1.11: Solutions

• Henry Dauderis and David Annand
• Athabasca University via Lyryx Learning
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Discussion Questions

1. Generally accepted accounting principles (GAAP) are a set of principles and assumptions that guide the preparation of financial statements, and that have gained wide-spread acceptance among users and practitioners.
2. The revenue recognition principle assumes that revenue is earned by the entity at the time when a service is provided or when a sale is made, not necessarily when cash is received.
3. The matching concept states that revenue is recognized in the time period when goods and services are provided and that the assets of the entity that have been used up during the time period (expenses) must be matched with the asset inflows (revenues) during the same period.
4. Accounting information should be comparable, verifiable, timely and understandable. Accounting information should only be disclosed if it is material – that is, of sufficient size or importance to influence the judgement of a reasonably knowledgeable user. Accounting information should also be disclosed in such a manner that the benefits of doing so outweigh the costs.
5. An asset is anything of value that is owned by the entity. Assets are economic resources controlled by an entity. They have some future value to the entity, usually for generating revenue.
6. A liability is an obligation to pay an asset or to provide services or goods in the future. Until the obligations are paid, creditors have claims against the assets of the entity.

Equity represents the amount of assets owing to the owners of the entity. The total assets of an entity belong either to the shareholders or to the creditors.

7. The exchange of assets or obligations by a business entity, expressed in monetary terms like dollars, is called a financial transaction. The exchange of cash for land or a building is an example of such a transaction.
8. The three forms of business organization are corporations, sole proprietorships, and partnerships.
9. A business entity is a unit of accountability that exists independently from other units. A set of accounting records is kept for each unit or entity. The entity exists separately from its owners. This concept is important because it keeps separate all the various activities in which the owner is involved; lumping all the activities together would not yield useful information for keeping track of the financial performance each financial unit.
10. Financial statements evaluate the performance of an entity and measure its progress. Financial information is collected, then summarized and reported in the financial statements (balance sheet, income statement, statement of cash flows, and statement of changes in equity).
11. The date line on the income statement, statement of changes in equity, and statement of cash flows represents a period of time. The income statement details the revenues and expenses that occurred over a given period of time. The statement of changes in equity shows how equity changed over a given period of time. The statement of cash flows shows how the balance in cash changed over a given period of time. The date line on the balance sheet is a point in time because each account listed on the balance sheet identifies the account balance on a specific date.
12. The purpose of the income statement is to communicate the inflow of assets, in the form of revenues, and the outflow or consumption of assets, in the form of expenses, over a period of time. Total inflows greater than total outflows creates net income or profit, which is reported on the Income statement and in retained earnings in the equity section of the balance sheet. The purpose of the balance sheet is to communicate what the entity owns (its assets), what the entity owes (its liabilities), and the difference between assets and liabilities (its equity) at a point in time.

If revenue is recorded on the income statement, there is usually a corresponding increase in assets on the balance sheet. Similarly, if expenses are recorded on the income statement, there is generally a decrease in assets or increase of liabilities on the balance sheet.

13. Revenue is an increase in an entity's assets or a decrease in liabilities in return for services performed or goods sold, expressed in monetary units like dollars. An expense is an asset belonging to the entity that is used up or obligations incurred in selling goods or performing services.
14. Net income is the difference between revenues and expenses. It communicates whether the activities of the entity are being conducted profitably. Thus it is one measure of the success of the entity. Net income is one of the criteria used to determine the amount of dividends to be declared.
15. The statement of changes in equity shows why share capital and retained earnings have changed over a specified period of time – for instance, when shares are issued or net income is earned. The statement of cash flows explains to the users of the financial statements the entity's sources (inflows) and the uses (outflows) of cash over a specified period of time.
16. Financial statements are prepared at regular intervals to keep a number of interested groups informed about the financial performance of an entity. The timing is determined in response to the needs of management in running the entity or of outside parties, such as bankers to aid in granting loans to the entity, shareholders, or others interested in evaluating the progress of the entity. They are generally used as a means to inform investing and lending decisions.
17. The accounting equation has the following form:
 ASSETS = LIABILITIES + EQUITY (economic resources owned by an entity) (creditors' claims to assets) (owners' claims to assets – residual claims)

The entity has assets, which are the resources it owns. The total assets owned by an entity must always equal the total claims of creditors and owners, who have the residual claims.

A company's accounting equation is expanded to include major categories of the balance sheet, like cash and share capital. An expanded form of the accounting equation could be as follows:

 ASSETS = LIABILITIES + EQUITY Cash+Accounts Receivable+Equipment+Truck Accounts Payable Share Capital+Retained Earnings
18. The double entry accounting system reflects the fact that each financial transaction affects at least two items in the accounting equation, in order to maintain the equality of the equation. For example,
1. A truck is sold for cash: The asset truck decreases and the asset cash increases.
2. An obligation is paid: The liability accounts payable decreases and the asset cash decreases.
3. An account is collected: The asset cash increases and the asset accounts receivable decreases.

In this way, the equation always remains in balance after each transaction is recorded.

19. A year-end is the last day of the fiscal year of the entity. The income statement, statement of cash flows, and statement of changes in equity reflect financial translations for the year up to this date. The balance sheet reflects the financial position of the entity at the year-end date. Interim financial statements may be prepared more frequently, say quarterly or monthly; these are prepared for each entity only if required by certain users, usually shareholders of large corporations with many shareholders. Year-end financial statements must be prepared for all entities.
20. A fiscal year refers to a 12-month accounting period and that may not coincide with the calendar year. A company whose fiscal year-end coincides with the calendar year has a December 31 year-end.

Exercises

EXERCISE 1–1

1. Partnership
2. International Financial Reporting Standards
3. Ethics
4. Financial accounting
5. Managerial accounting
6. Separate legal entity
7. Limited liability
8. Unlimited liability

EXERCISE 1–2

1. Violation Cost principle
4. Violation: Revenue recognition principle
5. Correct: Materiality principle
6. Correct: Monetary unit principle
7. Correct: Matching principle
8. Violation: Consistency principle
9. Violation: Full disclosure principle and possibly going concern principle if the company is no longer viable

EXERCISE 1–3

1. 30,000
2. 9,000
3. 95,000
4. In a, debt financing = (20,000/50,000) × 100=40%. In b, debt financing = (9,000/10,000) × 100=90%. In c, debt financing = (15,000/95,000) × 100 = 15.79% (rounded to two decimal places). Therefore, the greatest percentage of debt financing is reflected in b.
5. In a, equity financing = 100 − 40 = 60%. In b, equity financing = 100 − 90 = 10%. In c, equity financing = 100 − 15.79 = 84.21%. Therefore, the greatest percentage of equity financing is reflected in c.

EXERCISE 1–4

 ASSETS = LIABILITIES + EQUITY Cash + Equipment = Accounts Payable + Share Capital + Retained Earnings
 A. Retained earnings = $5,000 (3,000 + 8,000 − 4,000 − 2,000) B. Accounts payable =$3,000 (1,000 + 6,000 − 3,000 − 1,000) C. Cash = $1,000 (4,000 − 1,500 − 3,000 − 500) D. Retained earnings =$6,000 (6,000 + 7,000 − 3,000 − 4,000) E. Equipment = $3,500 (2,500 −4,500 − 500 − 1,000) EXERCISE 1–5 1. ASSETS = LIABILITIES + EQUITY Equity at Jan. 1 =$10,000 ($50,000 − 40,000) Equity at Dec. 31 =$20,000 ($40,000 − 20,000) The increase in equity during the year was$10,000 ($20,000 ending equity − 10,000 beginning equity). Given that during the year no share capital was issued and no dividends were declared,$10,000 is the amount of net income earned during 2015.

2. ASSETS = LIABILITIES + EQUITY

Equity at Jan. 1 = $10,000 ($50,000 − 40,000)

Equity at Dec. 31 = $20,000 ($40,000 − 20,000)

The increase in equity during the year was $10,000 ($20,000 ending equity − 10,000 beginning equity). Given that during the year no share capital was issued and $5,000 of dividends were declared,$15,000 is the amount of net income earned during 2015 [calculated as net income − $5,000 dividends =$10,000 increase in equity; net income = 10,000 + 5,000 or 15,000].

3. ASSETS = LIABILITIES + EQUITY

Equity at Jan. 1 = $10,000 ($50,000 − 40,000)

Equity at Dec. 31 = $20,000 ($40,000 − 20,000)

Since equity is $200,000 and retained earnings is$40,000, share capital must be $160,000. EXERCISE 1–8  EDW Inc. Income Statement Month Ended March 31, 2015 EDW Inc. Statement of Changes in Equity Month Ended March 31, 2015 Revenues Share Capital Retained Earnings Total Equity Service Revenue$20,000 Expenses Opening Balance $-0-$ -0- $-0- Wages Expense$9,000 Shares Issued 2,000 2,000 Miscellaneous Expense 2,500 Net Income 6,000 6,000 Insurance Expense 1,500 Ending Balance $2,000$6,000 $8,000 Office Supplies Expense 1,000 14,000 Net Income$6,000
 EDW Inc. Balance Sheet March 31, 2015 Assets Liabilities Cash $1,000 Accounts Payable$5,000 Accounts Receivable 4,000 Equipment 8,000 Equity Share Capital $2,000 Retained Earnings 6,000 Total Equity 8,000 Total Assets$13,000 Total Liabilities and Equity $13,000 NOTE: The$2,000 amount for shares issued was calculated using A = L + E or, using the accounts in the order given in the alphabetized information; 4,000 + 1,000 + 8,000 = 5,000 − 1,500 − 2,500 − 1,000 + 20,000 + Share Capital − 9,000; 13,000 = 11,000 + Share Capital; 13,000 − 11,000 = 2,000 Share Capital.

Alternatively, you could have inserted all the values from the alphabetized information into the financial statements and then solved for the unknown Share Capital amount. There is often more than one approach to solving math related questions.

 Algonquin Inc. Income Statement Year Ended July 31, 2015 Algonquin Inc. Statement of Changes in Equity Year Ended July 31, 2015 Revenues Share Capital Retained Earnings Total Equity Service Revenue $81,000 Expenses Opening Balance$10,000 $6,000$16,000 Advertising Expense $5,000 Net Income 5,000 5,000 Insurance Expense 7,000 Dividends (2,000) (2,000) Salaries Expense 64,000 76,000 Ending Balance$10,000 $9,000$19,000 Net Income $5,000  Algonquin Inc. Balance Sheet July 31, 2015 Assets Liabilities Cash$9,000 Accounts Payable $3,000 Accounts Receivable 17,000 Note Payable 18,000 Machinery 14,000 Total Liabilities$21,000 Equity Share Capital $10,000 Retained Earnings 9,000 Total Equity 19,000 Total Assets$40,000 Total Liabilities and Equity $40,000 EXERCISE 1–10  Algonquin Inc. Income Statement Year Ended July 31, 2015 Algonquin Inc. Statement of Changes in Equity Year Ended July 31, 2015 Revenues Share Capital Retained Earnings Total Equity Service Revenue$81,000 Expenses Opening Balance $7,000$6,000 $13,000 Advertising Expense$5,000 Shares Issued 3,000 3,000 Insurance Expense 7,000 Net Income 5,000 5,000 Salaries Expense 64,000 76,000 Dividends (2,000) (2,000) Net Income $5,000 Ending Balance$10,000 $9,000$19,000
 Algonquin Inc. Balance Sheet July 31, 2015 Assets Liabilities Cash $9,000 Accounts Payable$3,000 Accounts Receivable 17,000 Note Payable 18,000 Machinery 14,000 Total Liabilities $21,000 Equity Share Capital$10,000 Retained Earnings 9,000 Total Equity 19,000 Total Assets $40,000 Total Liabilities and Equity$40,000

NOTE:

Given that additional shares were issued for cash of $3,000 during the year ended July 31, 2015 and share capital had a balance of$10,000 at July 31, 2015, the end of the year, the beginning balance in share capital must have been $7,000. EXERCISE 1–11  Wallaby Inc. Income Statement Month Ended March 31, 2015 Wallaby Inc. Statement of Changes in Equity Month Ended March 31, 2015 Revenues Share Capital Retained Earnings Total Equity Fees Earned$12,000 Expenses Opening Balance $6,400$4,000 $10,400 Equipment Rental Expense$9,400 Net Loss (1,300) (1,300) Wages Expense 3,400 Ending Balance $6,400$2,700 $9,100 Fuel Expense 500 13,300 Net Loss$1,300
 Wallaby Inc. Balance Sheet March 31, 2015 Assets Liabilities Cash $6,000 Rent Payable$2,500 Accounts Receivable 1,600 Note Payable 18,000 Truck 22,000 Total Liabilities $20,500 Equity Share Capital$6,400 Retained Earnings 2,700 Total Equity 9,100 Total Assets $29,600 Total Liabilities and Equity$29,600

EXERCISE 1–12

 Adams Ltd. Income Statement For the Month Ended January 31, 2015 Revenue Service Revenue $3,335 Expenses Rent expense$300 Repairs expense 500 Salaries expense 1,000 Miscellaneous expense 335 Total expenses 2,135 Net Income $1,200  Adams Ltd. Statement of Changes in Equity For the Month Ended January 31, 2015 Share Capital Retained Earnings Total Equity Opening balance$ -0- $-0-$ -0- Shares issued 3,000 -0- 3,000 Net income -0- 1,200 1,200 Ending balance $3,000$1,200 $4,200  Adams Ltd. Balance Sheet At January 31, 2015 Assets Cash$1,000 Land 1,000 Building 2,500 Total assets $4,500 Liabilities Accounts payable$300 Equity Share capital $3,000 Retained earnings 1,200 Total equity 4,200 Total liabilities and equity$4,500

 Mitch's Architects Ltd. Income Statement For the Year Ended December 31, 2015 Revenues Consulting fees earned $150,000 Expenses Office rent expense$60,000 Salaries and benefits expense 40,000 Utilities expense 12,000 Insurance expense 5,000 Supplies and postage expense 2,400 119,400 Net income $30,600 EXERCISE 1–14  Mitch's Architects Ltd. Statement of Changes in Equity For the Year Ended December 31, 2015 Share Capital Retained Earnings Total Equity Opening balance*$20,400 $6,000$26,400 Shares issued** 10,000 10,000 Net income 30,600 30,600 Dividends*** (1,000) (1,000) Ending balance $30,400$35,600 $66,000 * Share capital opening balance ($30,400−10,000)
* Retained earnings opening balance ($5,000 balance+1,000 dividends) ** Share capital issued during the current year given in the question as$10,000
*** Dividends paid during the current year given in the question as $1,000 EXERCISE 1–15  Mitch's Architects Ltd. Balance Sheet At December 31, 2015 Assets Liabilities Cash$23,000 Accounts payable $30,000 Accounts receivable 24,000 Unearned consulting fees 15,000 Office supplies inventory 2,000 Total liabilities$45,000 Prepaid insurance 7,000 Equity Truck 40,000 Share capital $30,400 Office equipment 15,000 Retained earnings 35,600 Total equity 66,000 Total assets$111,000 Total liabilities and equity $111,000 EXERCISE 1–16  Gillespie Corp. Income Statement For the Year Ended May 31, 2015 Revenues Service revenue$382,000 Rent revenue 90,000 Total Revenue 472,000 Expenses Warehouse rent expense 100,000 Salaries and benefits expense 110,000 Utilities expense 42,000 Insurance expense 15,000 Shop supplies expense 6,000 Net income $199,000  Gillespie Corp. Statement of Changes in Equity At May 31, 2015 Share Capital Retained Earnings Total Equity Opening balance$5,000 $140,000$145,000 Net income 199,000 199,000 Dividends (10,000) (10,000) Ending balance $5,000$329,000 $334,000  Gillespie Corp. Balance Sheet For the Year Ended May 31, 2015 Assets Liabilities Cash$50,000 Accounts payable $130,000 Accounts receivable 85,000 Unearned service revenue 25,000 Prepaid advertising 17,000 Total liabilities$155,000 Shop supplies 52,000 Equity Building 240,000 Share capital $5,000 Office equipment 45,000 Retained earnings 329,000 Total equity 334,000 Total assets$489,000 Total liabilities and equity $489,000 EXERCISE 1–17 Using the same calculation as the retained earnings column in the statement of changes in equity: Opening retained earnings + Net income (or minus net loss) – Dividends = Ending retained earnings 1.$50,000 + Net income ? – 20,000 = $40,000 Net income =$40,000 – 50,000 + 20,000 = $10,000 2. Retained earnings opening balance ? + 150,000 – 40,000 =$130,000
Retained earnings opening balance = $130,000 – 150,000 + 40,000 =$20,000
3. $75,000 – 35,000 – Dividends ? =$40,000

 a. Assets = Liabilities + Equity Balances at June 1, 2015 $160,000$100,000 $60,000$70,000 June net income(loss) (20,000) Dividends paid in June Balances at June 30, 2015 $200,000 =$90,000 + $110,000 b. Assets = Liabilities + Equity Balances at June 1, 2015$160,000 $100,000$60,000 $40,000 Shares issued in June$90,000 June net income(loss) (80,000) Dividends paid in June Balances at June 30, 2015 $200,000 =$90,000 + $110,000 c. Assets = Liabilities + Equity Balances at June 1, 2015$160,000 $100,000$60,000 $130,000 Shares issued in June ($80,000) June net income(loss) -0- Dividends paid in June Balances at June 30, 2015 $200,000 =$90,000 + $110,000 EXERCISE 1–20  a. 3 Purchased a truck for cash. b. 1 Issued share capital for cash. c. 2 Incurred a bank loan as payment for equipment. d. 3 Made a deposit for electricity service to be provided to the company in the future. e. 4 Paid rent expense. f. NT Signed a new union contract that provides for increased wages in the future. g. NT Wrote a letter of complaint to the prime minister about a mail strike and hired a messenger service to deliver letters. h. 4 Received a collect telegram from the prime minister; paid the messenger. i. 1 Billed customers for services performed. j. 5 Made a cash payment to satisfy an outstanding obligation. k. 3 Received a payment of cash in satisfaction of an amount owed by a customer. l. 1 Collected cash from a customer for services rendered. m. 4 Paid cash for truck operation expenses. n. 5&4 Made a monthly payment on the bank loan; this payment included a payment on part of the loan and also an amount of interest expense. (Hint: This transaction affects more than two parts of the accounting equation.) o. 7 Issued shares in the company to pay off a loan. Problems PROBLEM 1–1  Dumont Inc. Income Statement For the Month Ended January 31, 2015 Dumont Inc. Balance Sheet At January 31, 2015 Assets Cash$1,300 Revenue Accounts receivable 2,400 Service revenue $7,500 Prepaid expenses 550 Unused supplies 750 Expenses Truck 9,000 Advertising expense$500 Total assets $14,000 Commissions expense 720 Insurance expense 50 Interest expense 80 Liabilities Rent expense 400 Bank loan$8,000 Supplies expense 100 Accounts payable 1,000 Telephone expense 150 Total liabilities 9,000 Wages expense 2,500 Equity Total expenses 4,500 Share capital $2,000 Net income$3,000 Retained earnings 3,000 Total equity 5,000 Total liabilities and equity $14,000  Dumont Inc. Statement of Changes in Equity For the Month Ended January 31, 2015 Share Capital Retained Earnings Total Equity Opening balance$ -0- $-0-$ -0- Shares issued 2,000 -0- 2,000 Net income -0- 3,000 3,000 Ending balance $2,000$3,000 $5,000 PROBLEM 1–2 1. The income statement and statement of changes in equity are as follows:  Laberge Sheathing Inc. Balance Sheet August 31, 2015 Laberge Sheathing Inc. Income Statement For the Month Ended August 31, 2015 Assets Cash$400 Accounts receivable 3,800 Revenue Unused supplies 100 Service revenue $2,000 Equipment 8,700 Total assets$13,000 Expenses Advertising expense $300 Interest expense 500 Liabilities Maintenance expense 475 Accounts payable$7,800 Supplies expense 125 Wages expense 2,600 Equity Total expenses 4,000 Share capital 3,200 Net loss $2,000 Retained earnings 2,000 5,200 Total liabilities and equity$13,000
 Laberge Sheathing Inc. Statement of Changes in Equity Month Ended August 31, 2015 Share Capital Retained Earnings Total Equity Opening balance $3,200$4,000 $7,200 Net loss -0- (2,000) (2,000) Ending balance$3,200 $2,000$5,200
2. The percentage of assets financed by equity is 40% calculated as (5,200/13,000) × 100. Although part 2 of this question did not require that the percentage of assets financed by debt be calculated, it is 60% calculated as 100% − 40%.

PROBLEM 1–3

Figure $$\PageIndex{2}$$

 Larson Services Inc. Balance Sheet At August 31, 2015 Larson Services Inc. Income Statement For the Month Ended August 31, 2015 Assets Cash $3,900 Accounts receivable 10,000 Prepaid expenses 600 Revenues Unused supplies 500 Fees earned$11,500 Truck 8,000 Total assets $23,000 Expenses Advertising expense$200 Liabilities Rent expense 350 Bank loan $10,000 Salaries expense 2,150 Accounts payable 250 Supplies expense 250 Unearned revenue 1,500 Telephone expense 50 Total liabilities 11,750 Truck operation expense 250 Total expenses 3,250 Equity Net income$8,250 Share capital 3,000 Retained earnings 8,250 Total equity 11,250 Total liabilities and equity $23,000  Larson Services Inc. Statement of Changes in Equity For the Month Ended August 31, 2015 Share Capital Retained Earnings Total Equity Opening balance$ -0- $-0-$ -0- Shares issued 3,000 -0- 3,000 Net income -0- 8,250 8,250 Ending balance $3,000$8,250 $11,250 PROBLEM 1–5  Cash Accounts receivable Office supplies Prepaid expenses Equipment Office furniture Accounts payable Note/Loan payable Unearned revenue Share capital Retained earnings Open Bal +10,000 +25,000 +2,000 0 +25,000 +15,000 +35,000 0 0 +8,000 +34,000 1 +5,000 +5,000 2 -5,000 -5,000 3 +3,000 +3,000 4 +27,000 +27,000 5 +3,000 +3,000 6 7 +300 -300 8 +20,000 +20,000 9 -8,000 -8,000 10 -3,000 -3,000 11 +25,000 +25,000 12 +25,000 -25,000 13 14 15 -3,500 -3,500 16 -5,000 +5,000 17 -50 -50 18 +3,000 +3,000 Bal +35,450 +52,000 +5,000 +5,000 +28,000 +18,000 +33,300 +23,000 +5,000 +8,000 +74,150 PROBLEM 1–6  Olivier Bondar Ltd. Balance Sheet At May 31, 2016 Assets Liabilities Cash$35,450 Accounts payable $33,300 Accounts receivable 52,000 Note/Loan payable 23,000 Unearned revenue 5,000 Office supplies 5,000 Total liabilities$61,300 Prepaid expenses 5,000 Equipment 28,000 Equity Office furniture 18,000 Share capital $8,000 Retained earnings 74,150 Total equity 82,150 Total assets$143,450 Total liabilities and equity \$143,450

This page titled 1.11: Solutions is shared under a CC BY-NC-SA license and was authored, remixed, and/or curated by Henry Dauderis and David Annand (Lyryx Learning) .