E2-7 (Accounting Principles—Comprehensive) Presented below are a number of business
transactions
that occurred during the current year for Fresh Horses, Inc.
Instructions
In each of the situations, discuss the appropriateness of the journal entries in terms of generally
accepted
accounting principles.
(a) The president of Fresh Horses, Inc. used his expense account to purchase a new Suburban
solely
for personal use. The following journal entry was made.
Miscellaneous Expense 29,000
Cash 29,000
(b) Merchandise inventory that cost $620,000 is reported on the balance sheet at $690,000, the
expected
selling price less estimated selling costs. The following entry was made to record this increase
in value.
Merchandise Inventory 70,000
Revenue 70,000
(c) The company is being sued for $500,000 by a customer who claims damages for personal
injury
apparently caused by a defective product. Company attorneys feel extremely confident that the
company will have no liability for damages resulting from the situation. Nevertheless, the
company
decides to make the following entry.
Loss from Lawsuit 500,000
Liability for Lawsuit 500,000
(d) Because the general level of prices increased during the current year, Fresh Horses, Inc.
determined
that there was a $16,000 understatement of depreciation expense on its equipment and decided to
record it in its accounts. The following entry was made.
Depreciation Expense 16,000
Accumulated Depreciation 16,000
(e) Fresh Horses, Inc. has been concerned about whether intangible assets could generate cash in
case
of liquidation. As a consequence, goodwill arising from a purchase transaction during the current
year and recorded at $800,000 was written off as follows.
Retained Earnings 800,000
Goodwill 800,000
(f) Because of a “fire sale,” equipment obviously worth $200,000 was acquired at a cost of
$155,000.
The following entry was made.
Equipment 200,000
Cash 155,000
Revenue 45,000
(a)
This entry violates the economic entity assumption. This assumption in accounting
indicates that economic activity can be identified with a particular unit of
accountability. In this situation, the company erred by charging this cost to the
wrong economic entity.
(b)
The historical cost principle indicates that assets and liabilities are accounted for on
the basis of cost. If we were to select sales value, for example, we would have an
extremely difficult time in attempting to establish a sales value for a given item
without selling it. It should further be noted that the revenue recognition principle
provides the answer to when revenue should be recognized. Revenue should be
recognized when (1) realized or realizable and (2) earned. In this situation, an earnings
process has definitely not taken place.
(c)
Probably the company is too conservative in its accounting for this transaction. The
matching principle indicates that expenses should be allocated to the appropriate
periods involved. In this case, there appears to be a high uncertainty that the
company will have to pay. FASB Statement No. 5 requires that a loss should be
accrued only (1) when it is probable that the company would lose the suit and
(2) the amount of the loss can be reasonably estimated. (Note to instructor: The
student will probably be unfamiliar with FASB Statement No. 5. The purpose of this
question is to develop some decision framework when the probability of a future
event must be assumed.)
(d)
At the present time, accountants do not recognize price-level adjust-ments in the
accounts. Hence, it is misleading to deviate from the cost principle because
conjecture or opinion can take place. It should also be noted that depreciation is not
so much a matter of valuation as it is a means of cost allocation. Assets are not
depreciated on the basis of a decline in their fair market value, but are depreciated on
the basis of systematic charges of expired costs against revenues. (Note to instructor:
It might be called to the students’ attention that the FASB does encourage
supplemental disclosure of price-level information.)
(e)
Most accounting methods are based on the assumption that the busi-ness enterprise
will have a long life. Acceptance of this assumption provides credibility to the
historical cost principle, which would be of limited usefulness if liquidation were
assumed. Only if we assume some permanence to the enterprise is the use of
depreciation and amortization policies justifiable and appropriate. Therefore, it is
incor-rect to assume liquidation as Fresh Horses, Inc. has done in this situation. It
should be noted that only where liquidation appears imminent is the going concern
assumption inapplicable.
(f)
The answer to this situation is the same as (b).
E3-5 (Adjusting Entries) The ledger of Duggan Rental Agency on March 31 of the current year
includes
the following selected accounts before adjusting entries have been prepared.
Debit Credit
Prepaid Insurance $ 3,600
Supplies 2,800
Equipment 25,000
Accumulated Depreciation—Equipment $ 8,400
Notes Payable 20,000
Unearned Rent Revenue 9,300
Rent Revenue 60,000
Interest Expense –0–
Wage Expense 14,000
An analysis of the accounts shows the following.
1. The equipment depreciates $250 per month.
2. One-third of the unearned rent was earned during the quarter.
3. Interest of $500 is accrued on the notes payable.
4. Supplies on hand total $850.
5. Insurance expires at the rate of $300 per month.
Instructions
Prepare the adjusting entries at March 31, assuming that adjusting entries are made quarterly.
Additional
accounts are: Depreciation Expense; Insurance Expense; Interest Payable; and Supplies Expense.
(Omit
explanations.)
WATTEAU CO.
TRIAL BALANCE
JUNE 30, 2007
Debit Credit
Cash $ 2,870
Accounts Receivable $ 3,231
Supplies 800
Equipment 3,800
Accounts Payable 2,666
Unearned Service Revenue 1,200
Common Stock 6,000
Retained Earnings 3,000
Service Revenue 2,380
Wages Expense 3,400
Office Expense 940
$13,371 $16,916
(L0 5)
1.
Depreciation Expense ..........................................................................................................
750
Accumulated Depreciation – Equipment .................................................................
2.
750
Unearned Rent Revenue .....................................................................................................
3,100
Rent Revenue.............................................................................................................. 3,100
3.
Interest Expense ..................................................................................................................
500
Interest Payable..........................................................................................................
4.
500
Supplies Expense .................................................................................................................
1,950
Supplies ....................................................................................................................... 1,950
5.
Insurance Expense ...............................................................................................................
900
Prepaid Insurance ......................................................................................................
900
Instructions
(a) Construct T-accounts and enter the balances shown.
(b) Prepare adjusting journal entries for the following and post to the T-accounts. (Omit
explanations.)
Open additional T-accounts as necessary. (The books are closed yearly on December 31.)
(1) Bad debts are estimated to be $1,400.
(2) Furniture and equipment is depreciated based on a 6-year life (no salvage value).
(3) Insurance expired during the year $2,550.
(4) Interest accrued on notes payable $3,360.
(5) Sales salaries earned but not paid $2,400.
(6) Advertising paid in advance $700.
(7) Office supplies on hand $1,500, charged to Office Expense when purchased.
(c) Prepare closing entries and post to the accounts.
(a), (b), (c)
Cash
Bal.
18,500
Accounts Receivable
Bal.
42,000
Allow. for Doubtful Accts.
Bal.
700
Adj.
1,400
Inventory
Bal.
Furniture & Equipment
80,000
Bal.
Prepaid Insurance
Bal.
5,100 Adj.
2,550
Bal.
Cls.
Sales Salaries Expense
50,000 Cls. 52,400
Bal.
6,700 Adj.
Close
52,400
6,700
Bad Debt Expense
1,400 Cls.
1,400
5,000 Adj.
5,000
Interest Payable
Bal.
600,000
Adj.
Adj.
14,000
65,000 Cls.
65,000
2,550 Cls.
2,550
Interest Expense
700
Adj.
3,360 Close
3,360
6,000
Prepaid Advertising Expense
1,500
Adj.
14,000 Cls.
700
3,500
5,000
Depr. Exp.—Furn. & Equip.
3,360
Adj.
Insurance Expense
Office Expense
Bal.
35,000
6,700
Close
Adj.
28,000
Advertising Expense
2,400
52,400
Adj.
600,000 Bal.
Bal.
Admin. Salaries Expense
Sales
Bal. 80,600
Adj.
84,000
Notes Payable
Common Stock
Bal.
Accum. Depr. of F. & E.
14,000
Income Summary
Exp.
Inc.
546,210 Sales
600,000
53,790
600,000
600,000
Office Supplies
Adj.
Salaries Payable
1,500
Adj.
Retained Earnings
Bal. 10,000
2,400
Cost of Goods Sold
Bal.
398,000 Cls.
398,000
Inc. 53,790
Bal. 63,790
(b)
-1Bad Debts Expense ..............................................................................................................
1,400
Allowance for Doubtful Accounts ............................................................................
1,400
-2Depreciation Expense—Furniture and
Equipment ($84,000 ÷ 6) .................................................................................................
14,000
Accum. Depr.—Furniture and Equipment .............................................................
14,000
-3Insurance Expense ..............................................................................................................
2,550
Prepaid Insurance .....................................................................................................
2,550
-4Interest Expense ..................................................................................................................
3,360
Interest Payable .........................................................................................................
3,360
-5Sales Salaries Expense ........................................................................................................
2,400
Salaries Payable .........................................................................................................
2,400
-6Prepaid Advertising Expense .............................................................................................
700
Advertising Expense ..................................................................................................
700
-7Office Supplies .....................................................................................................................
1,500
Office Expense ...........................................................................................................
(c)
1,500
Dec. 31
Sales
600,000
Income Summary.......................................................................................................
600,000
Dec. 31
Income Summary ................................................................................................................
546,210
Cost of Goods Sold.....................................................................................................
398,000
Advertising Expense ..................................................................................................
6,000
Administrative Salaries Expense..............................................................................
65,000
Sales Salaries Expense ...............................................................................................
52,400
Office Expense ...........................................................................................................
3,500
Insurance Expense .....................................................................................................
2,550
Bad Debt Expense ......................................................................................................
1,400
Depreciation Expense—Furniture and
Equipment ..............................................................................................................
14,000
Interest Expense.........................................................................................................
3,360
Dec. 31
Income Summary ................................................................................................................
53,790
Retained Earnings .....................................................................................................
53,790
Instructions
(a) For each plant:
(2) Compute equivalent units of production for materials and for conversion costs.
(b) Prepare the production cost report for Plant A for June 2005.
(a)
(1)
(2)
Physical units
R12
Refrigerators
F24
Freezers
Units to be accounted for
Work in process, June 1
Started into production
Total units
0
20,000
20,000
0
20,000
20,000
Units accounted for
Transferred out
Work in process, June 30
Total units
18,000
2,000
20,000
17,000
3,000
20,000
Equivalent units
R12 Refrigerators
Conversion
Units transferred out
Work in process, June 30
(2,000 X 100%)
(2,000 X 70%)
Total equivalent units
Materials
Costs
18,000
18,000
2,000
00,000
20,000
1,400
19,400
F24 Freezers
(3)
Units transferred out
Work in process, June 30
(3,000 X 100%)
(3,000 X 50%)
Total equivalent units
Unit costs
Materials
Conversion
Costs
17,000
17,000
3,000
00,000
20,000
1,500
18,500
Plant A
R12
Refrigerators
Materials ($840,000 ÷ 20,000)
($700,000 ÷ 20,000)
Conversion costs
($620,800* ÷ 19,400)
($555,000** ÷ 18,500)
Total
Plant B
F24
Freezers
$42
$35
32
000
$74
30
$65
*$200,800 + $420,000
**$236,000 + $319,000
(4)
Plant A
R12 Refrigerators
Costs accounted for
Transferred out (18,000 X $74)
Work in process
Materials (2,000 X $42)
Conversion costs
(1,400 X $32.00)
Total costs
$1,332,000
$84,000
44,800
128,800
$1,460,800
Plant B
F24 Freezers
Costs accounted for
Transferred out (17,000 X $65)
Work in process
Materials (3,000 X $35)
$105,000
Conversion costs
(1,500 X $30)
45,000
Total costs
STEIN CORPORATION
Stamping Department—Plant A
Production Cost Report
For the Month Ended June 30, 2007
(b)
Quantities
Physical
Units
(Step 1)
0
20,000
20,000
Units accounted for
Transferred out
Work in process, June 30
18,000
2,000
18,000
2,000
18,000
1,400
20,000
20,000
19,400
Materials
Conversion
Costs
Costs
Unit costs (Step 3)
Costs in June
Equivalent units
Unit costs [(a) ÷ (b)]
Costs to be accounted for
Work in process, June 1
Started into production
Total costs
Cost Reconciliation Schedule (Step 4)
150,000
$1,255,000
Equivalent Units
Conversion
Materials
Costs
(Step 2)
Units to be accounted for
Work in process, June 1
Started into production
Total units
Total units
$1,105,000
(a) $840,000
(b) 20,000
$42
$620,800
19,400
$32
(2,000 X
70%)
Total
$1,460,800
$74
$
0
1,460,800
$1,460,800
Costs accounted for
Transferred out (18,000 X $74)
Work in process, June 30
Materials (2,000 X $42)
Conversion costs (1,400 X $32)
Total costs
$1,332,000
$84,000
44,800
128,800
$1,460,800