3.17: Beyond the numbers—Critical thinking

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Business decision case A You have just been hired by Top Executive Employment Agency, Inc., to help prepare adjusting entries at the end of an accounting period. It becomes obvious to you that management does not seem to have much of an understanding about the necessity or adjusting entries or which accounts might possibly need adjustment. The first step you take is to prepare the following unadjusted trial balance from the general ledger. Only those ledger accounts that had end-of-year balances are included in the trial balance.

	Debits	Credits
Cash	$ 80,000
Accounts Receivable	28,000
Supplies on Hand	3,000
Prepaid Insurance	2,700
Office Equipment	120,000
Accumulated Depreciation—Office Equipment		$ 45,000
Buildings	360,000
Accumulated Depreciation—Buildings		105,000
Accounts Payable		9,000
Loan Payable (Bank)		15,000
Unearned Commission Fees		30,000
Capital Stock		160,000
Retained Earnings		89,300
Commissions Revenue		270,000
Advertising Expense	6,000
Salaries Expense	112,500
Utilities Expense	7,500
Miscellaneous Expense	3,600
	$723,300	$723,300

a. Explain to management why adjusting entries in general are made.

b. Explain to management why some of the specific accounts appearing in the trial balance may need adjustment and what the nature of each adjustment might be (do not worry about specific dollar amounts).

Business decision case B A friend of yours, Jack Andrews, is quite excited over the opportunity he has to purchase the land and several miscellaneous assets of Drake Bowling Lanes Company for USD 400,000. Andrews tells you that Mr and Mrs Drake (the sole stockholders in the company) are moving due to Mr Drake’s ill health. The annual rent on the building and equipment is USD 54,000.

Drake reports that the business earned a profit of USD 100,000 in 2010 (last year). Andrews believes an annual profit of USD 100,000 on an investment of USD 400,000 is a really good deal. But, before completing the deal, he asks you to look it over. You agree and discover the following:

Drake has computed his annual profit for 2010 as the sum of his cash dividends plus the increase in the Cash account: Dividends of USD 60,000 + Increase in Cash account of USD 40,000 = USD 100,000 profit.

As buyer of the business, Andrews will take over responsibility for repayment of a USD 300,000 loan (plus interest) on the land. The land was acquired at a cost of USD 624,000 seven years ago.

An analysis of the Cash account shows the following for 2010:

Rental revenues received		$465,000
Cash paid out in 2010 for—
Salaries paid to employees	$260,000
Utilities paid	18,000
Advertising expenses paid	15,000
Supplies purchased and used	24,000
Interest paid on loan	18,000
Loan principal paid	30,000
Cash dividends	60,000	425,000
In crease in cash balance for the year		$ 40,000

You also find that the annual rent of USD 54,000, a December utility bill of USD 4,000, and an advertising bill of USD 6,000 have not been paid.

a. Prepare a written report for Andrews giving your appraisal of Drake Bowling Lanes Company as an investment. Comment on Drake’s method of computing the annual profit of the business.

b. Include in your report an approximate income statement for 2010.

Group project C In teams of two or three students, go to the library to locate one company’s annual report for the most recent year. Identify the name of the company and the major products or services offered, as well as gross revenues, major expenses, and the trend of profits over the last three years. Calculate trend percentages for revenues, expenses, and profits using the oldest year as the base year. Each team should write a memorandum to management summarizing the data and commenting on the trend percentages. The heading of the memorandum should contain the date, to whom it is written, from whom, and the subject matter.

Group project D With one or two other students and using library and internet sources, write a paper on Statement of Accounting Standards No. 106, “Accounting for Postretirement Benefits Other Than Pensions”. This standard resulted in some of the largest adjusting entries ever made. Companies had to record an expense and a liability to account for these costs on an accrual basis. In the past they typically had recorded this expense on a cash basis, recognizing the expense only when cash was paid to retirees. Be sure to cite your sources and treat direct quotes properly.

Group project E With one or two other students and using library sources, write a paper on human resource accounting. Generally accepted accounting principles do not allow “human assets” to be included among assets on the balance sheet. Why is this? Be sure to cite your sources and to treat direct quotes properly.

Using the Internet—A view of the real world

Visit the website:

http://www.pwcglobal.com

Click on the Sarbanes-Oxley Act. Write a brief report to your instructor summarizing your findings.

Answers to self-test

True-false

True. Every adjusting entry involves either moving previously recorded data from an asset account to an expense account or from a liability account to a revenue account (or in the opposite direction) or simultaneously entering new data in an asset account and a revenue account or in a liability account and an expense account.

True. A fiscal year is any 12 consecutive months, so all calendar years are also fiscal years. A calendar year, however, must end on December 31, so it does not include fiscal years that end on any date other than December 31 (such as June 30).

False. The accumulated depreciation account is a contra asset that shows the total of all depreciation recorded on an asset from its acquisition date up through the balance sheet date.

False. The Unearned Delivery Fees account is a liability. As the fees are earned, the amount in that account is transferred to a revenue account.

True. If an adjusting entry is overlooked and not made, at least one income statement account and one balance sheet account will be incorrect.

Multiple-choice

d. One-third of the benefits have expired. Therefore, USD 400 must be moved from the asset (credit) to an expense (debit).

a. USD 1,100 of the supplies have been used, so that amount must be moved from the asset (credit) to an expense (debit).

c. The amount of annual depreciation is determined as (USD 20,000 – USD 5,000) divided by 5 = USD 3,000. The debit is to Depreciation Expense—Trucks, and the credit is to Accumulated Depreciation—Trucks, a contra asset account.

b. Each month USD 2,000 would be transferred from the liability account (debit), Unearned Subscription Fees, to a revenue account (credit).

b. An asset, Interest Receivable, is debited, and Interest Revenue is credited.

a. The debit would be to Salaries Expense, and the credit would be to Salaries Payable.