – $825,000)