Review the annual reports for PepsiCo, Inc. and The Coca-Cola Company in Appendixes A & B, especially the Consolidated Statements of Income and the Balance Sheets on pp. A4, A6, B1, & B2 of Financial Accounting.
Write a 1750- to 2,050-word paper in APA format with citations and references that provides a financial comparison of the two companies and your recommendations to improve the financial status of each.
Include the following:
• An introductory paragraph with a statement of the purpose of your paper and a synopsis of what readers may expect to find in the paper – It is best to write this after writing the rest of the paper.
• Vertical analyses for both companies – You may use your calculations from the Checkpoint Ratio, Vertical, and Horizontal Analyses, providing you show your work.
• Horizontal analyses for both companies – You may use your calculations from the Checkpoint Ratio, Vertical, and Horizontal Analyses, providing you show your work.
THE ANNUAL REPORT
SPECIMEN FINANCIAL STATEMENTS:
PepsiCo, Inc.
Appendix A
The financial information herein is reprinted with permission from the PepsiCo, Inc. 2005 Annual
Report. The complete financial statements are available through a link at the book’s companion
website.
Once each year a corporation communicates to its stockholders and other interested
parties by issuing a complete set of audited financial statements. The annual report, as
this communication is called, summarizes the financial results of the company’s oper-
ations for the year and its plans for the future. Many annual reports are attractive, mul-
ticolored, glossy public relations pieces, containing pictures of corporate officers and
directors as well as photos and descriptions of new products and new buildings. Yet
the basic function of every annual report is to report financial information, almost all
of which is a product of the corporation’s accounting system.
The content and organization of corporate annual reports have become fairly
standardized. Excluding the public relations part of the report (pictures, products,
etc.), the following are the traditional financial portions of the annual report:
FINANCIAL HIGHLIGHTS
Companies usually present the financial highlights section inside the front cover of
the annual report or on its first two pages. This section generally reports the total
or per share amounts for five to ten financial items for the current year and one or
more previous years. Financial items from the income statement and the balance
sheet that typically are presented are sales, income from continuing operations, net
income, net income per share, net cash provided by operating activities, dividends
per common share, and the amount of capital expenditures. The financial highlights
section from PepsiCo’s Annual Report is shown on page A-2.
A1
• Financial Highlights
• Letter to the Stockholders
• Management’s Discussion and
Analysis
• Financial Statements
• Notes to the Financial Statements
• Management’s Report on Internal
Control
• Management Certification of
Financial Statements
• Auditor’s Report
• Supplementary Financial Information
In this appendix we illustrate current financial reporting with a comprehensive
set of corporate financial statements that are prepared in accordance with gener-
ally accepted accounting principles and audited by an international independent
certified public accounting firm. We are grateful for permission to use the actual fi-
nancial statements and other accompanying financial information from the annual
report of a large, publicly held company, PepsiCo, Inc.
LETTER TO THE STOCKHOLDERS
A2 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Nearly every annual report contains a letter to the stockholders from the chairman
of the board or the president, or both. This letter typically discusses the company’s
accomplishments during the past year and highlights significant events such as
mergers and acquisitions, new products, operating achievements, business philoso-
phy, changes in officers or directors, financing commitments, expansion plans, and
2005 2004 % Chg(a)
Summary of Operations
Total net revenue $32,562 $29,261 11
Division operating profit $6,710 $6,098 10
Total operating profit $5,922 $5,259 13
Net income(b) $4,536 $4,004 13
Earnings per share(b) $2.66 $2.32 15
Other Data
Management operating cash flow(c) $4,204 $3,705 13
Net cash provided by
operating activities $5,852 $5,054 16
Capital spending $1,736 $1,387 25
Common share repurchases $3,012 $3,028 (0.5)
Dividends paid $1,642 $1,329 24
Long-term debt $2,313 $2,397 (3.5)
(a) Percentage changes above and in text are based on unrounded amounts.
(b) In 2005, excludes the impact of AJCA tax charge, the 53rd week and restructuring charges.
In 2004, excludes certain prior year tax benefits, and restructuring and impairment charges.
See page 76 for reconciliation to net income and earnings per share on a GAAP basis.
(c) Includes the impact of net capital spending. Also, see “Our Liquidity, Capital Resources
and Financial Position” in Management’s Discussion and Analysis.
PepsiCo International
PepsiCo Beverages North America
Frito-Lay North America
Quaker Foods North America35%
5%
32%28%
24%
38%
8%
30%
PepsiCo International
PepsiCo Beverages North America
Frito-Lay North America
Quaker Foods North America
Division Operating Profit
Total: $6,710
Net Revenue
Total: $32,562
Financial Highlights
PepsiCo, Inc. and Subsidiaries
($ in millions except per share amounts; all per share amounts assume dilution)
Financial Statements and Accompanying Notes A3
MANAGEMENT’S DISCUSSION AND ANALYSIS
The management’s discussion and analysis (MD&A) section covers three financial
aspects of a company: its results of operations, its ability to pay near-term obliga-
tions, and its ability to fund operations and expansion. Management must highlight
favorable or unfavorable trends and identity significant events and uncertainties
that affect these three factors. This discussion obviously involves a number of sub-
jective estimates and opinions. In its MD&A section, PepsiCo breaks its discussion
into three major headings: Our Business, Our Critical Accounting Policies, and Our
Financial Results. PepsiCo’s MD&A section is 22 pages long. You can access that
section at www.wiley.com/college/weygandt.
future prospects. The letter to the stockholders is signed by Steve Reinemund,
Chairman of the Board and Chief Executive Officer, of PepsiCo.
Only a short summary of the letter is provided below. The full letter can be
accessed at the book’s companion website at www.wiley.com/college/weygandt.
FINANCIAL STATEMENTS AND
ACCOMPANYING NOTES
The standard set of financial statements consists of: (1) a comparative income
statement for 3 years, (2) a comparative statement of cash flows for 3 years, (3) a
comparative balance sheet for 2 years, (4) a statement of stockholders’ equity for
3 years, and (5) a set of accompanying notes that are considered an integral part
of the financial statements. The auditor’s report, unless stated otherwise, covers
the financial statements and the accompanying notes. PepsiCo’s financial state-
ments and accompanying notes plus supplementary data and analyses follow.
Consolidated Statement of Income
PepsiCo, Inc. and Subsidiaries
Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003
(in millions except per share amounts) 2005 2004 2003
Net Revenue…………………………………………………………………………………………………………… $32,562 $29,261 $26,971
Cost of sales…………………………………………………………………………………………………………… 14,176 12,674 11,691
Selling, general and administrative expenses ……………………………………………………………… 12,314 11,031 10,148
Amortization of intangible assets ………………………………………………………………………………. 150 147 145
Restructuring and impairment charges………………………………………………………………………. – 150 147
Merger-related costs………………………………………………………………………………………………… – – 59
Operating Profit ……………………………………………………………………………………………………… 5,922 5,259 4,781
Bottling equity income……………………………………………………………………………………………… 557 380 323
Interest expense………………………………………………………………………………………………………. (256) (167) (163)
Interest income ……………………………………………………………………………………………………….. 159 74 51
Income from Continuing Operations before Income Taxes …………………………………………. 6,382 5,546 4,992
Provision for Income Taxes……………………………………………………………………………………… 2,304 1,372 1,424
Income from Continuing Operations…………………………………………………………………………. 4,078 4,174 3,568
Tax Benefit from Discontinued Operations ………………………………………………………………… – 38 –
Net Income ……………………………………………………………………………………………………………. $ 4,078 $ 4,212 $ 3,568
Net Income per Common Share — Basic
Continuing operations …………………………………………………………………………………………. $2.43 $2.45 $2.07
Discontinued operations………………………………………………………………………………………. – 0.02 –
Total …………………………………………………………………………………………………………………. $2.43 $2.47 $2.07
Net Income per Common Share — Diluted
Continuing operations …………………………………………………………………………………………. $2.39 $2.41 $2.05
Discontinued operations………………………………………………………………………………………. – 0.02 –
Total …………………………………………………………………………………………………………………. $2.39 $2.44* $2.05
* Based on unrounded amounts.
See accompanying notes to consolidated financial statements.
2003 2004 2005
2003 2004 2005 2003 2004 2005
2003 2004 2005
$2.05
$2.41
$32,562
$26,971
$29,261
$5,922
$4,781
$5,259
$3,568
$4,174 $4,078
$2.39
Net Revenue Operating Profit
Net Income per Common Share — Continuing OperationsIncome from Continuing Operations
A4 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Consolidated Statement of Cash Flows
PepsiCo, Inc. and Subsidiaries
Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003
(in millions) 2005 2004 2003
Operating Activities
Net income ………………………………………………………………………………………………………………… $ 4,078 $ 4,212 $ 3,568
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization ………………………………………………………………………………… 1,308 1,264 1,221
Stock-based compensation expense …………………………………………………………………………. 311 368 407
Restructuring and impairment charges ……………………………………………………………………. – 150 147
Cash payments for merger-related costs and restructuring charges …………………………….. (22) (92) (109)
Tax benefit from discontinued operations………………………………………………………………….. – (38) –
Pension and retiree medical plan contributions …………………………………………………………. (877) (534) (605)
Pension and retiree medical plan expenses……………………………………………………………….. 464 395 277
Bottling equity income, net of dividends …………………………………………………………………… (411) (297) (276)
Deferred income taxes and other tax charges and credits …………………………………………… 440 (203) (286)
Merger-related costs………………………………………………………………………………………………. – – 59
Other non-cash charges and credits, net ………………………………………………………………….. 145 166 101
Changes in operating working capital, excluding effects of acquisitions and divestitures
Accounts and notes receivable……………………………………………………………………………. (272) (130) (220)
Inventories ………………………………………………………………………………………………………. (132) (100) (49)
Prepaid expenses and other current assets ………………………………………………………….. (56) (31) 23
Accounts payable and other current liabilities………………………………………………………. 188 216 (11)
Income taxes payable………………………………………………………………………………………… 609 (268) 182
Net change in operating working capital…………………………………………………………………… 337 (313) (75)
Other……………………………………………………………………………………………………………………. 79 (24) (101)
Net Cash Provided by Operating Activities …………………………………………………………………… 5,852 5,054 4,328
Investing Activities
Snack Ventures Europe (SVE) minority interest acquisition ………………………………………………. (750) – –
Capital spending ……………………………………………………………………………………………………….. (1,736) (1,387) (1,345)
Sales of property, plant and equipment …………………………………………………………………………. 88 38 49
Other acquisitions and investments in noncontrolled affiliates ………………………………………… (345) (64) (71)
Cash proceeds from sale of PBG stock ………………………………………………………………………….. 214 – –
Divestitures……………………………………………………………………………………………………………….. 3 52 46
Short-term investments, by original maturity
More than three months — purchases …………………………………………………………………….. (83) (44) (38)
More than three months — maturities …………………………………………………………………….. 84 38 28
Three months or less, net ……………………………………………………………………………………….. (992) (963) (940)
Net Cash Used for Investing Activities…………………………………………………………………………. (3,517) (2,330) (2,271)
Financing Activities
Proceeds from issuances of long-term debt …………………………………………………………………… 25 504 52
Payments of long-term debt ………………………………………………………………………………………… (177) (512) (641)
Short-term borrowings, by original maturity
More than three months — proceeds……………………………………………………………………….. 332 153 88
More than three months — payments ……………………………………………………………………… (85) (160) (115)
Three months or less, net ……………………………………………………………………………………….. 1,601 1,119 40
Cash dividends paid …………………………………………………………………………………………………… (1,642) (1,329) (1,070)
Share repurchases — common ……………………………………………………………………………………. (3,012) (3,028) (1,929)
Share repurchases — preferred …………………………………………………………………………………… (19) (27) (16)
Proceeds from exercises of stock options……………………………………………………………………….. 1,099 965 689
Net Cash Used for Financing Activities………………………………………………………………………… (1,878) (2,315) (2,902)
Effect of exchange rate changes on cash and cash equivalents ……………………………………….. (21) 51 27
Net Increase/(Decrease) in Cash and Cash Equivalents ………………………………………………… 436 460 (818)
Cash and Cash Equivalents, Beginning of Year …………………………………………………………….. 1,280 820 1,638
Cash and Cash Equivalents, End of Year ……………………………………………………………………… $ 1,716 $ 1,280 $ 820
See accompanying notes to consolidated financial statements.
Financial Statements and Accompanying Notes A5
A6 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Consolidated Balance Sheet
PepsiCo, Inc. and Subsidiaries
December 31, 2005 and December 25, 2004
(in millions except per share amounts) 2005 2004
ASSETS
Current Assets
Cash and cash equivalents ………………………………………………………………………………………………………………….. $ 1,716 $ 1,280
Short-term investments ………………………………………………………………………………………………………………………. 3,166 2,165
4,882 3,445
Accounts and notes receivable, net……………………………………………………………………………………………………….. 3,261 2,999
Inventories…………………………………………………………………………………………………………………………………………. 1,693 1,541
Prepaid expenses and other current assets…………………………………………………………………………………………….. 618 654
Total Current Assets ……………………………………………………………………………………………………………………… 10,454 8,639
Property, Plant and Equipment, net …………………………………………………………………………………………………….. 8,681 8,149
Amortizable Intangible Assets, net ………………………………………………………………………………………………………. 530 598
Goodwill…………………………………………………………………………………………………………………………………………….. 4,088 3,909
Other nonamortizable intangible assets…………………………………………………………………………………………………. 1,086 933
Nonamortizable Intangible Assets…………………………………………………………………………………………………… 5,174 4,842
Investments in Noncontrolled Affiliates ……………………………………………………………………………………………….. 3,485 3,284
Other Assets ……………………………………………………………………………………………………………………………………… 3,403 2,475
Total Assets……………………………………………………………………………………………………………………………… $31,727 $ 27,987
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current Liabilities
Short-term obligations ………………………………………………………………………………………………………………………… $ 2,889 $ 1,054
Accounts payable and other current liabilities ………………………………………………………………………………………… 5,971 5,599
Income taxes payable ………………………………………………………………………………………………………………………….. 546 99
Total Current Liabilities …………………………………………………………………………………………………………………. 9,406 6,752
Long-Term Debt Obligations………………………………………………………………………………………………………………… 2,313 2,397
Other Liabilities …………………………………………………………………………………………………………………………………. 4,323 4,099
Deferred Income Taxes ………………………………………………………………………………………………………………………. 1,434 1,216
Total Liabilities……………………………………………………………………………………………………………………………… 17,476 14,464
Commitments and Contingencies
Preferred Stock, no par value …………………………………………………………………………………………………………….. 41 41
Repurchased Preferred Stock …………………………………………………………………………………………………………….. (110) (90)
Common Shareholders’ Equity
Common stock, par value 1 2/3¢ per share (issued 1,782 shares) …………………………………………………………….. 30 30
Capital in excess of par value ………………………………………………………………………………………………………………. 614 618
Retained earnings ………………………………………………………………………………………………………………………………. 21,116 18,730
Accumulated other comprehensive loss …………………………………………………………………………………………………. (1,053) (886)
20,707 18,492
Less: repurchased common stock, at cost (126 and 103 shares, respectively) …………………………………………… (6,387) (4,920)
Total Common Shareholders’ Equity ……………………………………………………………………………………………….. 14,320 13,572
Total Liabilities and Shareholders’ Equity …………………………………………………………………………………… $31,727 $27,987
See accompanying notes to consolidated financial statements.
Financial Statements and Accompanying Notes A7
Consolidated Statement of Common Shareholders’ Equity
PepsiCo, Inc. and Subsidiaries
Fiscal years ended December 31, 2005, December 25, 2004 and December 27, 2003
(in millions) 2005 2004 2003
Shares Amount Shares Amount Shares Amount
Common Stock 1,782 $ 30 1,782 $ 30 1,782 $ 30
Capital in Excess of Par Value
Balance, beginning of year……………………………………. 618 548 207
Stock-based compensation expense……………………….. 311 368 407
Stock option exercises(a) ……………………………………….. (315) (298) (66)
Balance, end of year…………………………………………….. 614 618 548
Retained Earnings
Balance, beginning of year……………………………………. 18,730 15,961 13,489
Net income …………………………………………………………. 4,078 4,212 3,568
Cash dividends declared — common …………………….. (1,684) (1,438) (1,082)
Cash dividends declared — preferred ……………………. (3) (3) (3)
Cash dividends declared — RSUs …………………………. (5) (2) –
Other …………………………………………………………………. – – (11)
Balance, end of year…………………………………………….. 21,116 18,730 15,961
Accumulated Other Comprehensive Loss
Balance, beginning of year …………………………………… (886) (1,267) (1,672)
Currency translation adjustment……………………………. (251) 401 410
Cash flow hedges, net of tax:
Net derivative gains/(losses) ……………………………. 54 (16) (11)
Reclassification of (gains)/losses to net income …. (8) 9 (1)
Minimum pension liability adjustment,
net of tax ……………………………………………………… 16 (19) 7
Unrealized gain on securities, net of tax …………………. 24 6 1
Other …………………………………………………………………. (2) – (1)
Balance, end of year…………………………………………….. (1,053) (886) (1,267)
Repurchased Common Stock
Balance, beginning of year……………………………………. (103) (4,920) (77) (3,376) (60) (2,524)
Share repurchases……………………………………………….. (54) (2,995) (58) (2,994) (43) (1,946)
Stock option exercises ………………………………………….. 31 1,523 32 1,434 26 1,096
Other …………………………………………………………………. – 5 – 16 – (2)
Balance, end of year…………………………………………….. (126) (6,387) (103) (4,920) (77) (3,376)
Total Common Shareholders’ Equity ………………………….. $14,320 $13,572 $11,896
2005 2004 2003
Comprehensive Income
Net income ………………………………………………………… $4,078 $4,212 $3,568
Currency translation adjustment……………………………. (251) 401 410
Cash flow hedges, net of tax …………………………………. 46 (7) (12)
Minimum pension liability adjustment, net of tax ……. 16 (19) 7
Unrealized gain on securities, net of tax …………………. 24 6 1
Other …………………………………………………………………. (2) – (1)
Total Comprehensive Income……………………………………. $3,911 $4,593 $3,973
(a) Includes total tax benefit of $125 million in 2005, $183 million in 2004 and $340 million in 2003.
See accompanying notes to consolidated financial statements.
A8 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Our financial statements include the con-
solidated accounts of PepsiCo, Inc. and
the affiliates that we control. In addition,
we include our share of the results of cer-
tain other affiliates based on our economic
ownership interest. We do not control these
other affiliates, as our ownership in these
other affiliates is generally less than 50%.
Our share of the net income of noncon-
trolled bottling affiliates is reported in our
income statement as bottling equity
income. Bottling equity income also
includes any changes in our ownership
interests of these affiliates. In 2005, bot-
tling equity income includes $126 million
of pre-tax gains on our sales of PBG stock.
See Note 8 for additional information on
our noncontrolled bottling affiliates. Our
share of other noncontrolled affiliates is
included in division operating profit.
Intercompany balances and transactions
are eliminated. In 2005, we had an addi-
tional week of results (53rd week). Our
fiscal year ends on the last Saturday of
each December, resulting in an additional
week of results every five or six years.
In connection with our ongoing BPT
initiative, we aligned certain accounting
policies across our divisions in 2005. We
conformed our methodology for calculating
our bad debt reserves and modified our
policy for recognizing revenue for products
shipped to customers by third-party
carriers. Additionally, we conformed our
method of accounting for certain costs,
primarily warehouse and freight. These
changes reduced our net revenue by
$36 million and our operating profit by
$60 million in 2005. We also made certain
reclassifications on our Consolidated
Statement of Income in the fourth quarter
of 2005 from cost of sales to selling,
general and administrative expenses in
connection with our BPT initiative. These
reclassifications resulted in reductions to
cost of sales of $556 million through the
third quarter of 2005, $732 million in the
full year 2004 and $688 million in the full
year 2003, with corresponding increases to
selling, general and administrative
expenses in those periods. These reclassifi-
cations had no net impact on operating
profit and have been made to all periods
presented for comparability.
The preparation of our consolidated
financial statements in conformity with
generally accepted accounting principles
requires us to make estimates and
assumptions that affect reported amounts
of assets, liabilities, revenues, expenses
and disclosure of contingent assets and
liabilities. Estimates are used in determin-
ing, among other items, sales incentives
accruals, future cash flows associated with
impairment testing for perpetual brands
and goodwill, useful lives for intangible
assets, tax reserves, stock-based compen-
sation and pension and retiree medical
accruals. Actual results could differ from
these estimates.
See “Our Divisions” below and for
additional unaudited information on items
affecting the comparability of our
consolidated results, see “Items Affecting
Comparability” in Management’s
Discussion and Analysis.
Tabular dollars are in millions, except per
share amounts. All per share amounts
reflect common per share amounts, assume
dilution unless noted, and are based on
unrounded amounts. Certain reclassifica-
tions were made to prior years’ amounts to
conform to the 2005 presentation.
We manufacture or use contract manufac-
turers, market and sell a variety of salty,
sweet and grain-based snacks, carbonated
and non-carbonated beverages, and foods
through our North American and interna-
tional business divisions. Our North
American divisions include the United
States and Canada. The accounting poli-
cies for the divisions are the same as those
described in Note 2, except for certain
allocation methodologies for stock-based
compensation expense and pension and
retiree medical expense, as described in
the unaudited information in “Our Critical
Accounting Policies.” Additionally, begin-
ning in the fourth quarter of 2005, we
began centrally managing commodity
derivatives on behalf of our divisions.
Certain of the commodity derivatives,
primarily those related to the purchase of
energy for use by our divisions, do not
qualify for hedge accounting treatment.
These derivatives hedge underlying com-
modity price risk and were not entered into
for speculative purposes. Such derivatives
are marked to market with the resulting
gains and losses recognized as a compo-
nent of corporate unallocated expense.
These gains and losses are reflected in
division results when the divisions take
delivery of the underlying commodity.
Therefore, division results reflect the
contract purchase price of the energy or
other commodities.
Division results are based on how our
Chairman and Chief Executive Officer
evaluates our divisions. Division results
exclude certain Corporate-initiated restruc-
turing and impairment charges, merger-
related costs and divested businesses.
For additional unaudited information on
our divisions, see “Our Operations” in
Management’s Discussion and Analysis.
Notes to Consolidated Financial Statements
Note 1 — Basis of Presentation and Our Divisions
Our Divisions
Basis of Presentation
Financial Statements and Accompanying Notes A9
2005 2004 2003 2005 2004 2003
Net Revenue Operating Profit
FLNA……………………………………………………………. $10,322 $ 9,560 $ 9,091 $2,529 $2,389 $ 2,242
PBNA …………………………………………………………… 9,146 8,313 7,733 2,037 1,911 1,690
PI ………………………………………………………………. 11,376 9,862 8,678 1,607 1,323 1,061
QFNA …………………………………………………………… 1,718 1,526 1,467 537 475 470
Total division ……………………………………………….. 32,562 29,261 26,969 6,710 6,098 5,463
Divested businesses ……………………………………… – – 2 – – 26
Corporate …………………………………………………….. – – – (788) (689) (502)
32,562 29,261 26,971 5,922 5,409 4,987
Restructuring and impairment charges……………. – – – – (150) (147)
Merger-related costs ……………………………………… – – – – – (59)
Total ……………………………………………………………. $32,562 $29,261 $26,971 $5,922 $5,259 $ 4,781
Divested Businesses
During 2003, we sold our Quaker Foods
North America Mission pasta business. The
results of this business are reported as
divested businesses.
Corporate
Corporate includes costs of our corporate
headquarters, centrally managed initia-
tives, such as our BPT initiative, unallo-
cated insurance and benefit programs,
foreign exchange transaction gains and
losses, and certain commodity derivative
gains and losses, as well as profit-in-inven-
tory elimination adjustments for our non-
controlled bottling affiliates and certain
other items.
Restructuring and Impairment Charges and
Merger-Related Costs — See Note 3.
QFNA
5%
FLNA
32%
PBNA
28%
PI
35%
Division Net Revenue
QFNA
8%
FLNA
38%
PBNA
30%
PI
24%
Division Operating Profit
Frito-Lay
North America
(FLNA)
Quaker Foods
North America
(QFNA)
PepsiCo
Beverages
North America
(PBNA)
PepsiCo
International
(PI)
A10 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Other Division Information
2005 2004 2003 2005 2004 2003
Total Assets Capital Spending
FLNA $ 5,948 $ 5,476 $ 5,332 $ 512 $ 469 $ 426
PBNA 6,316 6,048 5,856 320 265 332
PI 9,983 8,921 8,109 667 537 521
QFNA 989 978 995 31 33 32
Total division 23,236 21,423 20,292 1,530 1,304 1,311
Corporate(a) 5,331 3,569 2,384 206 83 34
Investments in bottling affiliates 3,160 2,995 2,651 – – –
$31,727 $27,987 $25,327 $1,736 $1,387 $1,345
(a) Corporate assets consist principally of cash and cash equivalents, short-term investments, and property, plant and equipment.
2005 2004 2003 2005 2004 2003
Amortization of Depreciation and
Intangible Assets Other Amortization
FLNA $ 3 $ 3 $ 3 $ 419 $ 420 $ 416
PBNA 76 75 75 264 258 245
PI 71 68 66 420 382 350
QFNA – 1 1 34 36 36
Total division 150 147 145 1,137 1,096 1,047
Corporate – – – 21 21 29
$150 $147 $145 $1,158 $1,117 $1,076
2005 2004 2003 2005 2004 2003
Net Revenue(a) Long-Lived Assets(b)
U.S. $19,937 $18,329 $17,377 $10,723 $10,212 $ 9,907
Mexico 3,095 2,724 2,642 902 878 869
United Kingdom 1,821 1,692 1,510 1,715 1,896 1,724
Canada 1,509 1,309 1,147 582 548 508
All other countries 6,200 5,207 4,295 3,948 3,339 3,123
$32,562 $29,261 $26,971 $17,870 $16,873 $16,131
(a) Represents net revenue from businesses operating in these countries.
(b) Long-lived assets represent net property, plant and equipment, nonamortizable and net amortizable intangible assets and investments in
noncontrolled affiliates. These assets are reported in the country where they are primarily used.
FLNA
19%
PBNA
20%
PI
31%
QFNA
3%
Other
27%
Total Assets
QFNA
2%
FLNA
30%
PBNA
18%
PI
38%
Other
12%
Capital Spending
Canada
4%
United States
61%
Mexico
10%
United
Kingdom
6%
Other
19%
Net Revenue
Canada
3%
United States
60%
Mexico
5%
United
Kingdom
10%
Other
22%
Long-Lived Assets
Financial Statements and Accompanying Notes A11
Revenue Recognition
We recognize revenue upon shipment or
delivery to our customers based on written
sales terms that do not allow for a right of
return. However, our policy for direct-store-
delivery (DSD) and chilled products is to
remove and replace damaged and out-of-
date products from store shelves to ensure
that our consumers receive the product
quality and freshness that they expect.
Similarly, our policy for warehouse distrib-
uted products is to replace damaged and
out-of-date products. Based on our histori-
cal experience with this practice, we have
reserved for anticipated damaged and out-
of-date products. For additional unaudited
information on our revenue recognition and
related policies, including our policy on
bad debts, see “Our Critical Accounting
Policies” in Management’s Discussion and
Analysis. We are exposed to concentration
of credit risk by our customers, Wal-Mart
and PBG. Wal-Mart represents approxi-
mately 9% of our net revenue, including
concentrate sales to our bottlers which are
used in finished goods sold by them to
Wal-Mart; and PBG represents approxi-
mately 10%. We have not experienced
credit issues with these customers.
Sales Incentives and Other Marketplace
Spending
We offer sales incentives and discounts
through various programs to our customers
and consumers. Sales incentives and dis-
counts are accounted for as a reduction of
revenue and totaled $8.9 billion in 2005,
$7.8 billion in 2004 and $7.1 billion in
2003. While most of these incentive
arrangements have terms of no more than
one year, certain arrangements extend
beyond one year. For example, fountain
pouring rights may extend up to 15 years.
Costs incurred to obtain these arrange-
ments are recognized over the contract
period and the remaining balances of
$321 million at December 31, 2005 and
$337 million at December 25, 2004 are
included in current assets and other assets
in our Consolidated Balance Sheet. For
additional unaudited information on our
sales incentives, see “Our Critical
Accounting Policies” in Management’s
Discussion and Analysis.
Other marketplace spending includes the
costs of advertising and other marketing
activities and is reported as selling, general
and administrative expenses. Advertising
expenses were $1.8 billion in 2005,
$1.7 billion in 2004 and $1.6 billion in
2003. Deferred advertising costs are not
expensed until the year first used and
consist of:
• media and personal service prepayments,
• promotional materials in inventory, and
• production costs of future media
advertising.
Deferred advertising costs of $202 mil-
lion and $137 million at year-end 2005
and 2004, respectively, are classified as
prepaid expenses in our Consolidated
Balance Sheet.
Distribution Costs
Distribution costs, including the costs of
shipping and handling activities, are
reported as selling, general and administra-
tive expenses. Shipping and handling
expenses were $4.1 billion in 2005,
$3.9 billion in 2004 and $3.6 billion
in 2003.
Cash Equivalents
Cash equivalents are investments with
original maturities of three months or less
which we do not intend to rollover beyond
three months.
Software Costs
We capitalize certain computer software
and software development costs incurred
in connection with developing or obtaining
computer software for internal use.
Capitalized software costs are included in
property, plant and equipment on our
Consolidated Balance Sheet and amortized
on a straight-line basis over the estimated
useful lives of the software, which gener-
ally do not exceed 5 years. Net capitalized
software and development costs were
$327 million at December 31, 2005 and
$181 million at December 25, 2004.
Commitments and Contingencies
We are subject to various claims and
contingencies related to lawsuits, taxes
and environmental matters, as well as
commitments under contractual and other
commercial obligations. We recognize lia-
bilities for contingencies and commitments
when a loss is probable and estimable. For
additional information on our commit-
ments, see Note 9.
Other Significant Accounting Policies
Our other significant accounting policies
are disclosed as follows:
• Property, Plant and Equipment and
Intangible Assets — Note 4 and, for
additional unaudited information on
brands and goodwill, see “Our Critical
Accounting Policies” in Management’s
Discussion and Analysis.
• Income Taxes — Note 5 and, for addi-
tional unaudited information, see “Our
Critical Accounting Policies” in
Management’s Discussion and Analysis.
• Stock-Based Compensation Expense —
Note 6 and, for additional unaudited
information, see “Our Critical
Accounting Policies” in Management’s
Discussion and Analysis.
• Pension, Retiree Medical and Savings
Plans — Note 7 and, for additional
unaudited information, see “Our Critical
Accounting Policies” in Management’s
Discussion and Analysis.
• Risk Management — Note 10 and, for
additional unaudited information, see
“Our Business Risks” in Management’s
Discussion and Analysis.
There have been no new accounting
pronouncements issued or effective during
2005 that have had, or are expected to
have, a material impact on our consoli-
dated financial statements.
Note 2 — Our Significant Accounting Policies
A12 Appendix A Specimen Financial Statements: PepsiCo, Inc.
2005 Restructuring Charges
In the fourth quarter of 2005, we incurred
a charge of $83 million ($55 million after-
tax or $0.03 per share) in conjunction with
actions taken to reduce costs in our opera-
tions, principally through headcount reduc-
tions. Of this charge, $34 million related
to FLNA, $21 million to PBNA, $16
million to PI and $12 million to Corporate
(recorded in corporate unallocated
expenses). Most of this charge related to
the termination of approximately 700
employees. We expect the substantial
portion of the cash payments related to
this charge to be paid in 2006.
2004 and 2003 Restructuring and
Impairment Charges
In the fourth quarter of 2004, we incurred
a charge of $150 million ($96 million
after-tax or $0.06 per share) in conjunc-
tion with the consolidation of FLNA’s
manufacturing network as part of its ongo-
ing productivity program. Of this charge,
$93 million related to asset impairment,
primarily reflecting the closure of four U.S.
plants. Production from these plants was
redeployed to other FLNA facilities in the
U.S. The remaining $57 million included
employee-related costs of $29 million,
contract termination costs of $8 million
and other exit costs of $20 million.
Employee-related costs primarily reflect
the termination costs for approximately
700 employees. Through December 31,
2005, we have paid $47 million and
incurred non-cash charges of $10 million,
leaving substantially no accrual.
In the fourth quarter of 2003, we
incurred a charge of $147 million
($100 million after-tax or $0.06 per share)
in conjunction with actions taken to
streamline our North American divisions
and PepsiCo International. These actions
were taken to increase focus and eliminate
redundancies at PBNA and PI and to
improve the efficiency of the supply chain
at FLNA. Of this charge, $81 million
related to asset impairment, reflecting
$57 million for the closure of a snack
plant in Kentucky, the retirement of snack
manufacturing lines in Maryland and
Arkansas and $24 million for the closure
of a PBNA office building in Florida. The
remaining $66 million included employee-
related costs of $54 million and facility
and other exit costs of $12 million.
Employee-related costs primarily reflect
the termination costs for approximately
850 sales, distribution, manufacturing,
research and marketing employees. As of
December 31, 2005, all terminations had
occurred and substantially no accrual
remains.
Merger-Related Costs
In connection with the Quaker merger in
2001, we recognized merger-related costs
of $59 million ($42 million after-tax or
$0.02 per share) in 2003.
Depreciation and amortization are
recognized on a straight-line basis over an
asset’s estimated useful life. Land is not
depreciated and construction in progress is
not depreciated until ready for service.
Amortization of intangible assets for each
of the next five years, based on average
2005 foreign exchange rates, is expected
to be $152 million in 2006, $35 million
in 2007, $35 million in 2008, $34 mil-
lion in 2009 and $33 million in 2010.
Depreciable and amortizable assets are
only evaluated for impairment upon a
significant change in the operating or
macroeconomic environment. In these
circumstances, if an evaluation of the
undiscounted cash flows indicates impair-
ment, the asset is written down to its
estimated fair value, which is based on
discounted future cash flows. Useful lives
are periodically evaluated to determine
whether events or circumstances have
occurred which indicate the need for revi-
sion. For additional unaudited information
on our amortizable brand policies, see
“Our Critical Accounting Policies” in
Management’s Discussion and Analysis.
Note 3 — Restructuring and Impairment Charges and Merger-Related Costs
Note 4 — Property, Plant and Equipment and Intangible Assets
Average Useful Life 2005 2004 2003
Property, plant and equipment, net
Land and improvements 10 – 30 yrs. $ 685 $ 646
Buildings and improvements 20 – 44 3,736 3,605
Machinery and equipment,
including fleet and software 5 – 15 11,658 10,950
Construction in progress 1,066 729
17,145 15,930
Accumulated depreciation (8,464) (7,781)
$ 8,681 $ 8,149
Depreciation expense $1,103 $1,062 $1,020
Amortizable intangible assets, net
Brands 5 – 40 $1,054 $1,008
Other identifiable intangibles 3 – 15 257 225
1,311 1,233
Accumulated amortization (781) (635)
$ 530 $ 598
Amortization expense $150 $147 $145
Financial Statements and Accompanying Notes A13
Nonamortizable Intangible Assets
Perpetual brands and goodwill are assessed for impairment at least annually to ensure that discounted future cash flows continue to
exceed the related book value. A perpetual brand is impaired if its book value exceeds its fair value. Goodwill is evaluated for
impairment if the book value of its reporting unit exceeds its fair value. A reporting unit can be a division or business within a division.
If the fair value of an evaluated asset is less than its book value, the asset is written down based on its discounted future cash flows to
fair value. No impairment charges resulted from the required impairment evaluations. The change in the book value of nonamortizable
intangible assets is as follows:
Balance, Translation Balance, Translation Balance,
Beginning 2004 Acquisition and Other End of 2004 Acquisition and Other End of 2005
Frito-Lay North America
Goodwill $ 130 $ – $ 8 $ 138 $ – $ 7 $ 145
PepsiCo Beverages North America
Goodwill 2,157 – 4 2,161 – 3 2,164
Brands 59 – – 59 – – 59
2,216 – 4 2,220 – 3 2,223
PepsiCo International
Goodwill 1,334 29 72 1,435 278 (109) 1,604
Brands 808 – 61 869 263 (106) 1,026
2,142 29 133 2,304 541 (215) 2,630
Quaker Foods North America
Goodwill 175 – – 175 – – 175
Corporate
Pension intangible 2 – 3 5 – (4) 1
Total goodwill 3,796 29 84 3,909 278 (99) 4,088
Total brands 867 – 61 928 263 (106) 1,085
Total pension intangible 2 – 3 5 – (4) 1
$4,665 $29 $148 $ 4,842 $541 $(209) $5,174
A14 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Note 5 — Income Taxes
2005 2004 2003
Income before income taxes — continuing operations
U.S. ………………………………………………………………………………………………………………………………… $3,175 $2,946 $3,267
Foreign……………………………………………………………………………………………………………………………. 3,207 2,600 1,725
$6,382 $5,546 $4,992
Provision for income taxes — continuing operations
Current: U.S. Federal ……………………………………………………………………………………………………….. $1,638 $1,030 $1,326
Foreign ……………………………………………………………………………………………………………… 426 256 341
State ………………………………………………………………………………………………………………… 118 69 80
2,182 1,355 1,747
Deferred: U.S. Federal ……………………………………………………………………………………………………….. 137 11 (274)
Foreign ……………………………………………………………………………………………………………… (26) 5 (47)
State ………………………………………………………………………………………………………………… 11 1 (2)
122 17 (323)
$2,304 $1,372 $1,424
Tax rate reconciliation — continuing operations
U.S. Federal statutory tax rate ……………………………………………………………………………………………. 35.0% 35.0% 35.0%
State income tax, net of U.S. Federal tax benefit…………………………………………………………………… 1.4 0.8 1.0
Taxes on AJCA repatriation…………………………………………………………………………………………………. 7.0 – –
Lower taxes on foreign results ……………………………………………………………………………………………. (6.5) (5.4) (5.5)
Settlement of prior years’ audit ………………………………………………………………………………………….. – (4.8) (2.2)
Other, net ………………………………………………………………………………………………………………………… (0.8) (0.9) 0.2
Annual tax rate ………………………………………………………………………………………………………………… 36.1% 24.7% 28.5%
Deferred tax liabilities
Investments in noncontrolled affiliates ……………………………………………………………………………….. $ 993 $ 850
Property, plant and equipment …………………………………………………………………………………………… 772 857
Pension benefits ………………………………………………………………………………………………………………. 863 669
Intangible assets other than nondeductible goodwill …………………………………………………………….. 135 153
Zero coupon notes ……………………………………………………………………………………………………………. 35 46
Other………………………………………………………………………………………………………………………………. 169 157
Gross deferred tax liabilities………………………………………………………………………………………………. 2,967 2,732
Deferred tax assets
Net carryforwards …………………………………………………………………………………………………………….. 608 666
Stock-based compensation………………………………………………………………………………………………… 426 402
Retiree medical benefits……………………………………………………………………………………………………. 400 402
Other employee-related benefits…………………………………………………………………………………………. 342 379
Other………………………………………………………………………………………………………………………………. 520 460
Gross deferred tax assets ………………………………………………………………………………………………….. 2,296 2,309
Valuation allowances………………………………………………………………………………………………………… (532) (564)
Deferred tax assets, net…………………………………………………………………………………………………….. 1,764 1,745
Net deferred tax liabilities …………………………………………………………………………………………………. $1,203 $ 987
Deferred taxes included within:
Prepaid expenses and other current assets ………………………………………………………………………. $231 $229
Deferred income taxes …………………………………………………………………………………………………… $1,434 $1,216
Analysis of valuation allowances
Balance, beginning of year ………………………………………………………………………………………………… $564 $438 $487
(Benefit)/provision ………………………………………………………………………………………………………… (28) 118 (52)
Other (deductions)/additions………………………………………………………………………………………….. (4) 8 3
Balance, end of year …………………………………………………………………………………………………………. $532 $564 $438
Financial Statements and Accompanying Notes A15
For additional unaudited information on
our income tax policies, including our
reserves for income taxes, see “Our Critical
Accounting Policies” in Management’s
Discussion and Analysis.
Carryforwards, Credits and Allowances
Operating loss carryforwards totaling
$5.1 billion at year-end 2005 are being
carried forward in a number of foreign and
state jurisdictions where we are permitted
to use tax operating losses from prior peri-
ods to reduce future taxable income. These
operating losses will expire as follows:
$0.1 billion in 2006, $4.1 billion between
2007 and 2025 and $0.9 billion may be
carried forward indefinitely. In addition,
certain tax credits generated in prior peri-
ods of approximately $39.4 million are
available to reduce certain foreign tax
liabilities through 2011. We establish
valuation allowances for our deferred tax
assets when the amount of expected future
taxable income is not likely to support the
use of the deduction or credit.
Undistributed International Earnings
The AJCA created a one-time incentive for
U.S. corporations to repatriate undistrib-
uted international earnings by providing an
85% dividends received deduction. As
approved by our Board of Directors in July
2005, we repatriated approximately
$7.5 billion in earnings previously consid-
ered indefinitely reinvested outside the U.S.
in the fourth quarter of 2005. In 2005, we
recorded income tax expense of $460 mil-
lion associated with this repatriation. Other
than the earnings repatriated, we intend to
continue to reinvest earnings outside the
U.S. for the foreseeable future and, there-
fore, have not recognized any U.S. tax
expense on these earnings. At December
31, 2005, we had approximately $7.5 bil-
lion of undistributed international earnings.
Reserves
A number of years may elapse before a par-
ticular matter, for which we have established
a reserve, is audited and finally resolved.
The number of years with open tax audits
varies depending on the tax jurisdiction.
During 2004, we recognized $266 million of
tax benefits related to the favorable resolu-
tion of certain open tax issues. In addition,
in 2004, we recognized a tax benefit of
$38 million upon agreement with the IRS on
an open issue related to our discontinued
restaurant operations. At the end of 2003,
we entered into agreements with the IRS for
open years through 1997. These agreements
resulted in a tax benefit of $109 million in
the fourth quarter of 2003. As part of these
agreements, we also resolved the treatment
of certain other issues related to future
tax years.
The IRS has initiated their audits of our
tax returns for the years 1998 through
2002. Our tax returns subsequent to 2002
have not yet been examined. While it is
often difficult to predict the final outcome or
the timing of resolution of any particular tax
matter, we believe that our reserves reflect
the probable outcome of known tax contin-
gencies. Settlement of any particular issue
would usually require the use of cash.
Favorable resolution would be recognized as
a reduction to our annual tax rate in the year
of resolution. Our tax reserves, covering all
federal, state and foreign jurisdictions, are
presented in the balance sheet within other
liabilities (see Note 14), except for any
amounts relating to items we expect to pay
in the coming year which are included in
current income taxes payable. For further
unaudited information on the impact of the
resolution of open tax issues, see “Other
Consolidated Results.”
Our stock-based compensation program is
a broad-based program designed to attract
and retain employees while also aligning
employees’ interests with the interests of
our shareholders. Employees at all levels
participate in our stock-based compensa-
tion program. In addition, members of our
Board of Directors participate in our stock-
based compensation program in connec-
tion with their service on our Board. Stock
options and RSUs are granted to employ-
ees under the shareholder-approved 2003
Long-Term Incentive Plan (LTIP), our only
active stock-based plan. Stock-based
compensation expense was $311 million
in 2005, $368 million in 2004 and
$407 million in 2003. Related income tax
benefits recognized in earnings were
$87 million in 2005, $103 million in
2004 and $114 million in 2003. At year-
end 2005, 51 million shares were avail-
able for future executive and SharePower
grants. For additional unaudited informa-
tion on our stock-based compensation pro-
gram, see “Our Critical Accounting Policies”
in Management’s Discussion and Analysis.
SharePower Grants
SharePower options are awarded under our
LTIP to all eligible employees, based on
job level or classification, and in the case
of international employees, tenure as well.
All stock option grants have an exercise
price equal to the fair market value of our
common stock on the day of grant and
generally have a 10-year term with vesting
after three years.
Executive Grants
All senior management and certain middle
management are eligible for executive
grants under our LTIP. All stock option
grants have an exercise price equal to the
fair market value of our common stock on
the day of grant and generally have a
10-year term with vesting after three years.
There have been no reductions to the exer-
cise price of previously issued awards, and
any repricing of awards would require
approval of our shareholders.
Beginning in 2004, executives who are
awarded long-term incentives based on
their performance are offered the choice of
stock options or RSUs. RSU expense is
based on the fair value of PepsiCo stock on
the date of grant and is amortized over the
vesting period, generally three years. Each
restricted stock unit can be settled in a
share of our stock after the vesting period.
Executives who elect RSUs receive one
RSU for every four stock options that would
have otherwise been granted. Senior offi-
cers do not have a choice and are granted
50% stock options and 50% RSUs.
Vesting of RSU awards for senior officers is
contingent upon the achievement of
pre-established performance targets. We
granted 3 million RSUs in both 2005 and
2004 with weighted-average intrinsic val-
ues of $53.83 and $47.28, respectively.
Note 6 — Stock-Based Compensation
A16 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Method of Accounting and Our Assumptions
We account for our employee stock options under the fair value
method of accounting using a Black-Scholes valuation model to
measure stock-based compensation expense at the date of grant.
We adopted SFAS 123R, Share-Based Payment, under the
modified prospective method in the first quarter of 2006. We do
not expect our adoption of SFAS 123R to materially impact our
financial statements.
Our weighted-average Black-Scholes fair value assumptions include:
2005 2004 2003
Expected life 6 yrs. 6 yrs. 6 yrs.
Risk free interest rate 3.8% 3.3% 3.1%
Expected volatility 23% 26% 27%
Expected dividend yield 1.8% 1.8% 1.15%
Our Stock Option Activity(a)
2005 2004 2003
Options Average Price(b) Options Average Price(b) Options Average Price(b)
Outstanding at beginning of year 174,261 $40.05 198,173 $38.12 190,432 $36.45
Granted 12,328 53.82 14,137 47.47 41,630 39.89
Exercised (30,945) 35.40 (31,614) 30.57 (25,833) 26.74
Forfeited/expired (5,495) 43.31 (6,435) 43.82 (8,056) 43.56
Outstanding at end of year 150,149 42.03 174,261 40.05 198,173 38.12
Exercisable at end of year 89,652 40.52 94,643 36.41 97,663 32.56
Stock options outstanding and exercisable at December 31, 2005(a)
Options Outstanding Options Exercisable
Range of Exercise Price Options Average Price(b) Average Life(c) Options Average Price(b) Average Life(c)
$14.40 to $21.54 905 $ 20.01 3.56 yrs. 905 $20.01 3.56 yrs.
$23.00 to $33.75 14,559 30.46 3.07 14,398 30.50 3.05
$34.00 to $43.50 82,410 39.44 5.34 48,921 39.19 4.10
$43.75 to $56.75 52,275 49.77 7.17 25,428 49.48 6.09
150,149 42.03 5.67 89,652 40.52 4.45
(a) Options are in thousands and include options previously granted under Quaker plans. No additional options or shares may be granted under the Quaker plans.
(b) Weighted-average exercise price.
(c) Weighted-average contractual life remaining.
Our RSU Activity(a)
2005 2004
Average Average
Intrinsic Average Intrinsic Average
RSUs Value(b) Life(c) RSUs Value(b) Life(c)
Outstanding at beginning of year 2,922 $ 47.30 – $ –
Granted 3,097 53.83 3,077 47.28
Converted (91) 48.73 (18) 47.25
Forfeited/expired (259) 50.51 (137) 47.25
Outstanding at end of year 5,669 50.70 1.8 yrs. 2,922 47.30 2.2 yrs.
(a) RSUs are in thousands.
(b) Weighted-average intrinsic value.
(c) Weighted-average contractual life remaining.
Other stock-based compensation data
Stock Options RSUs
2005 2004 2003 2005 2004
Weighted-average fair value of options granted $13.45 $12.04 $11.21
Total intrinsic value of options/RSUs exercised/converted(a) $632,603 $667,001 $466,719 $4,974 $914
Total intrinsic value of options/RSUs outstanding(a) $2,553,594 $2,062,153 $1,641,505 $334,931 $151,760
Total intrinsic value of options exercisable(a) $1,662,198 $1,464,926 $1,348,658
(a) In thousands.
At December 31, 2005, there was $315 million of total unrecognized compensation cost related to nonvested share-based
compensation grants. This unrecognized compensation is expected to be recognized over a weighted-average period of 1.6 years.
Financial Statements and Accompanying Notes A17
Our pension plans cover full-time employ-
ees in the U.S. and certain international
employees. Benefits are determined based
on either years of service or a combination
of years of service and earnings. U.S.
retirees are also eligible for medical and
life insurance benefits (retiree medical) if
they meet age and service requirements.
Generally, our share of retiree medical
costs is capped at specified dollar
amounts, which vary based upon years of
service, with retirees contributing the
remainder of the costs. We use a
September 30 measurement date and all
plan assets and liabilities are generally
reported as of that date. The cost or
benefit of plan changes that increase or
decrease benefits for prior employee
service (prior service cost) is included in
expense on a straight-line basis over the
average remaining service period of
employees expected to receive benefits.
The Medicare Act was signed into law in
December 2003 and we applied the provi-
sions of the Medicare Act to our plans in
2005 and 2004. The Medicare Act
provides a subsidy for sponsors of retiree
medical plans who offer drug benefits
equivalent to those provided under
Medicare. As a result of the Medicare Act,
our 2005 and 2004 retiree medical costs
were $11 million and $7 million lower,
respectively, and our 2005 and 2004 lia-
bilities were reduced by $136 million and
$80 million, respectively. We expect our
2006 retiree medical costs to be approxi-
mately $18 million lower than they other-
wise would have been as a result of the
Medicare Act.
For additional unaudited information on
our pension and retiree medical plans and
related accounting policies and assump-
tions, see “Our Critical Accounting Policies”
in Management’s Discussion and Analysis.
Pension Retiree Medical
2005 2004 2003 2005 2004 2003 2005 2004 2003
U.S. International
Weighted-average assumptions
Liability discount rate ……………………………………………….. 5.7% 6.1% 6.1% 5.1% 6.1% 6.1% 5.7% 6.1% 6.1%
Expense discount rate……………………………………………….. 6.1% 6.1% 6.7% 6.1% 6.1% 6.4% 6.1% 6.1% 6.7%
Expected return on plan assets ………………………………….. 7.8% 7.8% 8.3% 8.0% 8.0% 8.0% – – –
Rate of compensation increases…………………………………. 4.4% 4.5% 4.5% 4.1% 3.9% 3.8% – – –
Components of benefit expense
Service cost…………………………………………………………….. $ 213 $ 193 $ 153 $ 32 $ 27 $ 24 $ 40 $ 38 $ 33
Interest cost……………………………………………………………. 296 271 245 55 47 39 78 72 73
Expected return on plan assets …………………………………. (344) (325) (305) (69) (65) (54) – – –
Amortization of prior service cost/(benefit)………………….. 3 6 6 1 1 – (11) (8) (3)
Amortization of experience loss………………………………….. 106 81 44 15 9 5 26 19 13
Benefit expense……………………………………………………….. 274 226 143 34 19 14 133 121 116
Settlement/curtailment loss ……………………………………… – 4 – – 1 – – – –
Special termination benefits……………………………………… 21 19 4 – 1 – 2 4 –
Total ………………………………………………………………………. $ 295 $ 249 $ 147 $ 34 $ 21 $ 14 $135 $125 $116
Note 7 — Pension, Retiree Medical and Savings Plans
A18 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Pension Retiree Medical
2005 2004 2005 2004 2005 2004
U.S. International
Change in projected benefit liability
Liability at beginning of year $ 4,968 $4,456 $ 952 $758 $1,319 $1,264
Service cost 213 193 32 27 40 38
Interest cost 296 271 55 47 78 72
Plan amendments – (17) 3 1 (8) (41)
Participant contributions – – 10 9 – –
Experience loss/(gain) 517 261 203 73 (45) 58
Benefit payments (241) (205) (28) (29) (74) (76)
Settlement/curtailment loss – (9) – (2) – –
Special termination benefits 21 18 – 1 2 4
Foreign currency adjustment – – (68) 67 – –
Other (3) – 104 – – –
Liability at end of year $ 5,771 $4,968 $1,263 $952 $1,312 $1,319
Liability at end of year for service to date $ 4,783 $4,164 $1,047 $779
Change in fair value of plan assets
Fair value at beginning of year $ 4,152 $3,558 $ 838 $687 $ – $ –
Actual return on plan assets 477 392 142 77 – –
Employer contributions/funding 699 416 104 37 74 76
Participant contributions – – 10 9 – –
Benefit payments (241) (205) (28) (29) (74) (76)
Settlement/curtailment loss – (9) – (2) – –
Foreign currency adjustment – – (61) 59 – –
Other (1) – 94 – – –
Fair value at end of year $ 5,086 $4,152 $1,099 $838 $ – $ –
Funded status as recognized in our Consolidated Balance Sheet
Funded status at end of year $ (685) $ (817) $ (164) $(113) $(1,312) $(1,319)
Unrecognized prior service cost/(benefit) 5 9 17 13 (113) (116)
Unrecognized experience loss 2,288 2,013 474 380 402 473
Fourth quarter benefit payments 5 5 4 7 19 19
Net amounts recognized $1,613 $1,210 $ 331 $ 287 $(1,004) $ (943)
Net amounts as recognized in our Consolidated Balance Sheet
Other assets $2,068 $1,572 $367 $ 294 $ – $ –
Intangible assets – – 1 5 – –
Other liabilities (479) (387) (41) (37) (1,004) (943)
Accumulated other comprehensive loss 24 25 4 25 – –
Net amounts recognized $1,613 $1,210 $331 $ 287 $(1,004) $(943)
Components of increase in unrecognized experience loss
Decrease in discount rate $ 365 $ – $194 $ 4 $ 61 $ –
Employee-related assumption changes 57 196 2 65 – 109
Liability-related experience different from assumptions 95 65 7 4 (54) 31
Actual asset return different from expected return (133) (67) (73) (12) – –
Amortization of losses (106) (81) (15) (9) (26) (19)
Other, including foreign currency adjustments
and 2003 Medicare Act (3) (5) (22) 26 (52) (82)
Total $ 275 $108 $ 93 $ 78 $(71) $ 39
Selected information for plans with liability for service to date in excess of plan assets
Liability for service to date $ (374) $(320) $ (65) $(191) $(1,312) $(1,319)
Projected benefit liability $ (815) $(685) $ (84) $(227) $(1,312) $(1,319)
Fair value of plan assets $8 $11 $33 $161 $– $–
Of the total projected pension benefit liability at year-end 2005, $765 million relates to plans that we do not fund because the
funding of such plans does not receive favorable tax treatment.
Financial Statements and Accompanying Notes A19
Savings Plans
Our U.S. employees are eligible to partici-
pate in 401(k) savings plans, which are
voluntary defined contribution plans. The
plans are designed to help employees
accumulate additional savings for retire-
ment. We make matching contributions on
a portion of eligible pay based on years of
service. In 2005 and 2004, our matching
contributions were $52 million and $35
million, respectively.
Future Benefit Payments
Our estimated future benefit payments are as follows:
2006 2007 2008 2009 2010 2011-15
Pension $235 $255 $275 $300 $330 $2,215
Retiree medical $85 $90 $90 $95 $100 $545
These future benefits to beneficiaries include payments from both funded and unfunded pension plans.
Pension Assets
The expected return on pension plan
assets is based on our historical experi-
ence, our pension plan investment guide-
lines, and our expectations for long-term
rates of return. We use a market-related
value method that recognizes each year’s
asset gain or loss over a five-year period.
Therefore, it takes five years for the gain or
loss from any one year to be fully included
in the value of pension plan assets that is
used to calculate the expected return. Our
pension plan investment guidelines are
established based upon an evaluation of
market conditions, tolerance for risk and
cash requirements for benefit payments.
Our investment objective is to ensure that
funds are available to meet the plans’ ben-
efit obligations when they are due. Our
investment strategy is to prudently invest
plan assets in high-quality and diversified
equity and debt securities to achieve our
long-term return expectation. Our target
allocation and actual pension plan asset
allocations for the plan years 2005 and
2004, are below.
Pension assets include approximately
5.5 million shares of PepsiCo common
stock with a market value of $311 million
in 2005, and 5.5 million shares with a
market value of $267 million in 2004. Our
investment policy limits the investment in
PepsiCo stock at the time of investment to
10% of the fair value of plan assets.
1% Increase 1% Decrease
2005 service and interest cost components $3 $(2)
2005 benefit liability $38 $(33)
Actual Allocation
Asset Category Target Allocation 2005 2004
Equity securities 60% 60% 60%
Debt securities 40% 39% 39%
Other, primarily cash – 1% 1%
Total 100% 100% 100%
Our most significant noncontrolled bottling
affiliates are PBG and PAS. Approximately
10% of our net revenue in 2005, 2004
and 2003 reflects sales to PBG.
The Pepsi Bottling Group
In addition to approximately 41% and
42% of PBG’s outstanding common stock
that we own at year-end 2005 and 2004,
respectively, we own 100% of PBG’s class
B common stock and approximately 7% of
the equity of Bottling Group, LLC, PBG’s
principal operating subsidiary. This gives
us economic ownership of approximately
45% and 46% of PBG’s combined opera-
tions at year-end 2005 and 2004, respec-
tively. In 2005, bottling equity income
includes $126 million of pre-tax gains on
our sales of PBG stock.
Note 8 — Noncontrolled Bottling Affiliates
Retiree Medical Cost Trend Rates
An average increase of 10% in the cost of
covered retiree medical benefits is
assumed for 2006. This average increase
is then projected to decline gradually to
5% in 2010 and thereafter. These
assumed health care cost trend rates have
an impact on the retiree medical plan
expense and liability. However, the cap on
our share of retiree medical costs limits
the impact. A 1 percentage point change
in the assumed health care trend rate
would have the following effects:
A20 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Such amounts are settled on terms
consistent with other trade receivables and
payables. See Note 9 regarding our guaran-
tee of certain PBG debt.
In addition, we coordinate, on an aggre-
gate basis, the negotiation and purchase of
sweeteners and other raw materials
requirements for certain of our bottlers
with suppliers. Once we have negotiated
the contracts, the bottlers order and take
delivery directly from the supplier and pay
the suppliers directly. Consequently, these
transactions are not reflected in our
consolidated financial statements. As the
contracting party, we could be liable to
these suppliers in the event of any nonpay-
ment by our bottlers, but we consider this
exposure to be remote.
2005 2004 2003
Net revenue $ 4,633 $ 4,170 $3,699
Selling, general and administrative expenses $143 $114 $128
Accounts and notes receivable $178 $157
Accounts payable and other current liabilities $117 $95
Our investment in PBG, which includes
the related goodwill, was $400 million and
$321 million higher than our ownership
interest in their net assets at year-end
2005 and 2004, respectively. Based upon
the quoted closing price of PBG shares at
year-end 2005 and 2004, the calculated
market value of our shares in PBG, exclud-
ing our investment in Bottling Group, LLC,
exceeded our investment balance by
approximately $1.5 billion and $1.7
billion, respectively.
PepsiAmericas
At year-end 2005 and 2004, we owned approximately 43% and 41% of PepsiAmericas,
respectively, and their summarized financial information is as follows:
2005 2004 2003
Current assets $ 598 $ 530
Noncurrent assets 3,456 3,000
Total assets $4,054 $3,530
Current liabilities $ 722 $ 521
Noncurrent liabilities 1,763 1,386
Total liabilities $2,485 $1,907
Our investment $968 $924
Net revenue $3,726 $3,345 $3,237
Gross profit $1,562 $1,423 $1,360
Operating profit $393 $340 $316
Net income $195 $182 $158
PBG’s summarized financial information is as follows:
2005 2004 2003
Current assets $ 2,412 $ 2,183
Noncurrent assets 9,112 8,754
Total assets $11,524 $10,937
Current liabilities $2,598 $1,725
Noncurrent liabilities 6,387 6,818
Minority interest 496 445
Total liabilities $9,481 $8,988
Our investment $1,738 $1,594
Net revenue $11,885 $10,906 $10,265
Gross profit $5,632 $5,250 $5,050
Operating profit $1,023 $976 $956
Net income $466 $457 $416
Related Party Transactions
Our significant related party transactions
involve our noncontrolled bottling affiliates.
We sell concentrate to these affiliates,
which is used in the production of carbon-
ated soft drinks and non-carbonated bever-
ages. We also sell certain finished goods
to these affiliates and we receive royalties
for the use of our trademarks for certain
products. Sales of concentrate and
finished goods are reported net of bottler
funding. For further unaudited information
on these bottlers, see “Our Customers” in
Management’s Discussion and Analysis.
These transactions with our bottling
affiliates are reflected in our consolidated
financial statements as follows:
Our investment in PAS, which includes
the related goodwill, was $292 million
and $253 million higher than our owner-
ship interest in their net assets at year-end
2005 and 2004, respectively. Based upon
the quoted closing price of PAS shares at
year-end 2005 and 2004, the calculated
market value of our shares in PepsiAmericas
exceeded our investment balance by
approximately $364 million and
$277 million, respectively.
In January 2005, PAS acquired a
regional bottler, Central Investment
Corporation. The table above includes the
results of Central Investment Corporation
from the transaction date forward.
Financial Statements and Accompanying Notes A21
Note 9 — Debt Obligations and Commitments
Short-term borrowings are reclassified to
long-term when we have the intent and
ability, through the existence of the unused
lines of credit, to refinance these borrow-
ings on a long-term basis. At year-end
2005, we maintained $2.1 billion in
corporate lines of credit subject to normal
banking terms and conditions. These credit
facilities support short-term debt issuances
and remained unused as of December 31,
2005. Of the $2.1 billion, $1.35 billion
expires in May 2006 with the remaining
$750 million expiring in June 2009.
In addition, $181 million of our debt
was outstanding on various lines of credit
maintained for our international divisions.
These lines of credit are subject to normal
banking terms and conditions and are
committed to the extent of our borrowings.
Interest Rate Swaps
We entered into interest rate swaps in
2004 to effectively convert the interest rate
of a specific debt issuance from a fixed
rate of 3.2% to a variable rate. The vari-
able weighted-average interest rate that we
pay is linked to LIBOR and is subject to
change. The notional amount of the inter-
est rate swaps outstanding at December
31, 2005 and December 25, 2004 was
$500 million. The terms of the interest
rate swaps match the terms of the debt
they modify. The swaps mature in 2007.
At December 31, 2005, approximately
78% of total debt, after the impact of the
associated interest rate swaps, was exposed
to variable interest rates, compared to 67%
at December 25, 2004. In addition to vari-
able rate long-term debt, all debt with matu-
rities of less than one year is categorized
as variable for purposes of this measure.
Cross Currency Interest Rate Swaps
In 2004, we entered into a cross currency
interest rate swap to hedge the currency
exposure on U.S. dollar denominated debt
of $50 million held by a foreign affiliate.
The terms of this swap match the terms of
the debt it modifies. The swap matures in
2008. The unrecognized gain related to
this swap was less than $1 million at
December 31, 2005, resulting in a U.S.
dollar liability of $50 million. At December
25, 2004, the unrecognized loss related to
this swap was $3 million, resulting in a
U.S. dollar liability of $53 million. We
have also entered into cross currency
interest rate swaps to hedge the currency
exposure on U.S. dollar denominated
intercompany debt of $125 million. The
terms of the swaps match the terms of the
debt they modify. The swaps mature over
the next two years. The net unrecognized
gain related to these swaps was $5 million
at December 31, 2005. The net unrecog-
nized loss related to these swaps was less
than $1 million at December 25, 2004.
2005 2004
Short-term debt obligations
Current maturities of long-term debt $ 143 $ 160
Commercial paper (3.3% and 1.6%) 3,140 1,287
Other borrowings (7.4% and 6.6%) 356 357
Amounts reclassified to long-term debt (750) (750)
$2,889 $1,054
Long-term debt obligations
Short-term borrowings, reclassified $ 750 $ 750
Notes due 2006-2026 (5.4% and 4.7%) 1,161 1,274
Zero coupon notes, $475 million due 2006-2012 (13.4%) 312 321
Other, due 2006-2014 (6.3% and 6.2%) 233 212
2,456 2,557
Less: current maturities of long-term debt obligations (143) (160)
$2,313 $2,397
The interest rates in the above table reflect weighted-average rates as of year-end.
Long-Term Contractual Commitments
Payments Due by Period Total 2006 2007-2008 2009-2010 2011 and beyond
Long-term debt obligations(a) …………………………………………………. $2,313 $ – $1,052 $ 876 $ 385
Operating leases ………………………………………………………………….. 769 187 253 132 197
Purchasing commitments(b) …………………………………………………… 4,533 1,169 1,630 775 959
Marketing commitments………………………………………………………… 1,487 412 438 381 256
Other commitments ………………………………………………………………. 99 82 10 6 1
$9,201 $1,850 $3,383 $2,170 $1,798
(a) Excludes current maturities of long-term debt of $143 million which are classified within current liabilities.
(b) Includes approximately $13 million of long-term commitments which are reflected in other liabilities in our Consolidated Balance Sheet.
The above table reflects non-cancelable commitments as of December 31, 2005 based on year-end foreign exchange rates.
A22 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Most long-term contractual commit-
ments, except for our long-term debt
obligations, are not recorded in our
Consolidated Balance Sheet. Non-cance-
lable operating leases primarily represent
building leases. Non-cancelable purchasing
commitments are primarily for oranges and
orange juices to be used for our Tropicana
brand beverages. Non-cancelable marketing
commitments primarily are for sports
marketing and with our fountain customers.
Bottler funding is not reflected in our
long-term contractual commitments as it is
negotiated on an annual basis. See Note 7
regarding our pension and retiree medical
obligations and discussion below regarding
our commitments to noncontrolled bottling
affiliates and former restaurant operations.
Off-Balance Sheet Arrangements
It is not our business practice to enter into
off-balance sheet arrangements, other than
in the normal course of business, nor is
it our policy to issue guarantees to our
bottlers, noncontrolled affiliates or third
parties. However, certain guarantees were
necessary to facilitate the separation of our
bottling and restaurant operations from us.
In connection with these transactions, we
have guaranteed $2.3 billion of Bottling
Group, LLC’s long-term debt through 2012
and $28 million of YUM! Brands, Inc.
(YUM) outstanding obligations, primarily
property leases, through 2020. The terms
of our Bottling Group, LLC debt guarantee
are intended to preserve the structure of
PBG’s separation from us and our payment
obligation would be triggered if Bottling
Group, LLC failed to perform under these
debt obligations or the structure signifi-
cantly changed. Our guarantees of certain
obligations ensured YUM’s continued use of
certain properties. These guarantees would
require our cash payment if YUM failed to
perform under these lease obligations.
See “Our Liquidity, Capital Resources
and Financial Position” in Management’s
Discussion and Analysis for further
unaudited information on our borrowings.
We are exposed to the risk of loss arising
from adverse changes in:
• commodity prices, affecting the cost of
our raw materials and energy,
• foreign exchange risks,
• interest rates,
• stock prices, and
• discount rates affecting the measure-
ment of our pension and retiree medical
liabilities.
In the normal course of business, we
manage these risks through a variety of
strategies, including the use of derivatives.
Certain derivatives are designated as either
cash flow or fair value hedges and qualify
for hedge accounting treatment, while oth-
ers do not qualify and are marked to market
through earnings. See “Our Business
Risks” in Management’s Discussion and
Analysis for further unaudited information
on our business risks.
For cash flow hedges, changes in fair
value are deferred in accumulated other
comprehensive loss within shareholders’
equity until the underlying hedged item is
recognized in net income. For fair value
hedges, changes in fair value are recognized
immediately in earnings, consistent with the
underlying hedged item. Hedging transac-
tions are limited to an underlying exposure.
As a result, any change in the value of our
derivative instruments would be substan-
tially offset by an opposite change in the
value of the underlying hedged items.
Hedging ineffectiveness and a net earnings
impact occur when the change in the value
of the hedge does not offset the change in
the value of the underlying hedged item. If
the derivative instrument is terminated, we
continue to defer the related gain or loss
and include it as a component of the cost of
the underlying hedged item. Upon determi-
nation that the underlying hedged item
will not be part of an actual transaction, we
recognize the related gain or loss in net
income in that period.
We also use derivatives that do not
qualify for hedge accounting treatment.
We account for such derivatives at market
value with the resulting gains and losses
reflected in our income statement. We do
not use derivative instruments for trading
or speculative purposes and we limit our
exposure to individual counterparties to
manage credit risk.
Commodity Prices
We are subject to commodity price risk
because our ability to recover increased
costs through higher pricing may be
limited in the competitive environment in
which we operate. This risk is managed
through the use of fixed-price purchase
orders, pricing agreements, geographic
diversity and derivatives. We use deriva-
tives, with terms of no more than two
years, to economically hedge price fluctua-
tions related to a portion of our anticipated
commodity purchases, primarily for natural
gas and diesel fuel. For those derivatives
that are designated as cash flow hedges,
any ineffectiveness is recorded immedi-
ately. However, our commodity cash flow
hedges have not had any significant inef-
fectiveness for all periods presented. We
classify both the earnings and cash flow
impact from these derivatives consistent
with the underlying hedged item. During
the next 12 months, we expect to reclas-
sify gains of $24 million related to cash
flow hedges from accumulated other
comprehensive loss into net income.
Foreign Exchange
Our operations outside of the U.S. generate
over a third of our net revenue of which
Mexico, the United Kingdom and Canada
comprise nearly 20%. As a result, we are
exposed to foreign currency risks from
unforeseen economic changes and political
unrest. On occasion, we enter into hedges,
primarily forward contracts with terms of no
more than two years, to reduce the effect of
foreign exchange rates. Ineffectiveness on
these hedges has not been material.
Interest Rates
We centrally manage our debt and invest-
ment portfolios considering investment
opportunities and risks, tax consequences
and overall financing strategies. We may
use interest rate and cross currency
interest rate swaps to manage our overall
interest expense and foreign exchange risk.
These instruments effectively change the
interest rate and currency of specific debt
issuances. These swaps are entered into
Note 10 — Risk Management
Financial Statements and Accompanying Notes A23
concurrently with the issuance of the debt
that they are intended to modify. The
notional amount, interest payment and
maturity date of the swaps match the
principal, interest payment and maturity
date of the related debt. These swaps are
entered into only with strong creditworthy
counterparties, are settled on a net basis
and are of relatively short duration.
Stock Prices
The portion of our deferred compensation
liability that is based on certain market
indices and on our stock price is subject
to market risk. We hold mutual fund
investments and prepaid forward contracts
to manage this risk. Changes in the fair
value of these investments and contracts
are recognized immediately in earnings
and are offset by changes in the related
compensation liability.
Fair Value
All derivative instruments are recognized in
our Consolidated Balance Sheet at fair
value. The fair value of our derivative instru-
ments is generally based on quoted market
prices. Book and fair values of our derivative
and financial instruments are as follows:
2005 2004
Book Value Fair Value Book Value Fair Value
Assets
Cash and cash equivalents(a) ………………………………………………………………………. $1,716 $1,716 $1,280 $1,280
Short-term investments(b) ……………………………………………………………………………. $3,166 $3,166 $2,165 $2,165
Forward exchange contracts(c) ……………………………………………………………………… $19 $19 $8 $8
Commodity contracts(d) ……………………………………………………………………………….. $41 $41 $7 $7
Prepaid forward contract(e) ………………………………………………………………………….. $107 $107 $120 $120
Cross currency interest rate swaps(f) …………………………………………………………….. $6 $6 $– $–
Liabilities
Forward exchange contracts(c) ……………………………………………………………………… $15 $15 $35 $35
Commodity contracts(d) ……………………………………………………………………………….. $3 $3 $8 $8
Debt obligations…………………………………………………………………………………………. $5,202 $5,378 $3,451 $3,676
Interest rate swaps(g) ………………………………………………………………………………….. $9 $9 $1 $1
Cross currency interest rate swaps(f) ……………………………………………………………. $– $– $3 $3
Included in our Consolidated Balance Sheet under the captions noted above or as indicated below. In addition, derivatives are designated as accounting hedges unless otherwise noted below.
(a) Book value approximates fair value due to the short maturity.
(b) Principally short-term time deposits and includes $124 million at December 31, 2005 and $118 million at December 25, 2004 of mutual fund investments used to manage a portion of market risk arising from our
deferred compensation liability.
(c) 2005 asset includes $14 million related to derivatives not designated as accounting hedges. Assets are reported within current assets and other assets and liabilities are reported within current liabilities and
other liabilities.
(d) 2005 asset includes $2 million related to derivatives not designated as accounting hedges and the liability relates entirely to derivatives not designated as accounting hedges. Assets are reported within current
assets and other assets and liabilities are reported within current liabilities and other liabilities.
(e) Included in current assets and other assets.
(f ) Asset included within other assets and liability included in long-term debt.
(g) Reported in other liabilities.
This table excludes guarantees, including our guarantee of $2.3 billion of Bottling Group, LLC’s long-term debt. The guarantee had a
fair value of $47 million at December 31, 2005 and $46 million at December 25, 2004 based on an external estimate of the cost to
us of transferring the liability to an independent financial institution. See Note 9 for additional information on our guarantees.
Basic net income per common share is net
income available to common shareholders
divided by the weighted average of com-
mon shares outstanding during the period.
Diluted net income per common share is
calculated using the weighted average of
common shares outstanding adjusted to
include the effect that would occur if
in-the-money employee stock options were
exercised and RSUs and preferred shares
were converted into common shares.
Options to purchase 3.0 million shares in
2005, 7.0 million shares in 2004 and
49.0 million shares in 2003 were not
included in the calculation of diluted
earnings per common share because these
options were out-of-the-money. Out-of-the-
money options had average exercise prices
of $53.77 in 2005, $52.88 in 2004 and
$48.27 in 2003.
Note 11 — Net Income per Common Share from Continuing Operations
A24 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Comprehensive income is a measure of
income which includes both net income
and other comprehensive income or loss.
Other comprehensive loss results from
items deferred on the balance sheet in
shareholders’ equity. Other comprehensive
(loss)/income was $(167) million in 2005,
$381 million in 2004, and $405 million
in 2003. The accumulated balances for
each component of other comprehensive
loss were as follows:
2005 2004 2003
Currency translation adjustment $ (971) $(720) $(1,121)
Cash flow hedges, net of tax(a) 27 (19) (12)
Minimum pension liability adjustment(b) (138) (154) (135)
Unrealized gain on securities, net of tax 31 7 1
Other (2) – –
Accumulated other comprehensive loss $(1,053) $(886) $(1,267)
(a) Includes net commodity gains of $55 million in 2005. Also includes no impact in 2005, $6 million gain in 2004 and $8 million gain in 2003
for our share of our equity investees’ accumulated derivative activity. Deferred gains/(losses) reclassified into earnings were $8 million in
2005, $(10) million in 2004 and no impact in 2003.
(b) Net of taxes of $72 million in 2005, $77 million in 2004 and $67 million in 2003. Also, includes $120 million in 2005, $121 million in 2004
and $110 million in 2003 for our share of our equity investees’ minimum pension liability adjustments.
As of December 31, 2005 and December
25, 2004, there were 3.6 billion shares of
common stock and 3 million shares of
convertible preferred stock authorized. The
preferred stock was issued only for an
employee stock ownership plan (ESOP)
established by Quaker and these shares
are redeemable for common stock by the
ESOP participants. The preferred stock
accrues dividends at an annual rate of
$5.46 per share. At year-end 2005 and
2004, there were 803,953 preferred
shares issued and 354,853 and 424,853
shares outstanding, respectively. Each
share is convertible at the option of the
holder into 4.9625 shares of common
stock. The preferred shares may be called
by us upon written notice at $78 per share
plus accrued and unpaid dividends.
As of December 31, 2005, 0.3 million
outstanding shares of preferred stock with
a fair value of $104 million and 17 million
shares of common stock were held in the
accounts of ESOP participants. As of
December 25, 2004, 0.4 million outstand-
ing shares of preferred stock with a fair
value of $110 million and 18 million
shares of common stock were held in the
accounts of ESOP participants. Quaker
made the final award to its ESOP plan in
June 2001.
Note 12 — Preferred and Common Stock
2005 2004 2003
Income Shares(a) Income Shares(a) Income Shares(a)
Net income $4,078 $4,174 $3,568
Preferred shares:
Dividends (2) (3) (3)
Redemption premium (16) (22) (12)
Net income available for common shareholders $4,060 1,669 $4,149 1,696 $3,553 1,718
Basic net income per common share $2.43 $2.45 $2.07
Net income available for common shareholders $4,060 1,669 $4,149 1,696 $3,553 1,718
Dilutive securities:
Stock options and RSUs – 35 – 31 – 17
ESOP convertible preferred stock 18 2 24 2 15 3
Unvested stock awards – – – – – 1
Diluted $4,078 1,706 $4,173 1,729 $3,568 1,739
Diluted net income per common share $2.39 $2.41 $2.05
(a) Weighted-average common shares outstanding.
2005 2004 2003
Shares Amount Shares Amount Shares Amount
Preferred stock 0.8 $41 0.8 $41 0.8 $41
Repurchased preferred stock
Balance, beginning of year 0.4 $ 90 0.3 $63 0.2 $48
Redemptions 0.1 19 0.1 27 0.1 15
Balance, end of year 0.5 $110* 0.4 $90 0.3 $63
*Does not sum due to rounding.
Note 13 — Accumulated Other Comprehensive Loss
The computations of basic and diluted net income per common share from continuing operations are as follows:
Financial Statements and Accompanying Notes A25
2005 2004 2003
Accounts receivable
Trade receivables …………………………………………….. $2,718 $2,505
Other receivables …………………………………………….. 618 591
3,336 3,096
Allowance, beginning of year …………………………….. 97 105 $116
Net amounts (credited)/charged to expense …….. (1) 18 32
Deductions(a) ……………………………………………….. (22) (25) (43)
Other(b) ……………………………………………………….. 1 (1) –
Allowance, end of year ……………………………………… 75 97 $105
Net receivables ……………………………………………….. $3,261 $2,999
Inventory(c)
Raw materials…………………………………………………. $ 738 $ 665
Work-in-process ………………………………………………. 112 156
Finished goods ………………………………………………… 843 720
$1,693 $1,541
Accounts payable and other current liabilities
Accounts payable …………………………………………….. $1,799 $1,731
Accrued marketplace spending ………………………….. 1,383 1,285
Accrued compensation and benefits …………………… 1,062 961
Dividends payable……………………………………………. 431 387
Insurance accruals ………………………………………….. 136 131
Other current liabilities …………………………………….. 1,160 1,104
$5,971 $5,599
Other liabilities
Reserves for income taxes…………………………………. $1,884 $1,567
Other ……………………………………………………………… 2,439 2,532
$4,323 $4,099
Other supplemental information
Rent expense…………………………………………………… $228 $245 $231
Interest paid …………………………………………………… $213 $137 $147
Income taxes paid, net of refunds………………………. $1,258 $1,833 $1,530
Acquisitions(d)
Fair value of assets acquired…………………………. $ 1,089 $ 78 $178
Cash paid and debt issued ……………………………. (1,096) (64) (71)
SVE minority interest eliminated…………………….. 216 – –
Liabilities assumed………………………………………. $ 209 $ 14 $107
(a) Includes accounts written off.
(b) Includes collections of previously written-off accounts and currency translation effects.
(c) Inventories are valued at the lower of cost or market. Cost is determined using the average, first-in, first-out (FIFO) or last-in, first-out
(LIFO) methods. Approximately 17% in 2005 and 15% in 2004 of the inventory cost was computed using the LIFO method. The differences
between LIFO and FIFO methods of valuing these inventories were not material.
(d) In 2005, these amounts include the impact of our acquisition of General Mills, Inc.’s 40.5% ownership interest in SVE for $750 million. The
excess of our purchase price over the fair value of net assets acquired is $250 million and is included in goodwill. We also reacquired rights
to distribute global brands for $263 million which is included in other nonamortizable intangible assets.
Note 14 — Supplemental Financial Information
A26 Appendix A Specimen Financial Statements: PepsiCo, Inc.
ADDITIONAL INFORMATION
In addition to the financial statements and accompanying notes, companies are re-
quired to provide a report on internal control over financial reporting and to have
an auditor’s report on the financial statements. In addition, PepsiCo has provided
a report indicating that financial reporting is management’s responsibility. Finally,
PepsiCo also provides selected financial data it believes is useful. The two required
reports are further explained below.
Management’s Report on Internal Control over
Financial Reporting
The Sarbanes-Oxley Act of 2002 requires managers of publicly traded companies
to establish and maintain systems of internal control over the company’s financial
reporting processes. In addition, management must express its responsibility for fi-
nancial reporting, and it must provide certifications regarding the accuracy of the
financial statements.
Auditor’s Report
All publicly held corporations, as well as many other enterprises and organizations
engage the services of independent certified public accountants for the purpose of
obtaining an objective, expert report on their financial statements. Based on a
comprehensive examination of the company’s accounting system, accounting
records, and the financial statements, the outside CPA issues the auditor’s report.
The standard auditor’s report identifies who and what was audited and indi-
cates the responsibilities of management and the auditor relative to the financial
statements. It states that the audit was conducted in accordance with generally ac-
cepted auditing standards and discusses the nature and limitations of the audit. It
then expresses an informed opinion as to (1) the fairness of the financial state-
ments and (2) their conformity with generally accepted accounting principles. It
also expresses an opinion regarding the effectiveness of the company’s internal
controls. All of this additional information for PepsiCo is provided on the follow-
ing pages.
Additional Information A27
At PepsiCo, our actions — the actions of all our associates — are
governed by our Worldwide Code of Conduct. This code is clearly
aligned with our stated values — a commitment to sustained
growth, through empowered people, operating with responsibility
and building trust. Both the code and our core values enable us to
operate with integrity — both within the letter and the spirit of
the law. Our code of conduct is reinforced consistently at all levels
and in all countries. We have maintained strong governance
policies and practices for many years.
The management of PepsiCo is responsible for the objectivity
and integrity of our consolidated financial statements. The Audit
Committee of the Board of Directors has engaged independent
registered public accounting firm, KPMG LLP, to audit our
consolidated financial statements and they have expressed an
unqualified opinion.
We are committed to providing timely, accurate and understand-
able information to investors. Our commitment encompasses
the following:
Maintaining strong controls over financial reporting. Our system of
internal control is based on the control criteria framework of the
Committee of Sponsoring Organizations of the Treadway
Commission published in their report titled, Internal Control —
Integrated Framework. The system is designed to provide reason-
able assurance that transactions are executed as authorized and
accurately recorded; that assets are safeguarded; and that
accounting records are sufficiently reliable to permit the prepara-
tion of financial statements that conform in all material respects
with accounting principles generally accepted in the U.S. We
maintain disclosure controls and procedures designed to ensure
that information required to be disclosed in reports under the
Securities Exchange Act of 1934 is recorded, processed, summa-
rized and reported within the specified time periods. We monitor
these internal controls through self-assessments and an ongoing
program of internal audits. Our internal controls are reinforced
through our Worldwide Code of Conduct, which sets forth our
commitment to conduct business with integrity, and within both
the letter and the spirit of the law.
Exerting rigorous oversight of the business. We continuously review
our business results and strategies. This encompasses financial
discipline in our strategic and daily business decisions. Our
Executive Committee is actively involved — from understanding
strategies and alternatives to reviewing key initiatives and
financial performance. The intent is to ensure we remain objective
in our assessments, constructively challenge our approach to
potential business opportunities and issues, and monitor results
and controls.
Engaging strong and effective Corporate Governance from our Board of
Directors. We have an active, capable and diligent Board that
meets the required standards for independence, and we welcome
the Board’s oversight as a representative of our shareholders. Our
Audit Committee comprises independent directors with the
financial literacy, knowledge and experience to provide appropriate
oversight. We review our critical accounting policies, financial
reporting and internal control matters with them and encourage
their direct communication with KPMG LLP, with our General
Auditor, and with our General Counsel. In 2005, we named a
senior compliance officer to lead and coordinate our compliance
policies and practices.
Providing investors with financial results that are complete,
transparent and understandable. The consolidated financial state-
ments and financial information included in this report are the
responsibility of management. This includes preparing the
financial statements in accordance with accounting principles
generally accepted in the U.S., which require estimates based on
management’s best judgment.
PepsiCo has a strong history of doing what’s right. We realize that
great companies are built on trust, strong ethical standards and
principles. Our financial results are delivered from that culture of
accountability, and we take responsibility for the quality and
accuracy of our financial reporting.
Peter A. Bridgman
Senior Vice President and Controller
Indra K. Nooyi
President and Chief Financial Officer
Steven S Reinemund
Chairman of the Board
and Chief Executive Officer
Management’s Responsibility for Financial Reporting
To Our Shareholders:
A28 Appendix A Specimen Financial Statements: PepsiCo, Inc.
Our management is responsible for establishing and maintaining
adequate internal control over financial reporting, as such term is
defined in Rule 13a-15(f) of the Exchange Act. Under the supervi-
sion and with the participation of our management, including our
Chief Executive Officer and Chief Financial Officer, we conducted
an evaluation of the effectiveness of our internal control over finan-
cial reporting based upon the framework in Internal Control —
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Based on that
evaluation, our management concluded that our internal control
over financial reporting is effective as of December 31, 2005.
KPMG LLP, an independent registered public accounting firm, has
audited the consolidated financial statements included in this
Annual Report and, as part of their audit, has issued their report,
included herein, (1) on our management’s assessment of the effec-
tiveness of our internal controls over financial reporting and (2) on
the effectiveness of our internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
To Our Shareholders:
Peter A. Bridgman
Senior Vice President and Controller
Indra K. Nooyi
President and Chief Financial Officer
Steven S Reinemund
Chairman of the Board
and Chief Executive Officer
Additional Information A29
Report of Independent Registered Public Accounting Firm
We have audited the accompanying Consolidated Balance Sheet of
PepsiCo, Inc. and Subsidiaries as of December 31, 2005 and
December 25, 2004 and the related Consolidated Statements of
Income, Cash Flows and Common Shareholders’ Equity for each of
the years in the three-year period ended December 31, 2005. We
have also audited management’s assessment, included in
Management’s Report on Internal Control over Financial
Reporting, that PepsiCo, Inc. and Subsidiaries maintained
effective internal control over financial reporting as of
December 31, 2005, based on criteria established in Internal
Control — Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO).
PepsiCo, Inc.’s management is responsible for these consolidated
financial statements, for maintaining effective internal control
over financial reporting, and for its assessment of the effective-
ness of internal control over financial reporting. Our responsibility
is to express an opinion on these consolidated financial state-
ments, an opinion on management’s assessment, and an opinion
on the effectiveness of PepsiCo, Inc.’s internal control over
financial reporting based on our audits.
We conducted our audits in accordance with the standards of the
Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audits to
obtain reasonable assurance about whether the financial
statements are free of material misstatement and whether effective
internal control over financial reporting was maintained in all mate-
rial respects. Our audit of financial statements included examining,
on a test basis, evidence supporting the amounts and disclosures
in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluat-
ing the overall financial statement presentation. Our audit of
internal control over financial reporting included obtaining an
understanding of internal control over financial reporting, evaluat-
ing management’s assessment, testing and evaluating the design
and operating effectiveness of internal control, and performing
such other procedures as we considered necessary in the circum-
stances. We believe that our audits provide a reasonable basis for
our opinions.
A company’s internal control over financial reporting is a
process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally
accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of
the assets of the company; (2) provide reasonable assurance that
transactions are recorded as necessary to permit preparation of
financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations
of management and directors of the company; and (3) provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over finan-
cial reporting may not prevent or detect misstatements. Also,
projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because
of changes in conditions, or that the degree of compliance with
the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to
above present fairly, in all material respects, the financial position
of PepsiCo, Inc. and Subsidiaries as of December 31, 2005 and
December 25, 2004, and the results of their operations and their
cash flows for each of the years in the three-year period ended
December 31, 2005, in conformity with United States generally
accepted accounting principles. Also, in our opinion, manage-
ment’s assessment that PepsiCo, Inc. maintained effective
internal control over financial reporting as of December 31, 2005,
is fairly stated, in all material respects, based on criteria
established in Internal Control — Integrated Framework issued by
COSO. Furthermore, in our opinion, PepsiCo, Inc. maintained, in
all material respects, effective internal control over financial
reporting as of December 31, 2005, based on criteria established
in Internal Control — Integrated Framework issued by COSO.
KPMG LLP
New York, New York
February 24, 2006
Board of Directors and Shareholders PepsiCo, Inc.:
A30 Appendix A Specimen Financial Statements: PepsiCo, Inc.
First Second Third Fourth
Quarterly Quarter Quarter Quarter Quarter
Net revenue
2005 $6,585 $7,697 $8,184 $10,096
2004 $6,131 $7,070 $7,257 $8,803
Gross profit(a)
2005 $3,715 $4,383 $4,669 $5,619
2004 $3,466 $4,039 $4,139 $4,943
2005 restructuring charges(b)
2005 – – – $83
2004 restructuring and
impairment charges(c)
2004 – – – $150
AJCA tax charge(d)
2005 – – $468 $(8)
Net income(e)
2005 $912 $1,194 $864 $1,108
2004 $804 $1,059 $1,364 $985
Net income per common
share — basic(e)
2005 $0.54 $0.71 $0.52 $0.66
2004 $0.47 $0.62 $0.80 $0.58
Net income per common
share — diluted(e)
2005 $0.53 $0.70 $0.51 $0.65
2004 $0.46 $0.61 $0.79 $0.58
Cash dividends declared per
common share
2005 $0.23 $0.26 $0.26 $0.26
2004 $0.16 $0.23 $0.23 $0.23
2005 stock price per share(f)
High $55.71 $57.20 $56.73 $60.34
Low $51.34 $51.78 $52.07 $53.55
Close $52.62 $55.52 $54.65 $59.08
2004 stock price per share(f)
High $53.00 $55.48 $55.71 $53.00
Low $45.30 $50.28 $48.41 $47.37
Close $50.93 $54.95 $50.84 $51.94
The first, second, and third quarters consist of 12 weeks and the fourth quarter consists of 16 weeks in 2004
and 17 weeks in 2005.
(a) Reflects net reclassifications in all periods from cost of sales to selling, general and administrative
expenses related to the alignment of certain accounting policies in connection with our ongoing BPT
initiative. See Note 1.
(b) The 2005 restructuring charges were $83 million ($55 million or $0.03 per share after-tax). See Note 3.
(c) The 2004 restructuring and impairment charges were $150 million ($96 million or $0.06 per share
after-tax). See Note 3.
(d) Represents income tax expense associated with the repatriation of earnings in connection with the AJCA.
See Note 5.
(e) Fourth quarter 2004 net income reflects a tax benefit from discontinued operations of $38 million or
$0.02 per share. See Note 5.
(f) Represents the composite high and low sales price and quarterly closing prices for one share of PepsiCo
common stock.
Five-Year Summary 2005 2004 2003
Net revenue $32,562 $29,261 $26,971
Income from continuing operations $4,078 $4,174 $3,568
Net income $4,078 $4,212 $3,568
Income per common share — basic,
continuing operations $2.43 $2.45 $2.07
Income per common share — diluted,
continuing operations $2.39 $2.41 $2.05
Cash dividends declared per common share $1.01 $0.850 $0.630
Total assets $31,727 $27,987 $25,327
Long-term debt $2,313 $2,397 $1,702
Return on invested capital(a) 22.7% 27.4% 27.5%
Five-Year Summary (Cont.) 2002 2001
Net revenue $25,112 $23,512
Net income $3,000 $2,400
Income per common share — basic $1.69 $1.35
Income per common share — diluted $1.68 $1.33
Cash dividends declared per common share $0.595 $0.575
Total assets $23,474 $21,695
Long-term debt $2,187 $2,651
Return on invested capital(a) 25.7% 22.1%
(a) Return on invested capital is defined as adjusted net income divided by the sum of average
shareholders’ equity and average total debt. Adjusted net income is defined as net income plus net
interest expense after tax. Net interest expense after tax was $62 million in 2005, $60 million in
2004, $72 million in 2003, $93 million in 2002, and $99 million in 2001.
• As a result of the adoption of SFAS 142, Goodwill and Other Intangible Assets, and the consolidation
of SVE in 2002, the data provided above is not comparable.
• Includes restructuring and impairment charges of:
2005 2004 2003 2001
Pre-tax $83 $150 $147 $31
After-tax $55 $96 $100 $19
Per share $0.03 $0.06 $0.06 $0.01
• Includes Quaker merger-related costs of:
2003 2002 2001
Pre-tax $59 $224 $356
After-tax $42 $190 $322
Per share $0.02 $0.11 $0.18
• The 2005 fiscal year consisted of fifty-three weeks compared to fifty-two weeks in our normal fiscal
year. The 53rd week increased 2005 net revenue by an estimated $418 million and net income by an
estimated $57 million or $0.03 per share.
• Cash dividends per common share in 2001 are those of pre-merger PepsiCo prior to the effective
date of the merger.
• In the fourth quarter of 2004, we reached agreement with the IRS for an open issue related to
our discontinued restaurant operations which resulted in a tax benefit of $38 million or $0.02
per share.
Selected Financial Data (in millions except per share amounts, unaudited)
SPECIMEN FINANCIAL STATEMENTS:
The Coca-Cola Company
Appendix B
B1
THE COCA-COLA COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Year Ended December 31, 2005 2004 2003
(In millions except per share data)
NET OPERATING REVENUES $ 23,104 $ 21,742 $ 20,857
Cost of goods sold 8,195 7,674 7,776
GROSS PROFIT 14,909 14,068 13,081
Selling, general and administrative expenses 8,739 7,890 7,287
Other operating charges 85 480 573
OPERATING INCOME 6,085 5,698 5,221
Interest income 235 157 176
Interest expense 240 196 178
Equity income — net 680 621 406
Other loss — net (93) (82) (138)
Gains on issuances of stock by equity investees 23 24 8
INCOME BEFORE INCOME TAXES 6,690 6,222 5,495
Income taxes 1,818 1,375 1,148
NET INCOME $ 4,872 $ 4,847 $ 4,347
BASIC NET INCOME PER SHARE $ 2.04 $ 2.00 $ 1.77
DILUTED NET INCOME PER SHARE $ 2.04 $ 2.00 $ 1.77
AVERAGE SHARES OUTSTANDING 2,392 2,426 2,459
Effect of dilutive securities 1 3 3
AVERAGE SHARES OUTSTANDING ASSUMING DILUTION 2,393 2,429 2,462
Refer to Notes to Consolidated Financial Statements.
The financial information herein is reprinted with permission from The Coca-Cola Company 2005
Annual Report. The accompanying Notes are an integral part of the consolidated financial state-
ments. The complete financial statements are available through a link at the book’s companion
website.
B2 Appendix B Specimen Financial Statements: The Coca-Cola Company
THE COCA-COLA COMPANY AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 2005 2004
(In millions except par value)
ASSETS
CURRENT ASSETS
Cash and cash equivalents $ 4,701 $ 6,707
Marketable securities 66 61
Trade accounts receivable, less allowances of $72 and $69, respectively 2,281 2,244
Inventories 1,424 1,420
Prepaid expenses and other assets 1,778 1,849
TOTAL CURRENT ASSETS 10,250 12,281
INVESTMENTS
Equity method investments:
Coca-Cola Enterprises Inc. 1,731 1,569
Coca-Cola Hellenic Bottling Company S.A. 1,039 1,067
Coca-Cola FEMSA, S.A. de C.V. 982 792
Coca-Cola Amatil Limited 748 736
Other, principally bottling companies 2,062 1,733
Cost method investments, principally bottling companies 360 355
TOTAL INVESTMENTS 6,922 6,252
OTHER ASSETS 2,648 2,981
PROPERTY, PLANT AND EQUIPMENT — net 5,786 6,091
TRADEMARKS WITH INDEFINITE LIVES 1,946 2,037
GOODWILL 1,047 1,097
OTHER INTANGIBLE ASSETS 828 702
TOTAL ASSETS $ 29,427 $ 31,441
LIABILITIES AND SHAREOWNERS’ EQUITY
CURRENT LIABILITIES
Accounts payable and accrued expenses $ 4,493 $ 4,403
Loans and notes payable 4,518 4,531
Current maturities of long-term debt 28 1,490
Accrued income taxes 797 709
TOTAL CURRENT LIABILITIES 9,836 11,133
LONG-TERM DEBT 1,154 1,157
OTHER LIABILITIES 1,730 2,814
DEFERRED INCOME TAXES 352 402
SHAREOWNERS’ EQUITY
Common stock, $0.25 par value; Authorized — 5,600 shares;
Issued — 3,507 and 3,500 shares, respectively 877 875
Capital surplus 5,492 4,928
Reinvested earnings 31,299 29,105
Accumulated other comprehensive income (loss) (1,669) (1,348)
Treasury stock, at cost — 1,138 and 1,091 shares, respectively (19,644) (17,625)
TOTAL SHAREOWNERS’ EQUITY 16,355 15,935
TOTAL LIABILITIES AND SHAREOWNERS’ EQUITY $ 29,427 $ 31,441
Refer to Notes to Consolidated Financial Statements.
Specimen Financial Statements: The Coca-Cola Company B3
THE COCA-COLA COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year Ended December 31, 2005 2004 2003
(In millions)
OPERATING ACTIVITIES
Net income $ 4,872 $ 4,847 $ 4,347
Depreciation and amortization 932 893 850
Stock-based compensation expense 324 345 422
Deferred income taxes (88) 162 (188)
Equity income or loss, net of dividends (446) (476) (294)
Foreign currency adjustments 47 (59) (79)
Gains on issuances of stock by equity investees (23) (24) (8)
Gains on sales of assets, including bottling interests (9) (20) (5)
Other operating charges 85 480 330
Other items 299 437 249
Net change in operating assets and liabilities 430 (617) (168)
Net cash provided by operating activities 6,423 5,968 5,456
INVESTING ACTIVITIES
Acquisitions and investments, principally trademarks and bottling companies (637) (267) (359)
Purchases of investments and other assets (53) (46) (177)
Proceeds from disposals of investments and other assets 33 161 147
Purchases of property, plant and equipment (899) (755) (812)
Proceeds from disposals of property, plant and equipment 88 341 87
Other investing activities (28) 63 178
Net cash used in investing activities (1,496) (503) (936)
FINANCING ACTIVITIES
Issuances of debt 178 3,030 1,026
Payments of debt (2,460) (1,316) (1,119)
Issuances of stock 230 193 98
Purchases of stock for treasury (2,055) (1,739) (1,440)
Dividends (2,678) (2,429) (2,166)
Net cash used in financing activities (6,785) (2,261) (3,601)
EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH
EQUIVALENTS (148) 141 183
CASH AND CASH EQUIVALENTS
Net increase (decrease) during the year (2,006) 3,345 1,102
Balance at beginning of year 6,707 3,362 2,260
Balance at end of year $ 4,701 $ 6,707 $ 3,362
Refer to Notes to Consolidated Financial Statements.
B4 Appendix B Specimen Financial Statements: The Coca-Cola Company
THE COCA-COLA COMPANY AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREOWNERS’ EQUITY
Year Ended December 31, 2005 2004 2003
(In millions except per share data)
NUMBER OF COMMON SHARES OUTSTANDING
Balance at beginning of year 2,409 2,442 2,471
Stock issued to employees exercising stock options 7 5 4
Purchases of stock for treasury1 (47) (38) (33)
Balance at end of year 2,369 2,409 2,442
COMMON STOCK
Balance at beginning of year $ 875 $ 874 $ 873
Stock issued to employees exercising stock options 2 1 1
Balance at end of year 877 875 874
CAPITAL SURPLUS
Balance at beginning of year 4,928 4,395 3,857
Stock issued to employees exercising stock options 229 175 105
Tax benefit from employees’ stock option and restricted stock plans 11 13 11
Stock-based compensation 324 345 422
Balance at end of year 5,492 4,928 4,395
REINVESTED EARNINGS
Balance at beginning of year 29,105 26,687 24,506
Net income 4,872 4,847 4,347
Dividends (per share — $1.12, $1.00 and $0.88 in 2005, 2004 and 2003, respectively) (2,678) (2,429) (2,166)
Balance at end of year 31,299 29,105 26,687
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
Balance at beginning of year (1,348) (1,995) (3,047)
Net foreign currency translation adjustment (396) 665 921
Net gain (loss) on derivatives 57 (3) (33)
Net change in unrealized gain on available-for-sale securities 13 39 40
Net change in minimum pension liability 5 (54) 124
Net other comprehensive income adjustments (321) 647 1,052
Balance at end of year (1,669) (1,348) (1,995)
TREASURY STOCK
Balance at beginning of year (17,625) (15,871) (14,389)
Purchases of treasury stock (2,019) (1,754) (1,482)
Balance at end of year (19,644) (17,625) (15,871)
TOTAL SHAREOWNERS’ EQUITY $ 16,355 $ 15,935 $ 14,090
COMPREHENSIVE INCOME
Net income $ 4,872 $ 4,847 $ 4,347
Net other comprehensive income adjustments (321) 647 1,052
TOTAL COMPREHENSIVE INCOME $ 4,551 $ 5,494 $ 5,399
1 Common stock purchased from employees exercising stock options numbered 0.5 shares, 0.4 shares and 0.4 shares for the years
ended December 31, 2005, 2004 and 2003, respectively.
Refer to Notes to Consolidated Financial Statements.
Time Value of Money
Appendix C
C1
Would you rather receive $1,000 today or a year from now? You should prefer
to receive the $1,000 today because you can invest the $1,000 and earn interest
on it. As a result, you will have more than $1,000 a year from now. What this
example illustrates is the concept of the time value of money. Everyone
prefers to receive money today rather than in the future because of the interest
factor.
S T U D Y O B J E C T I V E S
After studying this appendix, you should be able to:
1 Distinguish between simple and compound interest.
2 Solve for future value of a single amount.
3 Solve for future value of an annuity.
4 Identify the variables fundamental to solving present value
problems.
5 Solve for present value of a single amount.
6 Solve for present value of an annuity.
7 Compute the present value of notes and bonds.
8 Use a financial calculator to solve time value of money problems.
THE NATURE OF INTEREST
Interest is payment for the use of another person’s money. It is the difference be-
tween the amount borrowed or invested (called the principal) and the amount re-
paid or collected. The amount of interest to be paid or collected is usually stated as
a rate over a specific period of time. The rate of interest is generally stated as an
annual rate.
The amount of interest involved in any financing transaction is based on three
elements:
1. Principal (p): The original amount borrowed or invested.
2. Interest Rate (i): An annual percentage of the principal.
3. Time (n): The number of years that the principal is borrowed or invested.
Simple Interest
Simple interest is computed on the principal amount only. It is the return
on the principal for one period. Simple interest is usually expressed as
shown in Illustration C-1 on the next page.
Distinguish between simple and
compound interest.
S T U D Y O B J E C T I V E 1
C2 Appendix C Time Value of Money
Interest � � �
For example, if you borrowed $5,000 for 2 years at a simple interest rate of 12%
annually, you would pay $1,200 in total interest computed as follows:
Interest � p � i � n
� $5,000 � .12 � 2
� $1,200
Time
n
Rate
i
Principal
p
Illustration C-1
Interest computation
Compound Interest
Compound interest is computed on principal and on any interest earned that has
not been paid or withdrawn. It is the return on the principal for two or more time
periods. Compounding computes interest not only on the principal but also on the
interest earned to date on that principal, assuming the interest is left on deposit.
To illustrate the difference between simple and compound interest, assume
that you deposit $1,000 in Bank Two, where it will earn simple interest of 9% per
year, and you deposit another $1,000 in Citizens Bank, where it will earn com-
pound interest of 9% per year compounded annually. Also assume that in both
cases you will not withdraw any interest until three years from the date of deposit.
Illustration C-2 shows the computation of interest you will receive and the accu-
mulated year-end balances.
Illustration C-2
Simple versus compound
interest
Note in Illustration C-2 that simple interest uses the initial principal of $1,000
to compute the interest in all three years. Compound interest uses the accumu-
lated balance (principal plus interest to date) at each year-end to compute inter-
est in the succeeding year—which explains why your compound interest account
is larger.
Obviously, if you had a choice between investing your money at simple interest
or at compound interest, you would choose compound interest, all other things—
especially risk—being equal. In the example, compounding provides $25.03 of ad-
ditional interest income. For practical purposes, compounding assumes that unpaid
interest earned becomes a part of the principal, and the accumulated balance at the
Simple Interest
Calculation
Year 1
Year 2
Year 3
$1,000.00 × 9%
$1,000.00 × 9%
$1,000.00 × 9%
$
$
90.00
90.00
90.00
270.00
$1,090.00
$1,180.00
$1,270.00
$25.03
Difference
Simple
Interest
Accumulated
Year-end
Balance
Bank Two
Compound Interest
Calculation
Year 1
Year 2
Year 3
$1,000.00 × 9%
$1,090.00 × 9%
$1,188.10 × 9%
$
$
90.00
98.10
106.93
295.03
$1,090.00
$1,188.10
$1,295.03
Compound
Interest
Accumulated
Year-end
Balance
Citizens Bank
Future Value of a Single Amount C3
SECTION 1 Future Value Concepts
FUTURE VALUE OF A SINGLE AMOUNT
Illustration C-4
Time diagram
FV � p � (1 � i )n
Illustration C-3
Formula for future value
where:
FV � future value of a single amount
p � principal (or present value)
i � interest rate for one period
n � number of periods
The $1,295.03 is computed as follows.
FV � p � (1 � i)n
� $1,000 � (1 � i)3
� $1,000 � 1.29503
� $1,295.03
The 1.29503 is computed by multiplying (1.09 � 1.09 � 1.09). The amounts in this
example can be depicted in the following time diagram.
The future value of a single amount is the value at a future date of a
given amount invested assuming compound interest. For example, in
Illustration C-2, $1,295.03 is the future value of the $1,000 at the end of
three years. The $1,295.03 could be determined more easily by using the
following formula.
end of each year becomes the new principal on which interest is earned during the
next year.
Illustration C-2 indicates that you should invest your money at the bank that
compounds interest annually. Most business situations use compound interest.
Simple interest is generally applicable only to short-term situations of one year
or less.
Present Value (p)
0
$1,000
1 2 3
$1,295.03
i = 9% Future
Value
n = 3 years
Solve for future value of a single
amount.
S T U D Y O B J E C T I V E 2
In Table 1, n is the number of compounding periods, the percentages are the peri-
odic interest rates, and the five-digit decimal numbers in the respective columns are
the future value of 1 factors. In using Table 1, the principal amount is multiplied by
the future value factor for the specified number of periods and interest rate. For ex-
ample, the future value factor for two periods at 9% is 1.18810. Multiplying this
factor by $1,000 equals $1,188.10, which is the accumulated balance at the end of
year 2 in the Citizens Bank example in Illustration C-2. The $1,295.03 accumulated
balance at the end of the third year can be calculated from Table 1 by multiplying
the future value factor for three periods (1.29503) by the $1,000.
The following demonstration problem illustrates how to use Table 1.
C4 Appendix C Time Value of Money
TABLE 1
Future Value of 1
(n)
Periods 4% 5% 6% 8% 9% 10% 11% 12% 15%
1 1.04000 1.05000 1.06000 1.08000 1.09000 1.10000 1.11000 1.12000 1.15000
2 1.08160 1.10250 1.12360 1.16640 1.18810 1.21000 1.23210 1.25440 1.32250
3 1.12486 1.15763 1.19102 1.25971 1.29503 1.33100 1.36763 1.40493 1.52088
4 1.16986 1.21551 1.26248 1.36049 1.41158 1.46410 1.51807 1.57352 1.74901
5 1.21665 1.27628 1.33823 1.46933 1.53862 1.61051 1.68506 1.76234 2.01136
6 1.26532 1.34010 1.41852 1.58687 1.67710 1.77156 1.87041 1.97382 2.31306
7 1.31593 1.40710 1.50363 1.71382 1.82804 1.94872 2.07616 2.21068 2.66002
8 1.36857 1.47746 1.59385 1.85093 1.99256 2.14359 2.30454 2.47596 3.05902
9 1.42331 1.55133 1.68948 1.99900 2.17189 2.35795 2.55803 2.77308 3.51788
10 1.48024 1.62889 1.79085 2.15892 2.36736 2.59374 2.83942 3.10585 4.04556
11 1.53945 1.71034 1.89830 2.33164 2.58043 2.85312 3.15176 3.47855 4.65239
12 1.60103 1.79586 2.01220 2.51817 2.81267 3.13843 3.49845 3.89598 5.35025
13 1.66507 1.88565 2.13293 2.71962 3.06581 3.45227 3.88328 4.36349 6.15279
14 1.73168 1.97993 2.26090 2.93719 3.34173 3.79750 4.31044 4.88711 7.07571
15 1.80094 2.07893 2.39656 3.17217 3.64248 4.17725 4.78459 5.47357 8.13706
16 1.87298 2.18287 2.54035 3.42594 3.97031 4.59497 5.31089 6.13039 9.35762
17 1.94790 2.29202 2.69277 3.70002 4.32763 5.05447 5.89509 6.86604 10.76126
18 2.02582 2.40662 2.85434 3.99602 4.71712 5.55992 6.54355 7.68997 12.37545
19 2.10685 2.52695 3.02560 4.31570 5.14166 6.11591 7.26334 8.61276 14.23177
20 2.19112 2.65330 3.20714 4.66096 5.60441 6.72750 8.06231 9.64629 16.36654
Another method that can be used to compute the future value of a single
amount involves the use of a compound interest table. This table shows the future
value of 1 for n periods. Table 1, shown below, is such a table.
Future Value of an Annuity C5
FUTURE VALUE OF AN ANNUITY
The preceding discussion involved the accumulation of only a single
principal sum. Individuals and businesses frequently encounter situa-
tions in which a series of equal dollar amounts are to be paid or received
periodically, such as loans or lease (rental) contracts. Such payments or
receipts of equal dollar amounts are referred to as annuities. The future value of
an annuity is the sum of all the payments (receipts) plus the accumulated com-
pound interest on them. In computing the future value of an annuity, it is neces-
sary to know (1) the interest rate, (2) the number of compounding periods, and
(3) the amount of the periodic payments or receipts.
To illustrate the computation of the future value of an annuity, assume that you
invest $2,000 at the end of each year for three years at 5% interest compounded
annually. This situation is depicted in the time diagram in Illustration C-6.
Solve for future value of an
annuity.
S T U D Y O B J E C T I V E 3
Illustration C-5
Demonstration Problem—
Using Table 1 for FV of 1
0
$20,000
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
i = 6%
Future
Value = ?Present Value (p)
n = 18 years
John and Mary Rich invested $20,000 in a savings account paying 6% interest at the time their son,
Mike, was born. The money is to be used by Mike for his college education. On his 18th birthday,
Mike withdraws the money from his savings account. How much did Mike withdraw from his account?
Answer: The future value factor from Table 1 is 2.85434 (18 periods at 6%). The future value of
$20,000 earning 6% per year for 18 years is $57,086.80 ($20,000 × 2.85434).
Illustration C-6
Time diagram for a three-
year annuity
0 1 2 3
$2,000
Present
Value $2,000 $2,000
i = 5% Future
Value = ?
n = 3 years
C6 Appendix C Time Value of Money
TABLE 2
Future Value of an Annuity of 1
(n)
Periods 4% 5% 6% 8% 9% 10% 11% 12% 15%
1 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000 1.00000
2 2.04000 2.05000 2.06000 2.08000 2.09000 2.10000 2.11000 2.12000 2.15000
3 3.12160 3.15250 3.18360 3.24640 3.27810 3.31000 3.34210 3.37440 3.47250
4 4.24646 4.31013 4.37462 4.50611 4.57313 4.64100 4.70973 4.77933 4.99338
5 5.41632 5.52563 5.63709 5.86660 5.98471 6.10510 6.22780 6.35285 6.74238
6 6.63298 6.80191 6.97532 7.33592 7.52334 7.71561 7.91286 8.11519 8.75374
7 7.89829 8.14201 8.39384 8.92280 9.20044 9.48717 9.78327 10.08901 11.06680
8 9.21423 9.54911 9.89747 10.63663 11.02847 11.43589 11.85943 12.29969 13.72682
9 10.58280 11.02656 11.49132 12.48756 13.02104 13.57948 14.16397 14.77566 16.78584
10 12.00611 12.57789 13.18079 14.48656 15.19293 15.93743 16.72201 17.54874 20.30372
11 13.48635 14.20679 14.97164 16.64549 17.56029 18.53117 19.56143 20.65458 24.34928
12 15.02581 15.91713 16.86994 18.97713 20.14072 21.38428 22.71319 24.13313 29.00167
13 16.62684 17.71298 18.88214 21.49530 22.95339 24.52271 26.21164 28.02911 34.35192
14 18.29191 19.59863 21.01507 24.21492 26.01919 27.97498 30.09492 32.39260 40.50471
15 20.02359 21.57856 23.27597 27.15211 29.36092 31.77248 34.40536 37.27972 47.58041
16 21.82453 23.65749 25.67253 30.32428 33.00340 35.94973 39.18995 42.75328 55.71747
17 23.69751 25.84037 28.21288 33.75023 36.97351 40.54470 44.50084 48.88367 65.07509
18 25.64541 28.13238 30.90565 37.45024 41.30134 45.59917 50.39593 55.74972 75.83636
19 27.67123 30.53900 33.75999 41.44626 46.01846 51.15909 56.93949 63.43968 88.21181
20 29.77808 33.06595 36.78559 45.76196 51.16012 57.27500 64.20283 72.05244 102.44358
Illustration C-7
Future value of periodic
payments
Year Amount Future Value of Future
Invested Invested � 1 Factor at 5% � Value
1 $2,000 � 1.10250 � $2,205
2 $2,000 � 1.05000 � 2,100
3 $2,000 � 1.00000 � 2,000
3.15250 $6,305
As can be seen in Illustration C-6, the $2,000 invested at the end of year 1 will
earn interest for two years (years 2 and 3), and the $2,000 invested at the end of
year 2 will earn interest for one year (year 3). However, the last $2,000 investment
(made at the end of year 3) will not earn any interest. The future value of these pe-
riodic payments could be computed using the future value factors from Table 1 as
shown in Illustration C-7.
The first $2,000 investment is multiplied by the future value factor for two periods
(1.1025) because two years’ interest will accumulate on it (in years 2 and 3). The
second $2,000 investment will earn only one year’s interest (in year 3) and there-
fore is multiplied by the future value factor for one year (1.0500). The final $2,000
investment is made at the end of the third year and will not earn any interest.
Consequently, the future value of the last $2,000 invested is only $2,000 since it
does not accumulate any interest.
This method of calculation is required when the periodic payments or receipts
are not equal in each period. However, when the periodic payments (receipts) are
the same in each period, the future value can be computed by using a future value
of an annuity of 1 table. Table 2, shown below, is such a table.
Present Value Variables C7
Illustration C-8
Demonstration Problem—
Using Table 2 for FV of an
annuity of 1
0 1 2 3 4
$25,000
Present
Value $25,000 $25,000 $25,000
i = 6% Future
Value = ?
n = 4 years
Henning Printing Company knows that in four years it must replace one of its existing printing
presses with a new one. To insure that some funds are available to replace the machine in
4 years, the company is depositing $25,000 in a savings account at the end of each of the
next four years (4 deposits in total). The savings account will earn 6% interest compounded
annually. How much will be in the savings account at the end of 4 years when the new
printing press is to be purchased?
Answer: The future value factor from Table 2 is 4.37462 (4 periods at 6%). The future value of
$25,000 invested at the end of each year for 4 years at 6% interest is $109,365.50
($25,000 × 4.37462).
Table 2 shows the future value of 1 to be received periodically for a given number
of periods. You can see from Table 2 that the future value of an annuity of 1 factor
for three periods at 5% is 3.15250. The future value factor is the total of the three
individual future value factors as shown in Illustration C-8. Multiplying this
amount by the annual investment of $2,000 produces a future value of $6,305.
The demonstration problem in Illustration C-8 illustrates how to use Table 2.
SECTION 2 Present Value Concepts
PRESENT VALUE VARIABLES
The present value is the value now of a given amount to be paid or re-
ceived in the future, assuming compound interest. The present value is
based on three variables: (1) the dollar amount to be received (future
amount), (2) the length of time until the amount is received (number of
periods), and (3) the interest rate (the discount rate). The process of determining
the present value is referred to as discounting the future amount.
In this textbook, we use present value computations in measuring several
items. For example, Chapter 11 computed the present value of the principal and in-
terest payments to determine the market price of a bond. In addition, determining
the amount to be reported for notes payable involves present value computations.
Identify the variables fundamental
to solving present value problems.
S T U D Y O B J E C T I V E 4
To illustrate present value, assume that you want to invest a sum of money
that will yield $1,000 at the end of one year. What amount would you need
to invest today to have $1,000 one year from now? Illustration C-9 shows
the formula for calculating present value.
C8 Appendix C Time Value of Money
PRESENT VALUE OF A SINGLE AMOUNT
Present Value � Future Value � (1 � i )n
Illustration C-9
Formula for present value
Thus, if you want a 10% rate of return, you would compute the present value of
$1,000 for one year as follows:
PV � FV � (1 � i)n
� $1,000 � (1 � .10)1
PV � $1,000 � 1.10
PV � $909.09
We know the future amount ($1,000), the discount rate (10%), and the
number of periods (one). These variables are depicted in the time diagram in
Illustration C-10.
Illustration C-10
Finding present value if dis-
counted for one period
i = 10%
n = 1 year
Present
Value (?)
$909.09
Future
Value
$1,000
If you receive the single amount of $1,000 in two years, discounted at
10% [PV � $1,000 � (1 � .10)2], the present value of your $1,000 is $826.45
[($1,000 � 1.21), depicted as shown in Illustration C-11 below.
Illustration C-11
Finding present value if
discounted for two periods
You also could find the present value of your amount through tables that show
the present value of 1 for n periods. In Table 3, on the next page, n (represented in
i = 10%
1
Present
Value (?)
0
Future
Value
2
n = 2 years$826.45 $1,000
Solve for present value of a single
amount.
S T U D Y O B J E C T I V E 5
Present Value of a Single Amount C9
For example, the present value factor for one period at a discount rate of 10%
is .90909, which equals the $909.09 ($1,000 � .90909) computed in Illustration C-10.
For two periods at a discount rate of 10%, the present value factor is .82645, which
equals the $826.45 ($1,000 � .82645) computed previously.
Note that a higher discount rate produces a smaller present value. For example,
using a 15% discount rate, the present value of $1,000 due one year from now is
$869.57, versus $909.09 at 10%. Also note that the further removed from the pres-
ent the future value is, the smaller the present value. For example, using the same
discount rate of 10%, the present value of $1,000 due in five years is $620.92, ver-
sus the present value of $1,000 due in one year, which is $909.09.
The two demonstration problems on the next page (Illustrations C-12, C-13)
illustrate how to use Table 3.
TABLE 3
Present Value of 1
(n)
Periods 4% 5% 6% 8% 9% 10% 11% 12% 15%
1 .96154 .95238 .94340 .92593 .91743 .90909 .90090 .89286 .86957
2 .92456 .90703 .89000 .85734 .84168 .82645 .81162 .79719 .75614
3 .88900 .86384 .83962 .79383 .77218 .75132 .73119 .71178 .65752
4 .85480 .82270 .79209 .73503 .70843 .68301 .65873 .63552 .57175
5 .82193 .78353 .74726 .68058 .64993 .62092 .59345 .56743 .49718
6 .79031 .74622 .70496 .63017 .59627 .56447 .53464 .50663 .43233
7 .75992 .71068 .66506 .58349 .54703 .51316 .48166 .45235 .37594
8 .73069 .67684 .62741 .54027 .50187 .46651 .43393 .40388 .32690
9 .70259 .64461 .59190 .50025 .46043 .42410 .39092 .36061 .28426
10 .67556 .61391 .55839 .46319 .42241 .38554 .35218 .32197 .24719
11 .64958 .58468 .52679 .42888 .38753 .35049 .31728 .28748 .21494
12 .62460 .55684 .49697 .39711 .35554 .31863 .28584 .25668 .18691
13 .60057 .53032 .46884 .36770 .32618 .28966 .25751 .22917 .16253
14 .57748 .50507 .44230 .34046 .29925 .26333 .23199 .20462 .14133
15 .55526 .48102 .41727 .31524 .27454 .23939 .20900 .18270 .12289
16 .53391 .45811 .39365 .29189 .25187 .21763 .18829 .16312 .10687
17 .51337 .43630 .37136 .27027 .23107 .19785 .16963 .14564 .09293
18 .49363 .41552 .35034 .25025 .21199 .17986 .15282 .13004 .08081
19 .47464 .39573 .33051 .23171 .19449 .16351 .13768 .11611 .07027
20 .45639 .37689 .31180 .21455 .17843 .14864 .12403 .10367 .06110
the table’s rows) is the number of discounting periods involved. The percentages
(represented in the table’s columns) are the periodic interest rates or discount
rates. The five-digit decimal numbers in the intersections of the rows and columns
are called the present value of 1 factors.
When using Table 3 to determine present value, you multiply the future value
by the present value factor specified at the intersection of the number of periods
and the discount rate.
C10 Appendix C Time Value of Money
Illustration C-13
Demonstration problem—
Using Table 3 for PV of 1
PRESENT VALUE OF AN ANNUITY
The preceding discussion involved the discounting of only a single future
amount. Businesses and individuals frequently engage in transactions in
which a series of equal dollar amounts are to be received or paid periodi-
cally. Examples of a series of periodic receipts or payments are loan
agreements, installment sales, mortgage notes, lease (rental) contracts, and pension
obligations. These periodic receipts or payments are annuities.
The present value of an annuity is the value now of a series of future receipts
or payments, discounted assuming compound interest. In computing the present
value of an annuity, you need to know: (1) the discount rate, (2) the number of dis-
count periods, and (3) the amount of the periodic receipts or payments.
To illustrate how to compute the present value of an annuity, assume that you
will receive $1,000 cash annually for three years at a time when the discount rate is
10%. Illustration C-14 depicts this situation, and Illustration C-15 shows the com-
putation of its present value.
Solve for present value of an
annuity.
S T U D Y O B J E C T I V E 6
Illustration C-12
Demonstration problem—
Using Table 3 for PV of 1
i = 8%
2
PV = ?
Now
$10,000
3 years1
Suppose you have a winning lottery ticket and the state gives you the
option of taking $10,000 three years from now or taking the present
value of $10,000 now. The state uses an 8% rate in discounting. How
much will you receive if you accept your winnings now?
Answer: The present value factor from Table 3 is .79383
(3 periods at 8%). The present value of $10,000 to be received in
3 years discounted at 8% is $7,938.30 ($10,000 × .79383).
n = 3
i = 9%
3
PV = ?
Now
$5,000
4 years1
Determine the amount you must deposit now in your SUPER
savings account, paying 9% interest, in order to accumulate $5,000
for a down payment 4 years from now on a new Chevy Tahoe.
Answer: The present value factor from Table 3 is .70843
(4 periods at 9%). The present value of $5,000 to be received in
4 years discounted at 9% is $3,542.15 ($5,000 × .70843).
2
n = 4
This method of calculation is required when the periodic cash flows are not
uniform in each period. However, when the future receipts are the same in each
period, there are two other ways to compute present value. First, you can multiply
the annual cash flow by the sum of the three present value factors. In the previous
example, $1,000 � 2.48686 equals $2,486.86. The second method is to use annuity
tables. As illustrated in Table 4 below, these tables show the present value of 1 to be
received periodically for a given number of periods.
Present Value of an Annuity C11
Present Value of 1
Future Amount � Factor at 10% � Present Value
$1,000 (one year away) .90909 $ 909.09
1,000 (two years away) .82645 826.45
1,000 (three years away) . 75132 751.32
2.48686 $2,486.86
Illustration C-14
Time diagram for a three-
year annuity
Illustration C-15
Present value of a series of
future amounts computation
i = 10%
2Now 3 years
PV = ? $1,000 $1,000$1,000
1
n = 3
TABLE 4
Present Value of an Annuity of 1
(n)
Periods 4% 5% 6% 8% 9% 10% 11% 12% 15%
1 .96154 .95238 .94340 .92593 .91743 .90909 .90090 .89286 .86957
2 1.88609 1.85941 1.83339 1.78326 1.75911 1.73554 1.71252 1.69005 1.62571
3 2.77509 2.72325 2.67301 2.57710 2.53130 2.48685 2.44371 2.40183 2.28323
4 3.62990 3.54595 3.46511 3.31213 3.23972 3.16986 3.10245 3.03735 2.85498
5 4.45182 4.32948 4.21236 3.99271 3.88965 3.79079 3.69590 3.60478 3.35216
6 5.24214 5.07569 4.91732 4.62288 4.48592 4.35526 4.23054 4.11141 3.78448
7 6.00205 5.78637 5.58238 5.20637 5.03295 4.86842 4.71220 4.56376 4.16042
8 6.73274 6.46321 6.20979 5.74664 5.53482 5.33493 5.14612 4.96764 4.48732
9 7.43533 7.10782 6.80169 6.24689 5.99525 5.75902 5.53705 5.32825 4.77158
10 8.11090 7.72173 7.36009 6.71008 6.41766 6.14457 5.88923 5.65022 5.01877
11 8.76048 8.30641 7.88687 7.13896 6.80519 6.49506 6.20652 5.93770 5.23371
12 9.38507 8.86325 8.38384 7.53608 7.16073 6.81369 6.49236 6.19437 5.42062
13 9.98565 9.39357 8.85268 7.90378 7.48690 7.10336 6.74987 6.42355 5.58315
14 10.56312 9.89864 9.29498 8.24424 7.78615 7.36669 6.98187 6.62817 5.72448
15 11.11839 10.37966 9.71225 8.55948 8.06069 7.60608 7.19087 6.81086 5.84737
16 11.65230 10.83777 10.10590 8.85137 8.31256 7.82371 7.37916 6.97399 5.95424
17 12.16567 11.27407 10.47726 9.12164 8.54363 8.02155 7.54879 7.11963 6.04716
18 12.65930 11.68959 10.82760 9.37189 8.75563 8.20141 7.70162 7.24967 6.12797
19 13.13394 12.08532 11.15812 9.60360 8.95012 8.36492 7.83929 7.36578 6.19823
20 13.59033 12.46221 11.46992 9.81815 9.12855 8.51356 7.96333 7.46944 6.25933
Table 4 shows that the present value of an annuity of 1 factor for three periods
at 10% is 2.48685.1 (This present value factor is the total of the three individual
present value factors, as shown in Illustration C-15.) Applying this amount to the
annual cash flow of $1,000 produces a present value of $2,486.85.
The following demonstration problem (Illustration C-16) illustrates how to use
Table 4.
C12 Appendix C Time Value of Money
1
The difference of .00001 between 2.48686 and 2.48685 is due to rounding.
Illustration C-16
Demonstration problem—
Using Table 4 for PV of an
annuity of 1
TIME PERIODS AND DISCOUNTING
In the preceding calculations, the discounting was done on an annual basis using an
annual interest rate. Discounting may also be done over shorter periods of time
such as monthly, quarterly, or semiannually.
When the time frame is less than one year, you need to convert the annual
interest rate to the applicable time frame. Assume, for example, that the investor in
Illustration C-14 received $500 semiannually for three years instead of $1,000 an-
nually. In this case, the number of periods becomes six (3 � 2), the discount rate is
5% (10% � 2), the present value factor from Table 4 is 5.07569, and the present
value of the future cash flows is $2,537.85 (5.07569 � $500). This amount is slightly
higher than the $2,486.86 computed in Illustration C-15 because interest is paid
twice during the same year; therefore interest is earned on the first half year’s
interest.
i = 12%
4
PV = ?
Now
$6,000
5 years1
Kildare Company has just signed a capitalizable lease contract for equip-
ment that requires rental payments of $6,000 each, to be paid at the end
of each of the next 5 years. The appropriate discount rate is 12%. What
is the present value of the rental payments—that is, the amount used to
capitalize the leased equipment?
Answer: The present value factor from Table 4 is 3.60478
(5 periods at 12%). The present value of 5 payments of $6,000 each
discounted at 12% is $21,628.68 ($6,000 × 3.60478).
$6,000 $6,000
2 3
$6,000 $6,000
n = 5
COMPUTING THE PRESENT VALUE
OF A LONG-TERM NOTE OR BOND
The present value (or market price) of a long-term note or bond is a func-
tion of three variables: (1) the payment amounts, (2) the length of time un-
til the amounts are paid, and (3) the discount rate. Our illustration uses a
five-year bond issue.
Compute the present value of
notes and bonds.
S T U D Y O B J E C T I V E 7
Computing the Present Value of a Long-Term Note or Bond C13
The first variable—dollars to be paid—is made up of two elements: (1) a series
of interest payments (an annuity), and (2) the principal amount (a single sum). To
compute the present value of the bond, we must discount both the interest pay-
ments and the principal amount—two different computations. The time diagrams
for a bond due in five years are shown in Illustration C-17.
When the investor’s market interest rate is equal to the bond’s contractual in-
terest rate, the present value of the bonds will equal the face value of the bonds. To
illustrate, assume a bond issue of 10%, five-year bonds with a face value of
$100,000 with interest payable semiannually on January 1 and July 1. If the discount
rate is the same as the contractual rate, the bonds will sell at face value. In this case,
the investor will receive the following: (1) $100,000 at maturity, and (2) a series of
ten $5,000 interest payments [($100,000 � 10%) � 2] over the term of the bonds.
The length of time is expressed in terms of interest periods—in this case—10,
and the discount rate per interest period, 5%. The following time diagram
(Illustration C-18) depicts the variables involved in this discounting situation.
Illustration C-17
Present value of a bond
time diagram
Illustration C-18
Time diagram for present
value of a 10%, five-year
bond paying interest
semiannually
Interest Rate (i)
1 yr.
Present
Value (?)
Now
Principal
Amount
5 yr.
Diagram
for
Principal
2 yr. 3 yr. 4 yr.
Interest
1 yr.
Present
Value (?)
Now 5 yr.
Diagram
for
Interest
2 yr. 3 yr. 4 yr.
Interest Rate (i)
Interest Interest Interest Interest
n = 5
n = 5
i = 5%
1
Present
Value
(?)
Now
Principal
Amount
$100,000
10
Diagram
for
Principal
5 6
1
Present
Value
(?)
Now 10
Diagram
for
Interest
5 6
i = 5%
$5,000
2
2
3
3
4
4
7
7
8
8
9
9
$5,000 $5,000 $5,000 $5,000$5,000 $5,000 $5,000 $5,000
n = 10
n = 10
$5,000
Interest
Payments
Illustration C-19 shows the computation of the present value of these bonds.
C14 Appendix C Time Value of Money
10% Contractual Rate—10% Discount Rate
Present value of principal to be received at maturity
$100,000 � PV of 1 due in 10 periods at 5%
$100,000 � .61391 (Table 3) $ 61,391
Present value of interest to be received periodically
over the term of the bonds
$5,000 � PV of 1 due periodically for 10 periods at 5%
$5,000 � 7.72173 (Table 4) 38,609*
Present value of bonds $100,000
*Rounded
10% Contractual Rate—12% Discount Rate
Present value of principal to be received at maturity
$100,000 � .55839 (Table 3) $55,839
Present value of interest to be received periodically
over the term of the bonds
$5,000 � 7.36009 (Table 4) 36,800
Present value of bonds $92,639
10% Contractual Rate—8% Discount Rate
Present value of principal to be received at maturity
$100,000 � .67556 (Table 3) $ 67,556
Present value of interest to be received periodically
over the term of the bonds
$5,000 � 8.11090 (Table 4) 40,555
Present value of bonds $108,111
Now assume that the investor’s required rate of return is 12%, not 10%. The fu-
ture amounts are again $100,000 and $5,000, respectively, but now a discount rate
of 6% (12% � 2) must be used. The present value of the bonds is $92,639, as com-
puted in Illustration C-20.
Conversely, if the discount rate is 8% and the contractual rate is 10%, the pres-
ent value of the bonds is $108,111, computed as shown in Illustration C-21.
The above discussion relies on present value tables in solving present value
problems. Many people use spreadsheets such as Excel or Financial calculators
(some even on websites) to compute present values, without the use of tables.
Many calculators, especially financial calculators, have present value (PV)
functions that allow you to calculate present values by merely inputting the
proper amount, discount rate, and periods, and pressing the PV key. The next
section illustrates how to use a financial calculator in various business situations.
Illustration C-19
Present value of principal
and interest—face value
Illustration C-20
Present value of principal
and interest—discount
Illustration C-21
Present value of principal
and interest—premium
Using Financial Calculators—Present Value of a Single Sum C15
SECTION 3 Using Financial Calculators
Business professionals, once they have mastered the underlying concepts
in sections 1 and 2, often use a financial (business) calculator to solve time
value of money problems. In many cases, they must use calculators if in-
terest rates or time periods do not correspond with the information pro-
vided in the compound interest tables.
To use financial calculators, you enter the time value of money variables into
the calculator. Illustration C-22 shows the five most common keys used to solve
time value of money problems.2
Use a financial calculator to solve
time value of money problems.
S T U D Y O B J E C T I V E 8
Illustration C-22
Financial calculator keys
N I PV PMT FV
where
N � number of periods
I � interest rate per period (some calculators use I/YR or i)
PV � present value (occurs at the beginning of the first period)
PMT � payment (all payments are equal, and none are skipped)
FV � future value (occurs at the end of the last period)
In solving time value of money problems in this appendix, you will generally be
given three of four variables and will have to solve for the remaining variable. The
fifth key (the key not used) is given a value of zero to ensure that this variable is
not used in the computation.
PRESENT VALUE OF A SINGLE SUM
To illustrate how to solve a present value problem using a financial calculator, assume
that you want to know the present value of $84,253 to be received in five years, dis-
counted at 11% compounded annually. Illustration C-23 pictures this problem.
2
On many calculators, these keys are actual buttons on the face of the calculator; on others they
appear on the display after the user accesses a present value menu.
Illustration C-23
Calculator solution for
present value of a single sum
? 0 84,253
–50,000
N
Inputs: 5
Answer:
11
I PV PMT FV
The diagram shows you the information (inputs) to enter into the calculator:
N � 5, I � 11, PMT � 0, and FV � 84,253. You then press PV for the answer:
�$50,000. As indicated, the PMT key was given a value of zero because a series of
payments did not occur in this problem.
Plus and Minus
The use of plus and minus signs in time value of money problems with a financial
calculator can be confusing. Most financial calculators are programmed so that the
positive and negative cash flows in any problem offset each other. In the present
value problem, we identified the $84,253 future value initial investment as a positive
(inflow); the answer �$50,000 was shown as a negative amount, reflecting a cash
outflow. If the 84,253 were entered as a negative, then the final answer would have
been reported as a positive 50,000.
Hopefully, the sign convention will not cause confusion. If you understand
what is required in a problem, you should be able to interpret a positive or negative
amount in determining the solution to a problem.
Compounding Periods
In the problem on page C15, we assumed that compounding occurs once a year.
Some financial calculators have a default setting, which assumes that compounding
occurs 12 times a year. You must determine what default period has been pro-
grammed into your calculator and change it as necessary to arrive at the proper
compounding period.
Rounding
Most financial calculators store and calculate using 12 decimal places. As a result,
because compound interest tables generally have factors only up to 5 decimal
places, a slight difference in the final answer can result. In most time value of
money problems, the final answer will not include more than two decimal points.
C16 Appendix C Time Value of Money
PRESENT VALUE OF AN ANNUITY
To illustrate how to solve a present value of an annuity problem using a financial
calculator, assume that you are asked to determine the present value of rental re-
ceipts of $6,000 each to be received at the end of each of the next five years, when
discounted at 12%, as pictured in Illustration C-24.
Illustration C-24
Calculator solution for
present value of an annuity
N
Inputs: 5 12 ? 6,000 0
Answer: –21,628.66
I PV PMT FV
In this case, you enter N � 5, I � 12, PMT � 6,000, FV � 0, and then press PV to
arrive at the answer of $21, 628.66.
USEFUL APPLICATIONS OF THE
FINANCIAL CALCULATOR
With a financial calculator you can solve for any interest rate or for any number
of periods in a time value of money problem. Here are some examples of these
applications.
Auto Loan
Assume you are financing a car with a three-year loan. The loan has a 9.5% nomi-
nal annual interest rate, compounded monthly. The price of the car is $6,000, and
you want to determine the monthly payments, assuming that the payments start
one month after the purchase. This problem is pictured in Illustration C-25.
Summary of Study Objectives C17
To solve this problem, you enter N � 36 (12 � 3), I � 9.5, PV � 6,000, FV � 0, and
then press PMT. You will find that the monthly payments will be $192.20. Note that
the payment key is usually programmed for 12 payments per year. Thus, you must
change the default (compounding period) if the payments are other than monthly.
Mortgage Loan Amount
Let’s say you are evaluating financing options for a loan on a house. You decide
that the maximum mortgage payment you can afford is $700 per month. The annual
interest rate is 8.4%. If you get a mortgage that requires you to make monthly pay-
ments over a 15-year period, what is the maximum purchase price you can afford?
Illustration C-26 depicts this problem.
Illustration C-25
Calculator solution for auto
loan payments
Illustration C-26
Calculator solution for
mortgage amount
N
Inputs: 36 9.5 6,000 ? 0
Answer: –192.20
I PV PMT FV
N
Inputs: 180 8.4 ? –700 0
Answer: 71,509.81
I PV PMT FV
You enter N � 180 (12 � 15 years), I � 8.4, PMT � �700, FV � 0, and press PV.
With the payment-per-year key set at 12, you find a present value of $71,509.81—
the maximum house price you can afford, given that you want to keep your mort-
gage payments at $700. Note that by changing any of the variables, you can quickly
conduct “what-if” analyses for different situations.
SUMMARY OF STUDY OBJECTIVES
1. Distinguish between simple and compound interest.
Simple interest is computed on the principal only, whereas
compound interest is computed on the principal and any
interest earned that has not been withdrawn.
2. Solve for future value of a single amount. Prepare a
time diagram of the problem. Identify the principal
amount, the number of compounding periods, and the in-
terest rate. Using the future value of 1 table, multiply the
principal amount by the future value factor specified at
the intersection of the number of periods and the interest
rate.
3. Solve for future value of an annuity. Prepare a time di-
agram of the problem. Identify the amount of the periodic
payments, the number of compounding periods, and the
C18 Appendix C Time Value of Money
GLOSSARY
Annuity A series of equal dollar amounts to be paid or
received periodically. (p. C5, C10)
Compound interest The interest computed on the principal
and any interest earned that has not been paid or received.
(p. C2)
Discounting the future amount(s) The process of determin-
ing present value. (p. C7)
Future value of a single amount The value at a future date
of a given amount invested assuming compound interest.
(p. C3)
Future value of an annuity The sum of all the payments or
receipts plus the accumulated compound interest on them.
(p. C5)
Interest Payment for the use of another’s money. (p. C1)
Present value The value now of a given amount to be invested
or received in the future assuming compound interest.
(p. C7)
Present value of an annuity A series of future receipts or
payments discounted to their value now assuming com-
pound interest. (p. C10)
Principal The amount borrowed or invested. (p. C1)
Simple interest The interest computed on the principal only.
(p. C1)
interest rate. Using the future value of an annuity of 1 table,
multiply the amount of the payments by the future value
factor specified at the intersection of the number of periods
and the interest rate.
4. Identify the variables fundamental to solving present
value problems. The following three variables are funda-
mental to solving present value problems: (1) the future
amount, (2) the number of periods, and (3) the interest rate
(the discount rate).
5. Solve for present value of a single amount. Prepare a
time diagram of the problem. Identify the future amount,
the number of discounting periods, and the discount (inter-
est) rate. Using the present value of 1 table, multiply the fu-
ture amount by the present value factor specified at the in-
tersection of the number of periods and the discount rate.
6. Solve for present value of an annuity. Prepare a time
diagram of the problem. Identify the future amounts (an-
nuities), the number of discounting periods, and the dis-
count (interest) rate. Using the present value of an annuity
of 1 table, multiply the amount of the annuity by the pres-
ent value factor specified at the intersection of the number
of periods and the interest rate.
7. Compute the present value of notes and bonds. To
determine the present value of the principal amount:
Multiply the principal amount (a single future amount) by
the present value factor (from the present value of 1 table)
intersecting at the number of periods (number of interest
payments) and the discount rate. To determine the present
value of the series of interest payments: Multiply the
amount of the interest payment by the present value factor
(from the present value of an annuity of 1 table) intersect-
ing at the number of periods (number of interest pay-
ments) and the discount rate. Add the present value of the
principal amount to the present value of the interest pay-
ments to arrive at the present value of the note or bond.
8. Use a financial calculator to solve time value of money
problems. Financial calculators can be used to solve the
same and additional problems as those solved with time
value of money tables. One enters into the financial calcu-
lator the amounts for all of the known elements of a time
value of money problem (periods, interest rate, payments,
future or present value) and solves for the unknown element.
Particularly useful situations involve interest rates and
compounding periods not presented in the tables.
BRIEF EXERCISES
Use tables to solve Brief Exercises 1-23.
BEC-1 Russ Holub invested $4,000 at 5% annual interest, and left the money invested without
withdrawing any of the interest for 10 years. At the end of the 10 years, Russ withdrew the accu-
mulated amount of money.
(a) What amount did Russ withdraw assuming the investment earns simple interest?
(b) What amount did Russ withdraw assuming the investment earns interest compound annually?
BEC-2 For each of the following cases, indicate (1) to what interest rate columns and (2) to
what number of periods you would refer in looking up the future value factor.
1. In Table 1 (future value of 1):
Annual Number of
Rate Years Invested Compounded
(a) 8% 5 Annually
(b) 5% 3 Semiannually
Compute the future value of
a single amount.
(SO 2)
Use future value tables.
(SO 2, 3)
2. In Table 2 (future value of an annuity of 1):
Brief Exercises C19
Annual Number of
Rate Years Invested Compounded
(a) 5% 10 Annually
(b) 4% 6 Semiannually
BEC-3 Racine Company signed a lease for an office building for a period of 10 years. Under the
lease agreement, a security deposit of $10,000 is made. The deposit will be returned at the expi-
ration of the lease with interest compounded at 4% per year. What amount will Racine receive
at the time the lease expires?
BEC-4 Chaffee Company issued $1,000,000, 10-year bonds and agreed to make annual sinking
fund deposits of $75,000. The deposits are made at the end of each year into an account paying
6% annual interest. What amount will be in the sinking fund at the end of 10 years?
BEC-5 Wayne and Brenda Anderson invested $5,000 in a savings account paying 5% com-
pound annual interest when their daughter, Sue, was born. They also deposited $1,000 on each of
her birthdays until she was 18 (including her 18th birthday). How much will be in the savings ac-
count on her 18th birthday (after the last deposit)?
BEC-6 Ty Ngu borrowed $20,000 on July 1, 2002. This amount plus accrued interest at 6% com-
pounded annually is to be repaid on July 1, 2008. How much will Ty have to repay on July 1, 2008?
BEC-7 For each of the following cases, indicate (a) to what interest rate columns and (b) to
what number of periods you would refer in looking up the discount rate.
1. In Table 3 (present value of 1):
Number of Discounts
Annual Rate Years Involved Per Year
(a) 12% 6 Annually
(b) 10% 15 Annually
(c) 8% 10 Semiannually
2. In Table 4 (present value of an annuity of 1):
Number of Number of Frequency of
Annual Rate Years Involved Payments Involved Payments
(a) 8% 20 20 Annually
(b) 10% 5 5 Annually
(c) 12% 4 8 Semiannually
BEC-8 (a) What is the present value of $20,000 due 8 periods from now, discounted at 8%?
(b) What is the present value of $20,000 to be received at the end of each of 6 periods, discounted
at 9%?
BEC-9 Gonzalez Company is considering an investment that will return a lump sum of
$500,000 5 years from now. What amount should Gonzalez Company pay for this investment in
order to earn a 10% return?
BEC-10 Lasorda Company earns 9% on an investment that will return $875,000 8 years
from now. What is the amount Lasorda should invest now in order to earn this rate of
return?
BEC-11 Bosco Company is considering investing in an annuity contract that will return $30,000
annually at the end of each year for 15 years. What amount should Bosco Company pay for this
investment if it earns a 6% return?
BEC-12 Modine Enterprises earns 11% on an investment that pays back $120,000 at the end of
each of the next 4 years. What is the amount Modine Enterprises invested to earn the 11% rate
of return?
BEC-13 Midwest Railroad Co. is about to issue $100,000 of 10-year bonds paying a 10% inter-
est rate, with interest payable semiannually. The discount rate for such securities is 8%. How
much can Midwest expect to receive from the sale of these bonds?
Compute the future value of
a single amount.
(SO 2)
Compute the future value of an
annuity.
(SO 3)
Compute the future value of
a single amount and of an
annuity.
(SO 2, 3)
Compute the future value of
a single amount.
(SO 2)
Use present value tables.
(SO 5, 6)
Determine present values.
(SO 5, 6)
Compute the present value of a
single-sum investment.
(SO 5)
Compute the present value of a
single-sum investment.
(SO 5)
Compute the present value of
an annuity investment.
(SO 6)
Compute the present value of
an annuity investment.
(SO 6)
Compute the present value of
bonds.
(SO 5, 6, 7)
BEC-14 Assume the same information as in BEC-13 except that the discount rate is 10% in-
stead of 8%. In this case, how much can Midwest expect to receive from the sale of these
bonds?
BEC-15 Lounsbury Company receives a $50,000, 6-year note bearing interest of 8% (paid an-
nually) from a customer at a time when the discount rate is 9%. What is the present value of the
note received by Lounsbury Company?
BEC-16 Hartzler Enterprises issued 8%, 8-year, $2,000,000 par value bonds that pay interest
semiannually on October 1 and April 1. The bonds are dated April 1, 2008, and are issued on that
date. The discount rate of interest for such bonds on April 1, 2008, is 10%. What cash proceeds
did Hartzler receive from issuance of the bonds?
BEC-17 Vinny Carpino owns a garage and is contemplating purchasing a tire retreading ma-
chine for $16,280. After estimating costs and revenues, Vinny projects a net cash flow from the re-
treading machine of $3,000 annually for 8 years. Vinny hopes to earn a return of 11% on such in-
vestments. What is the present value of the retreading operation? Should Vinny Carpino
purchase the retreading machine?
BEC-18 Rodriguez Company issues a 10%, 6-year mortgage note on January 1, 2008, to obtain
financing for new equipment. Land is used as collateral for the note. The terms provide for semi-
annual installment payments of $56,413. What were the cash proceeds received from the issuance
of the note?
BEC-19 Goltra Company is considering purchasing equipment. The equipment will produce
the following cash flows: Year 1, $30,000; Year 2, $40,000; Year 3, $50,000. Goltra requires a min-
imum rate of return of 12%. What is the maximum price Goltra should pay for this equipment?
BEC-20 If Maria Sanchez invests $3,152 now, she will receive $10,000 at the end of 15 years.
What annual rate of interest will Maria earn on her investment? (Hint: Use Table 3.)
BEC-21 Lori Burke has been offered the opportunity of investing $42,410 now. The investment
will earn 10% per year and at the end of that time will return Lori $100,000. How many years
must Lori wait to receive $100,000? (Hint: Use Table 3.)
BEC-22 Nancy Burns purchased an investment for $12,462.21. From this investment, she will
receive $1,000 annually for the next 20 years, starting one year from now. What rate of interest
will Nancy’s investment be earning for her? (Hint: Use Table 4.)
BEC-23 Betty Estes invests $7,536.08 now for a series of $1,000 annual returns, beginning one
year from now. Betty will earn a return of 8% on the initial investment. How many annual pay-
ments of $1,000 will Betty receive? (Hint: Use Table 4.)
BEC-24 Reba McEntire wishes to invest $19,000 on July 1, 2008, and have it accumulate to
$49,000 by July 1, 2018.
Instructions
Use a financial calculator to determine at what exact annual rate of interest Reba must invest the
$19,000.
BEC-25 On July 17, 2008, Tim McGraw borrowed $42,000 from his grandfather to open a
clothing store. Starting July 17, 2009, Tim has to make 10 equal annual payments of $6,500 each
to repay the loan.
Instructions
Use a financial calculator to determine what interest rate Tim is paying.
BEC-26 As the purchaser of a new house, Patty Loveless has signed a mortgage note to pay
the Memphis National Bank and Trust Co. $14,000 every 6 months for 20 years, at the end of
which time she will own the house. At the date the mortgage is signed the purchase price was
$198,000, and Loveless made a down payment of $20,000. The first payment will be made 6 months
after the date the mortgage is signed.
Instructions
Using a financial calculator, compute the exact rate of interest earned on the mortgage by the
bank.
C20 Appendix C Time Value of Money
Compute the present value of a
note.
(SO 5, 6, 7)
Compute the present value of
bonds.
(SO 5, 6, 7)
Compute the maximum price to
pay for the equipment.
(SO 7)
Compute the interest rate on a
single sum.
(SO 5)
Compute the number of
periods of a single sum.
(SO 5)
Compute the interest rate on an
annuity.
(SO 6)
Compute the number of
periods of an annuity.
(SO 6)
Compute the value of a
machine for purposes of
making a purchase decision.
(SO 7)
Compute the present value of a
note.
(SO 5, 6)
Compute the present value of
bonds.
(SO 5, 6, 7)
Determine interest rate.
(SO 8)
Determine interest rate.
(SO 8)
Determine interest rate.
(SO 8)
BEC-27 Using a financial calculator, solve for the unknowns in each of the following
situations.
(a) On June 1, 2008, Shelley Long purchases lakefront property from her neighbor, Joey
Brenner, and agrees to pay the purchase price in seven payments of $16,000 each, the first
payment to be payable June 1, 2009. (Assume that interest compounded at an annual rate of
7.35% is implicit in the payments.) What is the purchase price of the property?
(b) On January 1, 2008, Cooke Corporation purchased 200 of the $1,000 face value, 8% coupon,
10-year bonds of Howe Inc. The bonds mature on January 1, 2018, and pay interest annually
beginning January 1, 2009. Cooke purchased the bonds to yield 10.65%. How much did
Cooke pay for the bonds?
BEC-28 Using a financial calculator, provide a solution to each of the following situations.
(a) Bill Schroeder owes a debt of $35,000 from the purchase of his new sport utility vehicle. The
debt bears annual interest of 9.1% compounded monthly. Bill wishes to pay the debt and in-
terest in equal monthly payments over 8 years, beginning one month hence. What equal
monthly payments will pay off the debt and interest?
(b) On January 1, 2008, Sammy Sosa offers to buy Mark Grace’s used snowmobile for $8,000,
payable in five equal annual installments, which are to include 8.25% interest on the unpaid
balance and a portion of the principal. If the first payment is to be made on December 31,
2008, how much will each payment be?
Brief Exercises C21
Various time value of money
situations.
(SO 8)
Various time value of money
situations.
(SO 8)
D1
Payroll Accounting
Appendix D
Payroll and related fringe benefits often make up a large percentage of current lia-
bilities. Employee compensation is often the most significant expense that a com-
pany incurs. For example, Costco recently reported total employees of 103,000 and
labor and fringe benefits costs that approximated 70% of the company’s total cost
of operations.
Payroll accounting involves more than paying employees’ wages. Companies are
required by law to maintain payroll records for each employee, to file and pay payroll
taxes, and to comply with numerous state and federal tax laws related to employee
compensation. Accounting for payroll has become much more complex due to these
regulations.
After studying this appendix, you should be able to:
1. Discuss the objectives of internal control for payroll.
2. Compute and record the payroll for a pay period.
3. Describe and record employer payroll taxes.
S T U D Y O B J E C T I V E
PAYROLL DEFINED
The term “payroll” pertains to both salaries and wages. Managerial, administrative,
and sales personnel are generally paid salaries. Salaries are often expressed in
terms of a specified amount per month or per year rather than an hourly rate. Store
clerks, factory employees, and manual laborers are normally paid wages. Wages are
based on a rate per hour or on a piecework basis (such as per unit of product).
Frequently, people use the terms “salaries” and “wages” interchangeably.
The term “payroll” does not apply to payments made for services of profes-
sionals such as certified public accountants, attorneys, and architects. Such profes-
sionals are independent contractors rather than salaried employees. Payments to
them are called fees. This distinction is important because government regulations
relating to the payment and reporting of payroll taxes apply only to employees.
INTERNAL CONTROL OF PAYROLL
Chapter 8 introduced internal control. As applied to payrolls, the objec-
tives of internal control are (1) to safeguard company assets against unau-
thorized payments of payroll and (2) to ensure the accuracy and reliability
of the accounting records pertaining to payrolls.
Irregularities often result if internal control is lax. Methods of theft involving
payroll include overstating hours, using unauthorized pay rates, adding fictitious
employees to the payroll, continuing terminated employees on the payroll, and dis-
tributing duplicate payroll checks. Moreover, inaccurate records will result in in-
correct paychecks, financial statements, and payroll tax returns.
Discuss the objectives of internal
control for payroll.
S T U D Y O B J E C T I V E 1
Payroll activities involve four functions: hiring employees, timekeeping,
preparing the payroll, and paying the payroll. For effective internal control, the
company should assign these four functions to different departments or individuals.
To illustrate these functions, we will examine the case of Academy Company and
one of its employees, Michael Jordan.
Hiring Employees
The human resources (personnel) department is responsible for posting job open-
ings, screening and interviewing applicants, and hiring employees. From a control
standpoint, this department provides significant documentation and authorization.
When an employee is hired, the human resources department prepares an author-
ization form. The one used by Academy Company for Michael Jordan is shown in
Illustration D-1.
D2 Appendix D Payroll Accounting
Illustration D-1
Authorization form prepared
by the human resources
department
Human
Resources
Human Resources
department documents and
authorizes employment.
Hiring Employees
ACADEMY COMPANY
Employee Name
Classification
Department
LAST MI
Jordan,
Skilled-Level 10
Shipping
NEW
HIRE
RATE
CHANGE
SEPARATION
APPROVALS
FIRST
Michael Starting Date
Social Security No.
Division
9/01/06
329-36-9547
Entertainment
Classification
Rate $
Clerk
10.00 per hour Bonus N/A
Salary Grade Level 10
Non-exempt x Exempt
Trans. from Temp.
New Rate $
Present Rate $
12.00 9/1/07
10.00
Other
Effective Date
Merit x Promotion Decrease
Amount $ per TypePrevious Increase Date None
ReasonResignation Discharge Retirement
FromLeave of absence to Type
Last Day Worked
BRANCH OR DEPT. MANAGER DATE DIVISION V.P. DATE
PERSONNEL DEPARTMENT
The human resources department sends the authorization form to the payroll
department, where it is used to place the new employee on the payroll. A chief con-
cern of the human resources department is ensuring the accuracy of this form. The
reason is quite simple: One of the most common types of payroll frauds is adding
fictitious employees to the payroll.
The human resources department is also responsible for authorizing changes
in employment status. Specifically, they must authorize (1) changes in pay rates and
(2) terminations of employment. Every authorization should be in writing, and a
copy of the change in status should be sent to the payroll department. Notice in
Illustration D-1 that Jordan received a pay increase of $2 per hour.
Timekeeping
Another area in which internal control is important is timekeeping. Hourly em-
ployees are usually required to record time worked by “punching” a time clock. The
employee inserts a time card into the clock, which automatically records the
employee’s arrival and departure times. Illustration D-2 shows Michael Jordan’s
time card.
Internal Control of Payroll D3
In large companies, time clock procedures are often monitored by a supervisor
or security guard to make sure an employee punches only his or her own card. At the
end of the pay period, each employee’s supervisor approves the hours shown by sign-
ing the time card. When overtime hours are involved, approval by a supervisor is usu-
ally mandatory. This guards against unauthorized overtime. The approved time cards
are then sent to the payroll department. For salaried employees, a manually prepared
weekly or monthly time report kept by a supervisor may be used to record time
worked.
Preparing the Payroll
The payroll department prepares the payroll on the basis of two inputs: (1) human
resources department authorizations and (2) approved time cards. Numerous cal-
culations are involved in determining gross wages and payroll deductions.
Therefore, a second payroll department employee, working independently, verifies
all calculated amounts, and a payroll department supervisor then approves the
payroll.The payroll department is also responsible for preparing (but not signing) pay-
roll checks, maintaining payroll records, and preparing payroll tax returns.
Illustration D-2
Time card
Supervisors monitor hours
worked through time cards
and time reports.
Timekeeping
EXTRA TIME
NAME Michael Jordan
No. 17 1/14/08
PAY PERIOD ENDING
REGULAR TIME
A.M. 8:58
12:00
1:00
5:01
9:00
11:59
12:59
5:00
8:59
12:01
1:01
5:00
9:00
12:00
1:00
5:00
8:57
11:58
1:00
5:01
8:00
1:00
IN
OUT
IN
O
U
T
P.M.
N
O
O
N
7th D
ay
6th D
ay
5th D
ay
4th D
ay
3rd D
ay
2nd D
ay
1st D
ay
5:00
9:00
TT
HH
IISS
SS
II
DD
EE
O
U
O
U
TT
TOTAL 4 TOTAL 40
IN
OUT
IN
OUT
IN
OUT
IN
OUT
IN
OUT
IN
OUT
IN
OUT
IN
OUT
IN
OUT
IN
OUT
IN
OUT
IN
OUT
A.M.
P.M.
N
O
O
N
A.M.
P.M.
N
O
O
N
A.M.
P.M.
N
O
O
N
A.M.
P.M.
N
O
O
N
A.M.
P.M.
N
O
O
N
A.M.
P.M.
N
O
O
N
Two (or more) employees
verify payroll amounts;
supervisor approves.
Preparing the Payroll
Paying the Payroll
The treasurer’s department pays the payroll. Payment by check minimizes the risk
of loss from theft, and the endorsed check provides proof of payment. For good
internal control, payroll checks should be prenumbered, and all checks should be
accounted for. All checks must be signed by the treasurer (or a designated agent).
Distribution of the payroll checks to employees should be controlled by the trea-
surer’s department. Many employees have their pay credited electronically to their
bank accounts. To control these disbursements, the company provides to employ-
ees receipts detailing gross pay deductions and net pay.
Occasionally companies pay the payroll in currency. In such cases it is custom-
ary to have a second person count the cash in each pay envelope. The paymaster
should obtain a signed receipt from the employee upon payment.
D4 Appendix D Payroll Accounting
Treasurer signs and
distributes checks.
Paying the Payroll
Type of Pay Hours � Rate � Gross Earnings
Regular 40 � $12 � $480
Overtime 4 � 18 � 72
Total wages $552
Illustration D-3
Computation of total wages
This computation assumes that Jordan receives 11⁄2 times his regular
hourly rate ($12 � 1.5) for his overtime hours. Union contracts often re-
quire that overtime rates be as much as twice the regular rates.
An employee’s salary is generally based on a monthly or yearly rate.
The company then prorates these rates to its payroll periods (e.g., bi-
weekly or monthly). Most executive and administrative positions are
salaried. Federal law does not require overtime pay for employees in
such positions.
Many companies have bonus agreements for employees. One survey
found that over 94% of the largest U.S. manufacturing companies offer an-
nual bonuses to key executives. Bonus arrangements may be based on such factors
as increased sales or net income. Companies may pay bonuses in cash and/or by
granting employees the opportunity to acquire shares of company stock at favor-
able prices (called stock option plans).
E T H I C S N O T E
Bonuses often reward out-
standing individual per-
formance, but successful corpo-
rations also need considerable
teamwork. A challenge is to
motivate individuals while pre-
venting an unethical employee
from taking another’s idea for
his or her own advantage.
DETERMINING THE PAYROLL
Determining the payroll involves computing three amounts: (1) gross
earnings, (2) payroll deductions, and (3) net pay.
Gross Earnings
Gross earnings is the total compensation earned by an employee. It consists of
wages or salaries, plus any bonuses and commissions.
Companies determine total wages for an employee by multiplying the hours
worked by the hourly rate of pay. In addition to the hourly pay rate, most compa-
nies are required by law to pay hourly workers a minimum of 11⁄2 times the regular
hourly rate for overtime work in excess of eight hours per day or 40 hours per
week. In addition, many employers pay overtime rates for work done at night, on
weekends, and on holidays.
For example, assume that Michael Jordan, an employee of Academy Company,
worked 44 hours for the weekly pay period ending January 14. His regular wage is
$12 per hour. For any hours in excess of 40, the company pays at one-and-a-half times
the regular rate. Academy computes Jordan’s gross earnings (total wages) as follows.
Compute and record the payroll
for a pay period.
S T U D Y O B J E C T I V E 2
Payroll Deductions
As anyone who has received a paycheck knows, gross earnings are usually very
different from the amount actually received. The difference is due to payroll
deductions.
Payroll deductions may be mandatory or voluntary. Mandatory deductions are
required by law and consist of FICA taxes and income taxes. Voluntary deductions
are at the option of the employee. Illustration D-4 summarizes common types of
payroll deductions. Such deductions do not result in payroll tax expense to the
employer. The employer is merely a collection agent, and subsequently transfers
the deducted amounts to the government and designated recipients.
Determining the Payroll D5
Illustration D-4
Payroll deductions
Gross Pay Net Pay
Federal Income Tax
FICA Taxes State and City Income Taxes
Insurance, Pensions,
and/or Union Dues
Charity
1
The Medicare provision also includes a tax of 1.45% on gross earnings in excess of $97,500. In
the interest of simplification, we ignore this 1.45% charge in our end-of-chapter assignment mate-
rial. We assume zero FICA withholdings on gross earnings above $97,500.
FICA TAXES
In 1937 Congress enacted the Federal Insurance Contribution Act (FICA). FICA
taxes are designed to provide workers with supplemental retirement, employment dis-
ability, and medical benefits. In 1965, Congress extended benefits to include Medicare
for individuals over 65 years of age. The benefits are financed by a tax levied on
employees’ earnings. FICA taxes are commonly referred to as Social Security taxes.
Congress sets the tax rate and the tax base for FICA taxes. When FICA taxes
were first imposed, the rate was 1% on the first $3,000 of gross earnings, or a max-
imum of $30 per year. The rate and base have changed dramatically since that time!
In 2007, the rate was 7.65% (6.2% Social Security plus 1.45% Medicare) on the
first $97,500 of gross earnings for each employee.1 For purpose of illustration in
this chapter, we will assume a rate of 8% on the first $97,500 of gross earnings, or a
maximum of $7,800. Using the 8% rate, the FICA withholding for Jordan for the
weekly pay period ending January 14 is $44.16 ($552 � 8%).
INCOME TAXES
Under the U.S. pay-as-you-go system of federal income taxes, employers are
required to withhold income taxes from employees each pay period. Three variables
determine the amount to be withheld: (1) the employee’s gross earnings; (2) the
number of allowances claimed by the employee; and (3) the length of the pay
period.
The number of allowances claimed typically includes the employee, his or her
spouse, and other dependents. To indicate to the Internal Revenue Service the
number of allowances claimed, the employee must complete an Employee’s
Withholding Allowance Certificate (Form W-4). As shown in Illustration D-5,
Michael Jordan claims two allowances on his W-4.
D6 Appendix D Payroll Accounting
Illustration D-5
W-4 form
W-4Form
Department of the Treasury
Internal Revenue Service For Privacy Act and Paperwork Reduction Act Notice, see page 2.
Employee’s Withholding Allowance Certificate OMB No. 1545-0010
1 Type or print your first name and middle initial Last name
Michael Jordan
2 Your social security number
329-36-9547
Home address (number and street or rural route)
2345 Mifflin Ave.
City or town, State, and ZIP code
Hampton, MI 48292
3
4
Single Marriedx
Note: If married, but legally separated, or spouse is a nonresident alien, check the Single box.
If your last name differs from that on your social security card, check
here and call 1-800-772-1213 for a new card . . . . .
Married, but withhold at higher Single rate.
5 Total number of allowances you are claiming (from line H above or from the worksheet on page 2 if they apply)
6 Additional amount, if any, you want withheld from each paycheck
7 I claim exemption from withholding for 2006, and I certify that I meet BOTH of the following conditions for exemption:
• Last year I had a right to a refund of ALL Federal income tax withheld because I had NO tax liability AND
• This year I expect a refund of ALL Federal income tax withheld because I expect to have NO tax liability.
8 Employer’s name and address (Employer: Complete 8 and 10 only if sending to the IRS) 9 Office code
(optional)
10 Employer identification number
5
6
7If you meet both conditions, enter “Exempt” here
$
2
Under penalties of perjury, I certify that I am entitled to the number of withholding allowances claimed on this certificate or entitled to claim exempt status.
Employee’s signature Date
Cat. No. 102200
, 20 08September 1
Withholding tables furnished by the Internal Revenue Service indicate the
amount of income tax to be withheld. Withholding amounts are based on gross
wages and the number of allowances claimed. Separate tables are provided for
weekly, biweekly, semimonthly, and monthly pay periods. Illustration D-6 (next
page) shows the withholding tax table for Michael Jordan (assuming he earns
$552 per week and claims two allowances). For a weekly salary of $552 with two
allowances, the income tax to be withheld is $49.
In addition, most states (and some cities) require employers to withhold
income taxes from employees’ earnings. As a rule, the amounts withheld are a per-
centage (specified in the state revenue code) of the amount withheld for the fed-
eral income tax. Or they may be a specified percentage of the employee’s earnings.
For the sake of simplicity, we have assumed that Jordan’s wages are subject to state
income taxes of 2%, or $11.04 (2% � $552) per week.
There is no limit on the amount of gross earnings subject to income tax with-
holdings. In fact, under our progressive system of taxation, the higher the earnings,
the higher the percentage of income withheld for taxes.
OTHER DEDUCTIONS
Employees may voluntarily authorize withholdings for charitable, retirement, and
other purposes. All voluntary deductions from gross earnings should be authorized
in writing by the employee. The authorization(s) may be made individually or as
part of a group plan. Deductions for charitable organizations, such as the United
Way, or for financial arrangements, such as U.S. savings bonds and repayment of
loans from company credit unions, are made individually. Deductions for union
dues, health and life insurance, and pension plans are often made on a group basis.
We will assume that Jordan has weekly voluntary deductions of $10 for the United
Way and $5 for union dues.
Net Pay
Academy Company determines net pay by subtracting payroll deductions from
gross earnings. Illustration D-7 shows the computation of Jordan’s net pay for the
pay period.
Determining the Payroll D7
Illustration D-6
Withholding tax table
MARRIED Persons –– WEEKLY Payroll Period
(For Wages Paid in 2008)
If the wages are —
At least But less
than
And the number of withholding allowances claimed is —
The amount of income tax to be withheld is —
0 1 2 3 4 5 6 7 8 9 10
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
0
2
3
5
6
0
0
0
0
0
0
0
0
0
0
1
2
4
5
7
8
10
11
13
14
0
0
0
0
0
1
2
4
5
7
8
10
11
13
14
16
17
19
20
22
1
3
4
6
7
9
10
12
13
15
16
18
19
21
22
24
25
27
28
30
9
10
12
13
15
16
18
19
21
22
24
25
27
28
30
31
33
34
36
37
17
18
20
21
23
24
26
27
29
30
32
33
35
36
38
39
41
42
44
45
24
26
27
29
30
32
33
35
36
38
39
41
42
44
45
47
48
50
51
53
32
34
35
37
38
40
41
43
44
46
47
49
50
52
53
55
56
58
59
61
40
42
43
45
46
48
49
51
52
54
55
57
58
60
61
63
64
66
67
69
48
49
51
52
54
55
57
58
60
61
63
64
66
67
69
70
72
73
75
76
56
57
59
60
62
63
65
66
68
69
71
72
74
75
77
78
80
81
83
84
500
510
520
530
540
550
560
570
580
590
600
610
620
630
640
650
660
670
680
690
490
500
510
520
530
540
550
560
570
580
590
600
610
620
630
640
650
660
670
680
A L T E R N A T I V E
T E R M I N O L O G Y
Net pay is also called
take-home pay.
Gross earnings $552.00
Payroll deductions:
FICA taxes $44.16
Federal income taxes 49.00
State income taxes 11.04
United Way 10.00
Union dues 5.00 119.20
Net pay $432.80
Illustration D-7
Computation of net pay
Assuming that Michael Jordan’s wages for each week during the year are $552,
total wages for the year are $28,704 (52 � $552). Thus, all of Jordan’s wages are sub-
ject to FICA tax during the year. In comparison, let’s assume that Jordan’s depart-
ment head earns $2,000 per week, or $104,000 for the year. Since only the first
$97,500 is subject to FICA taxes, the maximum FICA withholdings on the depart-
ment head’s earnings would be $7,800 ($97,500 � 8%).
Recording the payroll involves maintaining payroll department records, recogniz-
ing payroll expenses and liabilities, and recording payment of the payroll.
Maintaining Payroll Department Records
To comply with state and federal laws, an employer must keep a cumulative record
of each employee’s gross earnings, deductions, and net pay during the year. The
record that provides this information is the employee earnings record. Illustration
D-8 shows Michael Jordan’s employee earnings record.
D8 Appendix D Payroll Accounting
Illustration D-8
Employee earnings record
File Edit View Insert Format Tools Data Window Help
A DB C FE G H I J K L M N
ACADEMY COMPANY
Employee Earnings Record
For the Year 2008
8
7
6
5
4
3
2
1
9
10
11
12
13
14
15
16
17
18
19
20
22
23
24
21
Name
Social Security Number
Date of Birth
Date Employed
Sex
Single
Michael Jordan
329-36-9547
December 24, 1962
September 1, 2003
Male
x
Address
Telephone
Date Employment Ended
Exemptions
2345 Mifflin Ave.
Hampton, Michigan 48292
555-238-9051
2
Married
1,920.00 1,665.202,118.00 169.44 181.00 452.8042.36 40.00 20.00198.00
480.00
480.00
480.00
480.00
36.00
54.00
36.00
72.00
41.28
42.72
41.28
44.16
43.00
46.00
43.00
49.00
10.32
10.68
10.32
11.04
10.00
10.00
10.00
10.00
5.00
5.00
5.00
5.00
109.60
114.40
109.60
119.20
406.40
419.60
406.40
432.80
974
1077
1133
1028
516.00
534.00
516.00
552.00
516.00
1,602.00
2,118.00
1,068.00
1/7
1/14
1/21
1/28
Jan.
Total
42
44
43
42
2008
Period
Ending
Gross Earnings Deductions Payment
Total
Hours Regular Overtime Total Cumulative FICA
Fed.
Inc. Tax
State
Inc. Tax
United
Way
Union
Dues Total
Net
Amount
Check
No.
RECORDING THE PAYROLL
Companies keep a separate earnings record for each employee, and update these
records after each pay period. The employer uses the cumulative payroll data on the
earnings record to: (1) determine when an employee has earned the maximum earn-
ings subject to FICA taxes, (2) file state and federal payroll tax returns (as explained
later), and (3) provide each employee with a statement of gross earnings and tax
withholdings for the year. (Illustration D-12 on page D13 shows this statement.)
In addition to employee earnings records, many companies find it useful to
prepare a payroll register. This record accumulates the gross earnings, deductions,
and net pay by employee for each pay period. It provides the documentation for
preparing a paycheck for each employee. Illustration D-9 (next page) presents
Academy Company’s payroll register. It shows the data for Michael Jordan in the
wages section. In this example, Academy Company’s total weekly payroll is
$17,210, as shown in the gross earnings column.
Note that this record is a listing of each employee’s payroll data for the pay pe-
riod. In some companies, a payroll register is a journal or book of original entry;
postings are made from the payroll register directly to ledger accounts. In other
companies, the payroll register is a memorandum record that provides the data for
a general journal entry and subsequent posting to the ledger accounts. At Academy
Company, the latter procedure is followed.
Recognizing Payroll Expenses and Liabilities
From the payroll register in Illustration D-9, Academy Company makes a journal
entry to record the payroll. For the week ending January 14 the entry is:
Jan. 14 Office Salaries Expense 5,200.00
Wages Expense 12,010.00
FICA Taxes Payable 1,376.80
Federal Income Taxes Payable 3,490.00
State Income Taxes Payable 344.20
United Way Payable 421.50
Union Dues Payable 115.00
Salaries and Wages Payable 11,462.50
(To record payroll for the week ending
January 14)
The company credits specific liability accounts for the mandatory and voluntary
deductions made during the pay period. In the example, Academy debits Office
Salaries Expense for the gross earnings of salaried office workers, and it debits
Wages Expense for the gross earnings of employees who are paid at an hourly rate.
Other companies may debit other accounts such as Store Salaries or Sales Salaries.
The amount credited to Salaries and Wages Payable is the sum of the individual
checks the employees will receive.
Recording the Payroll D9
Illustration D-9
Payroll register
File Edit View Insert Format Tools Data Window Help
A B C D E F G H I J K L M N O
ACADEMY COMPANY
Payroll Register
For the Week Ending January 14, 2008
8
7
6
5
4
3
2
1
9
10
12
13
11
14
15
16
17
18
19
20
21
22
23
24
25
40
40
40
42
44 72.00
43
580.00
590.00
530.00
5,200.00
480.00
480.00
480.00
11,000.00
16,200.00
580.00
590.00
530.00
5,200.00
516.00
552.00
534.00
12,010.00
17,210.00
46.40
47.20
42.40
416.00
41.28
44.16
42.72
960.80
1,376.80
61.00
63.00
54.00
1,090.00
43.00
49.00
46.00
2,400.00
3,490.00
11.60
11.80
10.60
104.00
10.32
11.04
10.68
240.20
344.20
15.00
20.00
11.00
120.00
18.00
10.00
10.00
301.50
421.50
134.00
142.00
118.00
1,730.00
117.60
119.20
114.40
4,017.50
5,747.50
580.00
590.00
530.00
5,200.00
5,200.00
446.00
448.00
412.00
3,470.00
398.40
432.80
419.60
7,992.50
11,462.50
516.00
552.00
534.00
12,010.00
12,010.00
998
999
1000
1025
1028
1029
5.00
5.00
5.00
115.00
115.00
54.00
1,010.00
1,010.00
36.00
Office Salaries
Arnold, Patricia
Mueller, William
Subtotal
Wages
Bennett, Robin
Jordan, Michael
Subtotal
Milroy, Lee
Total
Canton, Matthew
Regular Gross FICA Total Net Pay
Total
HoursEmployee
Over-
time
United
Way
Union
Dues
Check
No.
Wages
Expense
Federal
Income
Tax
State
Income
Tax
Office
Salaries
Expense
Earningsg Deductions Paid Accounts Debited
Cash Flows
no effect
A � L � SE
�5,200.00 Exp
�12,010.00 Exp
�1,376.80
�3,490.00
�344.20
�421.50
�115.00
�11,462.50
D10 Appendix D Payroll Accounting
REVIEW IT
1. Identify two internal control procedures that apply to each payroll function.
2. What are the primary sources of gross earnings?
3. What payroll deductions are (a) mandatory and (b) voluntary?
4. What account titles do companies use in recording a payroll, assuming only
mandatory payroll deductions are involved?
Before You Go On…
Illustration D-10
Paycheck and statement of
earnings
H E L P F U L H I N T
Do any of the income
tax liabilities result in
payroll tax expense for
the employer?
Answer: No. The
employer is acting only
as a collection agent for
the government.
AC ACADEMY COMPANY19 Center St.
Hampton, MI 48291
Pay to the
order of
No. 1028
20
$
Dollars
City Bank & Trust
P.O. Box 3000
Hampton, MI 48291
For
62—1113
610
DETACH AND RETAIN THIS PORTION FOR YOUR RECORDS
NAME SOC. SEC. NO. EMPL. NUMBER NO. EXEMP PAY PERIOD ENDING
OTH. EARNINGS (2) GROSS
NET PAY
OTH. EARNINGS (1)REG. EARNINGSOTH. HRS. (2)OTH. HRS. (1)O.T. HRS.REG. HRS. O.T. EARNINGS
LOCAL TAXSTATE TAXFICAFED. W/H TAX OTHER DEDUCTIONS
(1) (2) (3) (4)
Michael Jordan 329-36-9547 2 1/14/08
480.00 72.00440
44.1649.00 11.04 10.00 5.00
$552.00
432.80
NET PAYLOCAL TAXSTATE TAXFICAFED. W/H TAX OTHER DEDUCTIONS
(1) (2) (3) (4)
85.4492.00 21.36 20.00 10.00 $839.20
YEAR TO DATE
A � L � OE
�11,462.50
�11,462.50
Cash Flows
�11,462.50
Recording Payment of the Payroll
A company makes payments by check (or electronic funds transfer) either from its
regular bank account or a payroll bank account. Each paycheck is usually accompa-
nied by a detachable statement of earnings document.This shows the employee’s gross
earnings, payroll deductions, and net pay, both for the period and for the year-to-date.
Academy Company uses its regular bank account for payroll checks. Illustration D-10
shows the paycheck and statement of earnings for Michael Jordan.
Following payment of the payroll, the company enters the check numbers in
the payroll register. Academy Company records payment of the payroll as follows.
Jan. 14 Salaries and Wages Payable 11,462.50
Cash 11,462.50
(To record payment of payroll)
When a company uses currency in payment, it prepares one check for the pay-
roll’s total amount of net pay. The company cashes this check, and inserts the coins
and currency in individual pay envelopes for disbursement to individual employees.
Payroll tax expense for businesses results from three taxes that govern-
mental agencies levy on employers. These taxes are: (1) FICA, (2) federal
unemployment tax, and (3) state unemployment tax. These taxes plus such
items as paid vacations and pensions (discussed in the appendix to this
chapter) are collectively referred to as fringe benefits. As indicated earlier, the cost
of fringe benefits in many companies is substantial. The pie chart in the margin
shows the pieces of the benefits “pie.”
FICA Taxes
Each employee must pay FICA taxes. In addition, employers must match each
employee’s FICA contribution. The matching contribution results in payroll tax
expense to the employer. The employer’s tax is subject to the same rate and maxi-
mum earnings as the employee’s. The company uses the same account, FICA Taxes
Payable, to record both the employee’s and the employer’s FICA contributions.
For the January 14 payroll, Academy Company’s FICA tax contribution is
$1,376.80 ($17,210.00 � 8%).
Federal Unemployment Taxes
The Federal Unemployment Tax Act (FUTA) is another feature of the federal
Social Security program. Federal unemployment taxes provide benefits for a lim-
ited period of time to employees who lose their jobs through no fault of their
own. The FUTA tax rate is 6.2% of taxable wages. The taxable wage base is the
first $7,000 of wages paid to each employee in a calendar year. Employers who
Employer Payroll Taxes D11
DO IT
Your cousin Stan is establishing a house-cleaning business and will have a num-
ber of employees working for him. He is aware that documentation procedures
are an important part of internal control. But he is unsure about the difference
between an employee earnings record and a payroll register. He asks you to
explain the principal differences, because he wants to be sure that he sets up the
proper payroll procedures.
Action Plan
■ Determine the earnings and deductions data that must be recorded and re-
ported for each employee.
■ Design a record that will accumulate earnings and deductions data and will
serve as a basis for journal entries to be prepared and posted to the general
ledger accounts.
■ Explain the difference between the employee earnings record and the payroll
register.
Solution An employee earnings record is kept for each employee. It shows
gross earnings, payroll deductions, and net pay for each pay period, as well
as cumulative payroll data for that employee. In contrast, a payroll register
is a listing of all employees’ gross earnings, payroll deductions, and net pay
for each pay period. It is the documentation for preparing paychecks and for
recording the payroll. Of course, Stan will need to keep both documents.
Related exercise material: BED-1, BED-3, and ED-1.
Describe and record employer
payroll taxes.
S T U D Y O B J E C T I V E 3
EMPLOYER PAYROLL TAXES
BENEFITS
3% Disability and
life insurance
23% Legally required
benefits
such as Social Security
24% Medical benefits
37% Vacation and
other benefits
such as parental and sick
leaves, child care
13% Retirement
income
such as pensions
H E L P F U L H I N T
Both the employer and
employee pay FICA
taxes. Federal unem-
ployment taxes and
(in most states) the
state unemployment
taxes are borne entirely
by the employer.
pay the state unemployment tax on a timely basis will receive an offset credit of
up to 5.4%. Therefore, the net federal tax rate is generally 0.8% (6.2%–5.4%).
This rate would equate to a maximum of $56 of federal tax per employee per year
(.008 � $7,000). State tax rates are based on state law.
The employer bears the entire federal unemployment tax. There is no deduction
or withholding from employees. Companies use the account Federal Unemployment
Taxes Payable to recognize this liability. The federal unemployment tax for
Academy Company for the January 14 payroll is $137.68 ($17,210.00 � 0.8%).
State Unemployment Taxes
All states have unemployment compensation programs under state unemployment
tax acts (SUTA). Like federal unemployment taxes, state unemployment taxes pro-
vide benefits to employees who lose their jobs. These taxes are levied on employers.2
The basic rate is usually 5.4% on the first $7,000 of wages paid to an employee during
the year.The state adjusts the basic rate according to the employer’s experience rating:
Companies with a history of stable employment may pay less than 5.4%. Companies
with a history of unstable employment may pay more than the basic rate. Regardless
of the rate paid, the company’s credit on the federal unemployment tax is still 5.4%.
Companies use the account State Unemployment Taxes Payable for this liabil-
ity. The state unemployment tax for Academy Company for the January 14 payroll
is $929.34 ($17,210.00 � 5.4%). Illustration D-11 summarizes the types of em-
ployer payroll taxes.
D12 Appendix D Payroll Accounting
2
In a few states, the employee is also required to make a contribution. In this textbook, including
the homework, we will assume that the tax is only on the employer.
Illustration D-11
Employer payroll taxes
Federal Unemployment Taxes
FICA Taxes
State Unemployment Taxes
Computation
Based
on Wages
Recording Employer Payroll Taxes
Companies usually record employer payroll taxes at the same time they record the
payroll. The entire amount of gross pay ($17,210.00) shown in the payroll register
in Illustration D-9 is subject to each of the three taxes mentioned above.
Accordingly, Academy records the payroll tax expense associated with the January
14 payroll with the entry shown on page D13.
Jan. 14 Payroll Tax Expense 2,443.82
FICA Taxes Payable 1,376.80
Federal Unemployment Taxes Payable 137.68
State Unemployment Taxes Payable 929.34
(To record employer’s payroll taxes on
January 14 payroll)
Note that Academy uses separate liability accounts instead of a single credit to
Payroll Taxes Payable. Why? Because these liabilities are payable to different tax-
ing authorities at different dates. Companies classify the liability accounts in the
balance sheet as current liabilities since they will be paid within the next year. They
classify Payroll Tax Expense on the income statement as an operating expense.
Filing and Remitting Payroll Taxes D13
A � L � SE
�2,443.82 Exp
�1,376.80
�137.68
�929.34
Cash Flows
no effect
FILING AND REMITTING PAYROLL TAXES
Preparation of payroll tax returns is the responsibility of the payroll department.
The treasurer’s department makes the tax payment. Much of the information for
the returns is obtained from employee earnings records.
For purposes of reporting and remitting to the IRS, the Company combines the
FICA taxes and federal income taxes that it withheld. Companies must report the
taxes quarterly, no later than one month following the close of each quarter. The
remitting requirements depend on the amount of taxes withheld and the length of
the pay period. Companies remit funds through deposits in either a Federal
Reserve bank or an authorized commercial bank.
Companies generally file and remit federal unemployment taxes annually on
or before January 31 of the subsequent year. Earlier payments are required when
the tax exceeds a specified amount. Companies usually must file and pay state
unemployment taxes by the end of the month following each quarter. When payroll
taxes are paid, companies debit payroll liability accounts, and credit Cash.
Employers also must provide each employee with a Wage and Tax Statement
(Form W-2) by January 31 following the end of a calendar year. This statement
shows gross earnings, FICA taxes withheld, and income taxes withheld for the
year. The required W-2 form for Michael Jordan, using assumed annual data, is
shown in Illustration D-12. The employer must send a copy of each employee’s
Illustration D-12
W-2 form
Form W-2 Wage and Tax Statement Calendar Year 2008
1 Control number
2 Employer’s name, address and ZIP code
8 Employee’s social security number 9 Federal income tax withheld
12 Employee’s name, address, and ZIP code
3 Employer’s identification number 4 Employer’s State number
6 Allocated tips 7 Advance EIC payment
10 Wages, tips, other compensation 11 Social security tax withheld
13 Social security wages 14 Social security tips
16
17 State income tax
20 Local income tax
18 State wages, tips, etc.
21 Local wages, tips, etc.
19 Name of State
22 Name of locality
5 Stat.
employee
Deceased Legal
rep.
942
emp.
Subtotal Void
OMB No. 1545-0008
329-36-9547 $2,248.00
Michael Jordan
2345 Mifflin Ave.
Hampton, MI 48292
Academy Company
19 Center St.
Hampton, MI 48291
36-2167852
$26,300.00
$26,300.00
$2,104.00
$526.00 Michigan
H E L P F U L H I N T
Employers generally
transmit their W-2s to
the government elec-
tronically. The taxing
agencies store the infor-
mation in their com-
puter systems for
subsequent comparison
against earnings and
taxes withheld reported
on employees’ income
tax returns.
Wage and Tax Statement (Form W-2) to the Social Security Administration. This
agency subsequently furnishes the Internal Revenue Service with the income data
required.
D14 Appendix D Payroll Accounting
REVIEW IT
1. What payroll taxes do governments levy on employers?
2. What accounts are involved in accruing employer payroll taxes?
DO IT
In January, the payroll supervisor determines that gross earnings for Halo
Company are $70,000. All earnings are subject to 8% FICA taxes, 5.4% state
unemployment taxes, and 0.8% federal unemployment taxes. Halo asks you to
record the employer’s payroll taxes.
Action Plan
■ Compute the employer’s payroll taxes on the period’s gross earnings.
■ Identify the expense account(s) to be debited.
■ Identify the liability account(s) to be credited.
Solution The entry to record the employer’s payroll taxes is:
Payroll Tax Expense 9,940
FICA Taxes Payable ($70,000 � 8%) 5,600
Federal Unemployment Taxes Payable ($70,000 � 0.8%) 560
State Unemployment Taxes Payable ($70,000 � 5.4%) 3,780
(To record employer’s payroll taxes
on January payroll)
Related exercise material: BED-2, BED-3, BED-4, ED-1, ED-2, ED-3, ED-4, and ED-5.
Before You Go On…
Demonstration Problem
Indiana Jones Company had the following selected transactions.
Feb. 1 Signs a $50,000, 6-month, 9%-interest-bearing note payable to
CitiBank and receives $50,000 in cash.
10 Cash register sales total $43,200, which includes an 8% sales tax.
28 The payroll for the month consists of Sales Salaries $32,000 and Office
Salaries $18,000. All wages are subject to 8% FICA taxes. A total of
$8,900 federal income taxes are withheld. The salaries are paid on
March 1.
28 The following adjustment data are developed.
1. Interest expense of $375 has been incurred on the note.
2. Employer payroll taxes include 8% FICA taxes, a 5.4% state
unemployment tax, and a 0.8% federal unemployment tax.
Instructions
(a) Journalize the February transactions.
(b) Journalize the adjusting entries at February 28.
Glossary D15
Solution
(a) Feb. 1 Cash 50,000
Notes Payable 50,000
(Issued 6-month, 9%-interest-bearing note to
CitiBank)
10 Cash 43,200
Sales ($43,200 � 1.08) 40,000
Sales Taxes Payable ($40,000 � 8%) 3,200
(To record sales and sales taxes payable)
28 Sales Salaries Expense 32,000
Office Salaries Expense 18,000
FICA Taxes Payable (8% � $50,000) 4,000
Federal Income Taxes Payable 8,900
Salaries Payable 37,100
(To record February salaries)
(b) Feb. 28 Interest Expense 375
Interest Payable 375
(To record accrued interest for February)
28 Payroll Tax Expense 7,100
FICA Taxes Payable 4,000
Federal Unemployment Taxes Payable 400
(0.8% � $50,000)
State Unemployment Taxes Payable 2,700
(5.4% � $50,000)
(To record employer’s payroll taxes on
February payroll)
1 Discuss the objectives of internal control for payroll.
The objectives of internal control for payroll are (1) to
safeguard company assets against unauthorized payments
of payrolls, and (2) to ensure the accuracy and reliability of
the accounting records pertaining to payrolls.
2 Compute and record the payroll for a pay period. The
computation of the payroll involves gross earnings, payroll
deductions, and net pay. In recording the payroll, Salaries
(or Wages) Expense is debited for gross earnings, individ-
ual tax and other liability accounts are credited for payroll
deductions, and Salaries (Wages) Payable is credited for
net pay. When the payroll is paid, Salaries and Wages
Payable is debited, and Cash is credited.
3 Describe and record employer payroll taxes. Employer
payroll taxes consist of FICA, federal unemployment taxes,
and state unemployment taxes. The taxes are usually
accrued at the time the payroll is recorded by debiting
Payroll Tax Expense and crediting separate liability
accounts for each type of tax.
SUMMARY OF STUDY OBJECTIVES
GLOSSARY
Bonus Compensation to management personnel and other
employees, based on factors such as increased sales or the
amount of net income. (p. D4).
Employee earnings record A cumulative record of each
employee’s gross earnings, deductions, and net pay during
the year. (p. D8).
Employee’s Withholding Allowance Certificate (Form W-4)
An Internal Revenue Service form on which the employee
indicates the number of allowances claimed for withhold-
ing federal income taxes. (p. D6).
Federal unemployment taxes Taxes imposed on the
employer that provide benefits for a limited time period to
employees who lose their jobs through no fault of their
own. (p. D11).
Fees Payments made for the services of professionals. (p. D1).
FICA taxes Taxes designed to provide workers with supple-
mental retirement, employment disability, and medical
benefits. (p. D5).
Gross earnings Total compensation earned by an em-
ployee. (p. D4).
action plan
✔ To determine sales, divide
the cash register total by
100% plus the sales tax
percentage.
✔ Base payroll taxes on
gross earnings.
Net pay Gross earnings less payroll deductions. (p. D7).
Payroll deductions Deductions from gross earnings to
determine the amount of a paycheck. (p. D5).
Payroll register A payroll record that accumulates the
gross earnings, deductions, and net pay by employee for
each pay period. (p. D8).
Salaries Specified amount per month or per year paid to
managerial, administrative, and sales personnel. (p. D1).
Statement of earnings A document attached to a paycheck
that indicates the employee’s gross earnings, payroll de-
ductions, and net pay. (p. D10).
State unemployment taxes Taxes imposed on the em-
ployer that provide benefits to employees who lose their
jobs. (p. D12).
Wage and Tax Statement (Form W-2) A form showing
gross earnings, FICA taxes withheld, and income taxes
withheld which is prepared annually by an employer for
each employee. (p. D13).
Wages Amounts paid to employees based on a rate per
hour or on a piece-work basis. (p. D1).
D16 Appendix D Payroll Accounting
SELF-STUDY QUESTIONS
Answers are at the end of the appendix.
1. The department that should pay the payroll is the:
a. timekeeping department.
b. human resources department.
c. payroll department.
d. treasurer’s department.
2. J. Barr earns $14 per hour for a 40-hour week and $21 per
hour for any overtime work. If Barr works 45 hours in a
week, gross earnings are:
a. $560.
b. $630.
c. $650.
d. $665.
3. Employer payroll taxes do not include:
a. federal unemployment taxes.
b. state unemployment taxes.
c. federal income taxes.
d. FICA taxes.
Go to the book’s website,
www.wiley.com/college/weygandt,
for Additional Self-Study questions.
QUESTIONS
1. You are a newly hired accountant with Schindlebeck
Company. On your first day, the controller asks you to
identify the main internal control objectives related to
payroll accounting. How would you respond?
2. What are the four functions associated with payroll activ-
ities?
3. What is the difference between gross pay and net pay?
Which amount should a company record as wages or
salaries expense?
4. Which payroll tax is levied on both employers and em-
ployees?
5. Are the federal and state income taxes withheld from
employee paychecks a payroll tax expense for the em-
ployer? Explain your answer.
6. What do the following acronyms stand for: FICA, FUTA,
and SUTA?
7. What information is shown on a W-4 statement? On a W-2
statement?
8. Distinguish between the two types of payroll deduc-
tions and give examples of each.
9. What are the primary uses of the employee earnings
record?
10. (a) Identify the three types of employer payroll taxes.
(b) How are tax liability accounts and Payroll Tax
Expense classified in the financial statements?
BRIEF EXERCISES
BED-1 Hernandez Company has the following payroll procedures.
(a) Supervisor approves overtime work.
(b) The human resources department prepares hiring authorization forms for new hires.
(c) A second payroll department employee verifies payroll calculations.
(d) The treasurer’s department pays employees.
Identify the payroll function to which each procedure pertains.
Identify payroll functions.
(SO 1)
(SO 1)
(SO 2)
(SO 3)
BED-2 Sandy Teter’s regular hourly wage rate is $16, and she receives an hourly rate of $24 for
work in excess of 40 hours. During a January pay period, Sandy works 45 hours. Sandy’s federal
income tax withholding is $95, and she has no voluntary deductions. Compute Sandy Teter’s gross
earnings and net pay for the pay period.
BED-3 Data for Sandy Teter are presented in BED-2. Prepare the journal entries to record (a)
Sandy’s pay for the period and (b) the payment of Sandy’s wages. Use January 15 for the end of
the pay period and the payment date.
BED-4 In January, gross earnings in Yoon Company totaled $90,000. All earnings are subject to
8% FICA taxes, 5.4% state unemployment taxes, and 0.8% federal unemployment taxes. Prepare
the entry to record January payroll tax expense.
Exercises D17
Compute gross earnings and
net pay.
(SO 2)
Record a payroll and the
payment of wages.
(SO 2)
Record employer payroll taxes.
(SO 3)
EXERCISES
ED-1 Betty Williams’ regular hourly wage rate is $14, and she receives a wage of 11⁄2 times the
regular hourly rate for work in excess of 40 hours. During a March weekly pay period Betty
worked 42 hours. Her gross earnings prior to the current week were $6,000. Betty is married and
claims three withholding allowances. Her only voluntary deduction is for group hospitalization
insurance at $15 per week.
Instructions
(a) Compute the following amounts for Betty’s wages for the current week.
(1) Gross earnings.
(2) FICA taxes. (Assume an 8% rate on maximum of $97,500.)
(3) Federal income taxes withheld. (Use the withholding table in the text, page D7.)
(4) State income taxes withheld. (Assume a 2.0% rate.)
(5) Net pay.
(b) Record Betty’s pay, assuming she is an office computer operator.
ED-2 Employee earnings records for Brantley Company reveal the following gross earnings
for four employees through the pay period of December 15.
C. Mays $83,500 D. Delgado $95,700
L. Jeter $95,200 T. Rolen $97,500
For the pay period ending December 31, each employee’s gross earnings is $3,000. Employees
are required to pay a FICA tax rate of 8% gross earnings of $97,500.
Instructions
Compute the FICA withholdings that should be made for each employee for the December 31
pay period. (Show computations.)
ED-3 Piniella Company has the following data for the weekly payroll ending January 31.
Hours Federal
Hourly Income Tax Health
Employee M T W T F S Rate Withholding Insurance
M. Hindi 8 8 9 8 10 3 $11 $34 $10
E. Benson 8 8 8 8 8 2 13 37 15
K. Estes 9 10 8 8 9 0 14 58 15
Employees are paid 11⁄2 times the regular hourly rate for all hours worked in excess of 40 hours
per week. FICA taxes are 8% on the first $97,500 of gross earnings. Piniella Company is subject
to 5.4% state unemployment taxes on the first $9,800 and 0.8% federal unemployment taxes on
the first $7,000 of gross earnings.
Instructions
(a) Prepare the payroll register for the weekly payroll.
(b) Prepare the journal entries to record the payroll and Piniella’s payroll tax expense.
Compute net pay and record
pay for one employee.
(SO 2)
Compute maximum FICA
deductions.
(SO 2)
Prepare payroll register and
record payroll and payroll tax
expense.
(SO 2, 3)
ED-4 Selected data from a February payroll register for Landmark Company are presented
below. Some amounts are intentionally omitted.
Gross earnings:
Regular $8,900 State income taxes $ (3)
Overtime (1) Union dues 100
Total (2) Total deductions (4)
Deductions: Net pay $7,215
FICA taxes $ 760 Accounts debited:
Federal income taxes 1,140 Warehouse wages (5)
Store wages $4,000
FICA taxes are 8%. State income taxes are 3% of gross earnings.
Instructions
(a) Fill in the missing amounts.
(b) Journalize the February payroll and the payment of the payroll.
ED-5 According to a payroll register summary of Cruz Company, the amount of employees’
gross pay in December was $850,000, of which $70,000 was not subject to FICA tax and $760,000
was not subject to state and federal unemployment taxes.
Instructions
(a) Determine the employer’s payroll tax expense for the month, using the following rates:
FICA 8%, state unemployment 5.4%, federal unemployment 0.8%.
(b) Prepare the journal entry to record December payroll tax expense.
D18 Appendix D Payroll Accounting
Compute missing payroll
amounts and record payroll.
(SO 2)
Determine employer’s payroll
taxes; record payroll tax
expense.
(SO 3)
EXERCISES: SET B
Visit the book’s website at www.wiley.com/college/weygandt, and choose the Student
Companion site, to access Exercise Set B.
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.wiley.co
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ygandt
PROBLEMS: SET A
PD-1A The payroll procedures used by three different companies are described below.
1. In Brewer Company each employee is required to mark on a clock card the hours
worked. At the end of each pay period, the employee must have this clock card
approved by the department manager. The approved card is then given to the payroll
department by the employee. Subsequently, the treasurer’s department pays the
employee by check.
2. In Hilyard Computer Company clock cards and time clocks are used. At the end of each
pay period, the department manager initials the cards, indicates the rates of pay, and sends
them to payroll. A payroll register is prepared from the cards by the payroll department.
Cash equal to the total net pay in each department is given to the department manager,
who pays the employees in cash.
3. In Hyun-chan Company employees are required to record hours worked by “punching”
clock cards in a time clock. At the end of each pay period, the clock cards are collected by
the department manager. The manager prepares a payroll register in duplicate and
forwards the original to payroll. In payroll, the summaries are checked for mathematical
accuracy, and a payroll supervisor pays each employee by check.
Instructions
(a) Indicate the weakness(es) in internal control in each company.
(b) For each weakness, describe the control procedure(s) that will provide effective internal
control. Use the following format for your answer:
(a) Weaknesses (b) Recommended Procedures
Identify internal control
weaknesses and make
recommendations for
improvement.
(SO 1)
PD-2A Graves Drug Store has four employees who are paid on an hourly basis plus time-and-
a-half for all hours worked in excess of 40 a week. Payroll data for the week ended February 15,
2008, are presented below.
Federal
Hours Hourly Income Tax United
Employees Worked Rate Withholdings Way
L. Leiss 39 $14.00 $ ? $–0–
S. Bjork 42 $12.00 ? 5.00
M. Cape 44 $12.00 61 7.50
L. Wild 48 $12.00 52 5.00
Leiss and Bjork are married. They claim 2 and 4 withholding allowances, respectively. The fol-
lowing tax rates are applicable: FICA 8%, state income taxes 3%, state unemployment taxes
5.4%, and federal unemployment 0.8%. The first three employees are sales clerks (store wages
expense). The fourth employee performs administrative duties (office wages expense).
Instructions
(a) Prepare a payroll register for the weekly payroll. (Use the wage-bracket withholding table
in the text for federal income tax withholdings.)
(b) Journalize the payroll on February 15, 2008, and the accrual of employer payroll taxes.
(c) Journalize the payment of the payroll on February 16, 2008.
(d) Journalize the deposit in a Federal Reserve bank on February 28, 2008, of the FICA and
federal income taxes payable to the government.
PD-3A The following payroll liability accounts are included in the ledger of Eikleberry Com-
pany on January 1, 2008.
FICA Taxes Payable $ 662.20
Federal Income Taxes Payable 1,254.60
State Income Taxes Payable 102.15
Federal Unemployment Taxes Payable 312.00
State Unemployment Taxes Payable 1,954.40
Union Dues Payable 250.00
U.S. Savings Bonds Payable 350.00
In January, the following transactions occurred.
Jan. 10 Sent check for $250.00 to union treasurer for union dues.
12 Deposited check for $1,916.80 in Federal Reserve bank for FICA taxes and federal
income taxes withheld.
15 Purchased U.S. Savings Bonds for employees by writing check for $350.00.
17 Paid state income taxes withheld from employees.
20 Paid federal and state unemployment taxes.
31 Completed monthly payroll register, which shows office salaries $17,600, store wages
$27,400, FICA taxes withheld $3,600, federal income taxes payable $1,770, state income
taxes payable $360, union dues payable $400, United Fund contributions payable
$1,800, and net pay $37,070.
31 Prepared payroll checks for the net pay and distributed checks to employees.
At January 31, the company also makes the following accrual for employer payroll taxes: FICA
taxes 8%, state unemployment taxes 5.4%, and federal unemployment taxes 0.8%.
Instructions
(a) Journalize the January transactions.
(b) Journalize the adjustments pertaining to employee compensation at January 31.
Problems: Set A D19
Prepare payroll register and
payroll entries.
(SO 2, 3)
(a) Net pay $1,786.32; Store
wages expense $1,614.00
(b) Payroll tax expense
$317.79
Journalize payroll transactions
and adjusting entries.
(SO 2, 3)
(b) Payroll tax expense
$6,390.00
PD-4A For the year ended December 31, 2008, R. Visnak Company reports the following
summary payroll data.
Gross earnings:
Administrative salaries $180,000
Electricians’ wages 320,000
Total $500,000
Deductions:
FICA taxes $ 35,200
Federal income taxes withheld 153,000
State income taxes withheld (2.6%) 13,000
United Way contributions payable 25,000
*Hospital insurance premiums 15,800
Total $242,000
R. Visnak Company’s payroll taxes are: FICA 8%, state unemployment 2.5% (due to a stable
employment record), and 0.8% federal unemployment. Gross earnings subject to FICA taxes
total $440,000, and unemployment taxes total $110,000.
Instructions
(a) Prepare a summary journal entry at December 31 for the full year’s payroll.
(b) Journalize the adjusting entry at December 31 to record the employer’s payroll taxes.
(c) The W-2 Wage and Tax Statement requires the following dollar data.
Wages, Tips, Federal Income State Income FICA FICA Tax
Other Compensation Tax Withheld Tax Withheld Wages Withheld
Complete the required data for the following employees.
Employee Gross Earnings Federal Income Tax Withheld
R. Lopez $60,000 $27,500
K. Kirk 27,000 11,000
D20 Appendix D Payroll Accounting
Prepare entries for payroll and
payroll taxes; prepare W-2 data.
(SO 2, 3)
PROBLEMS: SET B
PD-1B Selected payroll procedures of Wallace Company are described below.
1. Department managers interview applicants and on the basis of the interview either hire or
reject the applicants. When an applicant is hired, the applicant fills out a W-4 form
(Employee’s Withholding Allowance Certificate). One copy of the form is sent to the
human resources department, and one copy is sent to the payroll department as notice that
the individual has been hired. On the copy of the W-4 sent to payroll, the managers manually
indicate the hourly pay rate for the new hire.
2. The payroll checks are manually signed by the chief accountant and given to the department
managers for distribution to employees in their department. The managers are responsible for
seeing that any absent employees receive their checks.
3. There are two clerks in the payroll department. The payroll is divided alphabetically; one
clerk has employees A to L and the other has employees M to Z. Each clerk computes the
gross earnings, deductions, and net pay for employees in the section and posts the data to
the employee earnings records.
Instructions
(a) Indicate the weaknesses in internal control.
(b) For each weakness, describe the control procedures that will provide effective internal con-
trol. Use the following format for your answer:
(a) Weaknesses (b) Recommended Procedures
Identify internal control
weaknesses and make
recommendations for
improvement.
(SO 1)
(a) Wages Payable $258,000
(b) Payroll tax expense
$38,830
PD-2B Lee Hardware has four employees who are paid on an hourly basis plus time-and-a
half for all hours worked in excess of 40 a week. Payroll data for the week ended March 15, 2008,
are presented below.
Federal
Hours Hourly Income Tax United
Employee Worked Rate Withholdings Way
Joe Coomer 40 $15.00 $? $5.00
Mary Walker 42 13.00 ? 5.00
Andy Dye 44 13.00 60 8.00
Kim Shen 48 13.00 67 5.00
Coomer and Walker are married. They claim 0 and 4 withholding allowances, respectively. The
following tax rates are applicable: FICA 8%, state income taxes 3%, state unemployment taxes
5.4%, and federal unemployment 0.8%. The first three employees are sales clerks (store wages
expense). The fourth employee performs administrative duties (office wages expense).
Instructions
(a) Prepare a payroll register for the weekly payroll. (Use the wage-bracket withholding table in
the text for federal income tax withholdings.)
(b) Journalize the payroll on March 15, 2008, and the accrual of employer payroll taxes.
(c) Journalize the payment of the payroll on March 16, 2008.
(d) Journalize the deposit in a Federal Reserve bank on March 31, 2008, of the FICA and federal
income taxes payable to the government.
PD-3B The following payroll liability accounts are included in the ledger of Nordlund
Company on January 1, 2008.
FICA Taxes Payable $ 760.00
Federal Income Taxes Payable 1,204.60
State Income Taxes Payable 108.95
Federal Unemployment Taxes Payable 288.95
State Unemployment Taxes Payable 1,954.40
Union Dues Payable 870.00
U.S. Savings Bonds Payable 360.00
In January, the following transactions occurred.
Jan. 10 Sent check for $870.00 to union treasurer for union dues.
12 Deposited check for $1,964.60 in Federal Reserve bank for FICA taxes and federal in-
come taxes withheld.
15 Purchased U.S. Savings Bonds for employees by writing check for $360.00.
17 Paid state income taxes withheld from employees.
20 Paid federal and state unemployment taxes.
31 Completed monthly payroll register, which shows office salaries $21,600, store wages
$28,400, FICA taxes withheld $4,000, federal income taxes payable $1,958, state income
taxes payable $414, union dues payable $400, United Fund contributions payable
$1,888, and net pay $41,340.
31 Prepared payroll checks for the net pay and distributed checks to employees.
At January 31, the company also makes the following accrued adjustment for employer pay-
roll taxes: FICA taxes 8%, federal unemployment taxes 0.8%, and state unemployment taxes
5.4%.
Instructions
(a) Journalize the January transactions.
(b) Journalize the adjustments pertaining to employee compensation at January 31.
Problems: Set B D21
(a) Net pay $1,910.37; Store
wages expense $1,757
(b) Payroll tax expense
$345.48
Prepare payroll register and
payroll entries.
(SO 2, 3)
Journalize payroll transactions
and adjusting entries.
(SO 2, 3)
(b) Payroll tax expense
$7,100
PD-4B For the year ended December 31, 2008, Niehaus Electrical Repair Company reports
the following summary payroll data.
Gross earnings:
Administrative salaries $180,000
Electricians’ wages 370,000
Total $550,000
Deductions:
FICA taxes $ 38,000
Federal income taxes withheld 168,000
State income taxes withheld (2.6%) 14,300
United Way contributions payable 27,500
*Hospital insurance premiums 17,200
Total $265,000
Niehaus Company’s payroll taxes are: FICA 8%, state unemployment 2.5% (due to a stable em-
ployment record), and 0.8% federal unemployment. Gross earnings subject to FICA taxes total
$475,000, and unemployment taxes total $125,000.
Instructions
(a) Prepare a summary journal entry at December 31 for the full year’s payroll.
(b) Journalize the adjusting entry at December 31 to record the employer’s payroll taxes.
(c) The W-2 Wage and Tax Statement requires the following dollar data.
Wages, Tips, Federal Income State Income FICA FICA
Other Compensation Tax Withheld Tax Withheld Wages Tax Withheld
Complete the required data for the following employees.
Employee Gross Earnings Federal Income Tax Withheld
Anna Hashmi $59,000 $28,500
Sharon Bishop 26,000 10,200
D22 Appendix D Payroll Accounting
Prepare entries for payroll and
payroll taxes; prepare W-2 data.
(SO 2, 3)
(a) Wages payable $285,000
(b) Payroll tax expense
$42,125
PROBLEMS: SET C
Visit the book’s website at www.wiley.com/college/weygandt, and choose the Student
Companion site, to access Problem Set C.
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Exploring the Web
BYPD-1 The Internal Revenue Service provides considerable information over the Internet.
The following demonstrates how useful one of its sites is in answering payroll tax questions
faced by employers.
Address: www.irs.ustreas.gov/formspubs/index.html, or go to www.wiley.com/college/weygandt
Steps
1. Go to the site shown above.
2. Choose View Online, Tax Publications.
3. Choose Publication 15, Circular E, Employer’s Tax Guide.
B R O A D E N I N G Y O U R P E R S P E C T I V E
FINANCIAL REPORTING AND ANALYSIS
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Instructions
Answer each of the following questions.
(a) How does the government define “employees”?
(b) What are the special rules for Social Security and Medicare regarding children who are em-
ployed by their parents?
(c) How can an employee obtain a Social Security card if he or she doesn’t have one?
(d) Must employees report to their employer tips received from customers? If so, what is the
process?
(e) Where should the employer deposit Social Security taxes withheld or contributed?
Broadening Your Perspective D23
CRITICAL THINKING
Decision Making Across the Organization
BYPD-2 Summerville Processing Company provides word-processing services for business
clients and students in a university community. The work for business clients is fairly steady
throughout the year. The work for students peaks significantly in December and May as a re-
sult of term papers, research project reports, and dissertations.
Two years ago, the company attempted to meet the peak demand by hiring part-time help.
However, this led to numerous errors and considerable customer dissatisfaction. A year ago, the
company hired four experienced employees on a permanent basis instead of using part-time
help. This proved to be much better in terms of productivity and customer satisfaction. But, it has
caused an increase in annual payroll costs and a significant decline in annual net income.
Recently, Valarie Flynn, a sales representative of Davidson Services Inc., has made a pro-
posal to the company. Under her plan, Davidson Services will provide up to four experienced
workers at a daily rate of $80 per person for an 8-hour workday. Davidson workers are not avail-
able on an hourly basis. Summerville Processing would have to pay only the daily rate for the
workers used.
The owner of Summerville Processing, Nancy Bell, asks you, as the company’s accountant,
to prepare a report on the expenses that are pertinent to the decision. If the Davidson plan is
adopted, Nancy will terminate the employment of two permanent employees and will keep two
permanent employees. At the moment, each employee earns an annual income of $22,000.
Summerville Processing pays 8% FICA taxes, 0.8% federal unemployment taxes, and 5.4% state
unemployment taxes. The unemployment taxes apply to only the first $7,000 of gross earnings. In
addition, Summerville Processing pays $40 per month for each employee for medical and dental
insurance.
Nancy indicates that if the Davidson Services plan is accepted, her needs for workers will be
as follows.
Working
Months Number Days per Month
January–March 2 20
April–May 3 25
June–October 2 18
November–December 3 23
Instructions
With the class divided into groups, answer the following.
(a) Prepare a report showing the comparative payroll expense of continuing to employ per-
manent workers compared to adopting the Davidson Services Inc. plan.
(b) What other factors should Nancy consider before finalizing her decision?
Communication Activity
BYPD-3 Ivan Blanco, president of the Blue Sky Company, has recently hired a number of
additional employees. He recognizes that additional payroll taxes will be due as a result of this
hiring, and that the company will serve as the collection agent for other taxes.
Instructions
In a memorandum to Ivan Blanco, explain each of the taxes, and identify the taxes that result in
payroll tax expense to Blue Sky Company.
Ethics Case
BYPD-4 Johnny Fuller owns and manages Johnny’s Restaurant, a 24-hour restaurant near the
city’s medical complex. Johnny employs 9 full-time employees and 16 part-time employees. He
pays all of the full-time employees by check, the amounts of which are determined by Johnny’s
public accountant, Mary Lake. Johnny pays all of his part-time employees in cash. He computes
their wages and withdraws the cash directly from his cash register.
Mary has repeatedly urged Johnny to pay all employees by check. But as Johnny has told his
competitor and friend, Steve Hill, who owns the Greasy Diner, “First of all, my part-time em-
ployees prefer the cash over a check, and secondly I don’t withhold or pay any taxes or work-
men’s compensation insurance on those wages because they go totally unrecorded and
unnoticed.”
Instructions
(a) Who are the stakeholders in this situation?
(b) What are the legal and ethical considerations regarding Johnny’s handling of his payroll?
(c) Mary Lake is aware of Johnny’s payment of the part-time payroll in cash. What are her
ethical responsibilities in this case?
(d) What internal control principle is violated in this payroll process?
Answers to Self-Study Questions
1. d 2. d 3. c
D24 Appendix D Payroll Accounting
E1
Subsidiary Ledgers
and Special Journals
Appendix E
SECTION 1 Expanding the Ledger—
Subsidiary Ledgers
After studying this appendix, you should be able to:
1. Describe the nature and purpose of a subsidiary ledger.
2. Explain how companies use special journals in journalizing.
3. Indicate how companies post a multi-column journal.
S T U D Y O B J E C T I V E S
NATURE AND PURPOSE OF
SUBSIDIARY LEDGERS
Imagine a business that has several thousand charge (credit) customers
and shows the transactions with these customers in only one general
ledger account—Accounts Receivable. It would be nearly impossible to
determine the balance owed by an individual customer at any specific
time. Similarly, the amount payable to one creditor would be difficult to locate
quickly from a single Accounts Payable account in the general ledger.
Instead, companies use subsidiary ledgers to keep track of individual balances.
A subsidiary ledger is a group of accounts with a common characteristic (for example,
all accounts receivable). It is an addition to, and an expansion of, the general ledger.
The subsidiary ledger frees the general ledger from the details of individual balances.
Two common subsidiary ledgers are:
1. The accounts receivable (or customers’) subsidiary ledger, which collects trans-
action data of individual customers.
2. The accounts payable (or creditors’) subsidiary ledger, which collects transac-
tion data of individual creditors.
In each of these subsidiary ledgers, companies usually arrange individual accounts
in alphabetical order.
A general ledger account summarizes the detailed data from a subsidiary
ledger. For example, the detailed data from the accounts receivable subsidiary
ledger are summarized in Accounts Receivable in the general ledger. The gen-
eral ledger account that summarizes subsidiary ledger data is called a control
account. Illustration E-1 (page E2) presents an overview of the relationship of sub-
sidiary ledgers to the general ledger. There, the general ledger control accounts and
subsidiary ledger accounts are in green. Note that cash and owner’s capital in this
Describe the nature and purpose
of a subsidiary ledger.
S T U D Y O B J E C T I V E 1
illustration are not control accounts because there are no subsidiary ledger accounts
related to these accounts.
At the end of an accounting period, each general ledger control account bal-
ance must equal the composite balance of the individual accounts in the related
subsidiary ledger. For example, the balance in Accounts Payable in Illustration E-1
must equal the total of the subsidiary balances of Creditors X � Y � Z.
E2 Appendix E Subsidiary Ledgers and Special Journals
CashGeneral
Ledger
Control
accounts
Subsidiary
Ledgers
Accounts
Receivable
Customer
B
Customer
C
Customer
A
Accounts
Payable
Common Stock
Creditor
Y
Creditor
Z
Creditor
X
Illustration E-1
Relationship of general
ledger and subsidiary ledgers Subsidiary Ledger Example
Illustration E-2 provides an example of a control account and subsidiary ledger for
Pujols Enterprises. (Due to space considerations, the explanation column in these
accounts is not shown in this and subsequent illustrations.) Illustration E-2 is based
on the transactions listed in Illustration E-3 (next page).Illustration E-2
Relationship between gen-
eral and subsidiary ledgers
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General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl
Date Ref. Debit Credit Balance
2008
Jan 12
21
Branden Inc.
3,000
3,000
3,000
——
Date Ref. Debit Credit Balance
2008
Jan 31
31
Accounts Receivable No. 112
12,000
8,000
12,000
4,000
The subsidiary ledger
is separate from the
general ledger.
Accounts Receivable
is a control account.
Date Ref. Debit Credit Balance
2008
Jan 20
29
Caron Co.
3,000
1,000
3,000
2,000
Date Ref. Debit Credit Balance
2008
Jan 10
19
Aaron Co.
6,000
4,000
6,000
2,000
Pujols can reconcile the total debits ($12,000) and credits ($8,000) in Accounts
Receivable in the general ledger to the detailed debits and credits in the subsidiary
accounts. Also, the balance of $4,000 in the control account agrees with the total of
the balances in the individual accounts (Aaron Co. $2,000 � Branden Inc. $0 �
Caron Co. $2,000) in the subsidiary ledger.
As Illustration E-2 shows, companies make monthly postings to the control ac-
counts in the general ledger. This practice allows them to prepare monthly financial
statements. Companies post to the individual accounts in the subsidiary ledger
daily. Daily posting ensures that account information is current. This enables the
company to monitor credit limits, bill customers, and answer inquiries from cus-
tomers about their account balances.
Advantages of Subsidiary Ledgers
Subsidiary ledgers have several advantages:
1. They show in a single account transactions affecting one customer or one cred-
itor, thus providing up-to-date information on specific account balances.
2. They free the general ledger of excessive details. As a result, a trial balance of the
general ledger does not contain vast numbers of individual account balances.
3. They help locate errors in individual accounts by reducing the number of ac-
counts in one ledger and by using control accounts.
4. They make possible a division of labor in posting. One employee can post to
the general ledger while someone else posts to the subsidiary ledgers.
Nature and Purpose of Subsidiary Ledgers E3
Illustration E-3
Sales and collection
transactions
Credit Sales Collections on Account
Jan. 10 Aaron Co. $ 6,000 Jan. 19 Aaron Co. $ 4,000
12 Branden Inc. 3,000 21 Branden Inc. 3,000
20 Caron Co. 3,000 29 Caron Co. 1,000
$12,000 $ 8,000
REVIEW IT
1. What is a subsidiary ledger, and what purpose does it serve?
2. What is a control account, and what purpose does it serve?
3. Name two general ledger accounts that may act as control accounts for a
subsidiary ledger. Can you think of a third control account?
DO IT
Presented below is information related to Sims Company for its first month of
operations. Determine the balances that appear in the accounts payable subsidiary
ledger. What Accounts Payable balance appears in the general ledger at the end
of January?
Action Plan
■ Subtract cash paid from credit purchases to determine the balances in the
accounts payable subsidiary ledger.
■ Sum the individual balances to determine the Accounts Payable balance.
Before You Go On…
Credit Purchases Cash Paid
Jan. 5 Devon Co. $11,000 Jan. 9 Devon Co. $7,000
11 Shelby Co. 7,000 14 Shelby Co. 2,000
22 Taylor Co. 14,000 27 Taylor Co. 9,000
E4 Appendix E Subsidiary Ledgers and Special Journals
Solution Subsidiary ledger balances:
Devon Co. $4,000 ($11,000 � $7,000)
Shelby Co. $5,000 ($7,000 � $2,000)
Taylor Co. $5,000 ($14,000 � $9,000).
General ledger Accounts Payable balance: $14,000 ($4,000 � $5,000 � $5,000).
Related exercise material: BEE-4, BEE-5, EE-1, EE-2, EE-4, and EE-5.
SECTION 2 Expanding the Journal—
Special Journals
So far you have learned to journalize transactions in a two-column general
journal and post each entry to the general ledger. This procedure is satisfac-
tory in only the very smallest companies. To expedite journalizing and post-
ing, most companies use special journals in addition to the general journal.
Companies use special journals to record similar types of transactions.
Examples are all sales of merchandise on account, or all cash receipts. The types of
transactions that occur frequently in a company determine what special journals
the company uses. Most merchandising enterprises record daily transactions using
the journals shown in Illustration E-4.
Explain how companies use
special journals in journalizing.
S T U D Y O B J E C T I V E 2
Illustration E-4
Use of special journals and
the general journal
Sales
Journal
All sales of
merchandise
on account
Used for:
Cash Receipts
Journal
All cash received
(including cash
sales)
Used for:
Purchases
Journal
All purchases
of merchandise
on account
Used for:
Cash Payments
Journal
All cash paid
(including cash
purchases)
Used for:
General
Journal
Transactions that
cannot be entered
in a special journal,
including correcting,
adjusting, and
closing entries
Used for:
If a transaction cannot be recorded in a special journal, the company records it in
the general journal. For example, if a company had special journals for only the four
types of transactions listed above, it would record purchase returns and allowances in
the general journal. Similarly, correcting, adjusting, and closing entries are recorded
in the general journal. In some situations, companies might use special journals other
than those listed above. For example, when sales returns and allowances are fre-
quent, a company might use a special journal to record these transactions.
Special journals permit greater division of labor because several people can
record entries in different journals at the same time. For example, one employee
may journalize all cash receipts, and another may journalize all credit sales. Also,
the use of special journals reduces the time needed to complete the posting
process. With special journals, companies may post some accounts monthly, instead
of daily, as we will illustrate later in the chapter. On the following pages, we discuss
the four special journals shown in Illustration E-4.
In the sales journal, companies record sales of merchandise on account. Cash sales
of merchandise go in the cash receipts journal. Credit sales of assets other than
merchandise go in the general journal.
Journalizing Credit Sales
To demonstrate use of a sales journal, we will use data for Karns Wholesale Supply,
which uses a perpetual inventory system. Under this system, each entry in the sales
journal results in one entry at selling price and another entry at cost. The entry at
selling price is a debit to Accounts Receivable (a control account) and a credit of
equal amount to Sales. The entry at cost is a debit to Cost of Goods Sold and a
credit of equal amount to Merchandise Inventory (a control account). Using a sales
journal with two amount columns, the company can show on only one line a sales
transaction at both selling price and cost. Illustration E-5 shows this two-column
sales journal of Karns Wholesale Supply, using assumed credit sales transactions
(for sales invoices 101–107).
Sales Journal E5
SALES JOURNAL
H E L P F U L H I N T
Postings are also made
daily to individual ledger
accounts in the inventory
subsidiary ledger to
maintain a perpetual
inventory.
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General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl
Date Account Debited
Invoice
No.
Accts. Receivable Dr.
Sales Cr.
Cost of Goods Sold Dr.
Merchandise Inventory Cr.Ref.
Abbot Sisters
Babson Co.
Carson Bros.
Deli Co.
Abbot Sisters
Deli Co.
Babson Co.
2008
May 3
7
14
19
21
24
27
101
102
103
104
105
106
107
10,600
11,350
7,800
9,300
15,400
21,210
14,570
90,230
6,360
7,370
5,070
6,510
10,780
15,900
10,200
62,190
,
,
,
,
Illustration E-5
Journalizing the sales
journal—perpetual
inventory system
Note several points: Unlike the general journal, an explanation is not required
for each entry in a special journal. Also, use of prenumbered invoices ensures that
all invoices are journalized. Finally, the reference (Ref.) column is not used in jour-
nalizing. It is used in posting the sales journal, as explained next.
Posting the Sales Journal
Companies make daily postings from the sales journal to the individual accounts
receivable in the subsidiary ledger. Posting to the general ledger is done monthly.
Illustration E-6 (page E6) shows both the daily and monthly postings.
A check mark (✓) is inserted in the reference posting column to indicate that
the daily posting to the customer’s account has been made. If the subsidiary ledger
accounts were numbered, the account number would be entered in place of the
check mark. At the end of the month, Karns posts the column totals of the sales
journal to the general ledger. Here, the column totals are as follows: From the selling-
price column, a debit of $90,230 to Accounts Receivable (account No. 112), and a
credit of $90,230 to Sales (account No. 401). From the cost column, a debit of
$62,190 to Cost of Goods Sold (account No. 505), and a credit of $62,190 to
Merchandise Inventory (account No. 120). Karns inserts the account numbers
E6 Appendix E Subsidiary Ledgers and Special Journals
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General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl
Date Account Debited
Invoice
No.
Accts. Receivable Dr.
Sales Cr.
Cost of Goods Sold Dr.
Merchandise Inventory Cr.Ref.
Abbot Sisters
Babson Co.
Carson Bros.
Deli Co.
Abbot Sisters
Deli Co.
Babson Co.
2008
May 3
7
14
19
21
24
27
101
102
103
104
105
106
107
10,600
11,350
7,800
9,300
15,400
21,210
14,570
90,230
6,360
7,370
5,070
6,510
10,780
15,900
10,200
62,190
,
,
,
,
(112) / (401) (505) / (120)
Date Ref. Debit Credit Balance
2008
May 3y
21
Abbot Sisters
10,600
15,400
10,600
26,000
Date Ref. Debit Credit Balance
2008
May 7
27
Babson Co.
11,350
14,570
11,350
25,920
Date Ref. Debit Credit Balance
2008
May 14
Carson Bros.
7,800 7,800
Date Ref. Debit Credit Balance
2008
May 31y
Accounts Receivable
90,230 90,230
Date Ref. Debit Credit Balance
2008
May 19
24
Deli Co.
9,300
21,210
9,300
30,510
Date Ref. Debit Credit Balance
2008
May 31
Sales
90,230 90,230
The company posts individual
amounts to the subsidiary ledger daily.
At the end of the
accounting period,
the company posts
totals to the general
ledger.
S1
S1
S1
S1
S1
S1
S1
S1
S1
No. 112
Date Ref. Debit Credit Balance
2008
May 31
Merchandise Inventory
62,190162,190S1
No. 120
No. 401
Date Ref. Debit Credit Balance
2008
May 31
Cost of Goods Sold
62,190 62,190S1
No. 505
The subsidiary ledger is separate
from the general ledger.
Accounts Receivable is a control
account.
1The normal balance for Merchandise Inventory is a debit. But, because of the sequence in which we have posted the special journals,
with the sales journals first, the credits to Merchandise Inventory are posted before the debits. This posting sequence explains the credit
balance in Merchandise Inventory, which exists only until the other journals are posted.
Illustration E-6
Posting the sales journal
below the column totals to indicate that the postings have been made. In both the
general ledger and subsidiary ledger accounts, the reference S1 indicates that the
posting came from page 1 of the sales journal.
Proving the Ledgers
The next step is to “prove” the ledgers. To do so, Karns must determine two things:
(1) The total of the general ledger debit balances must equal the total of the gen-
eral ledger credit balances. (2) The sum of the subsidiary ledger balances must
equal the balance in the control account. Illustration E-7 shows the proof of the
postings from the sales journal to the general and subsidiary ledger.
Cash Receipts Journal E7
Advantages of the Sales Journal
Use of a special journal to record sales on account has several advantages. First, the
one-line entry for each sales transaction saves time. In the sales journal, it is not nec-
essary to write out the four account titles for each transaction. Second, only totals,
rather than individual entries, are posted to the general ledger. This saves posting
time and reduces the possibilities of posting errors. Finally, a division of labor re-
sults, because one individual can take responsibility for the sales journal.
Illustration E-7
Proving the equality of the
postings from the sales
journal
Postings to
General Ledger
General Ledger
Credits
Debits
Debit Postings to the Accounts
Receivable Subsidiary Ledger
Subsidiary Ledger
$26,000
25,920
7,800
30,510
$90,230
Abbot Sisters
Babson Co.
Carson Bros.
Deli Co.
$62,190
90,230
$152,420
$90,230
62,190
$152,420
Merchandise Inventory
Sales
Accounts Receivable
Cost of Goods Sold
CASH RECEIPTS JOURNAL
In the cash receipts journal, companies record all receipts of cash. The most com-
mon types of cash receipts are cash sales of merchandise and collections of
accounts receivable. Many other possibilities exist, such as receipt of money from
bank loans and cash proceeds from disposal of equipment. A one- or two-column
cash receipts journal would not have space enough for all possible cash receipt trans-
actions. Therefore, companies use a multiple-column cash receipts journal.
Generally, a cash receipts journal includes the following columns: debit columns
for Cash and Sales Discounts, and credit columns for Accounts Receivable, Sales, and
“Other” accounts. Companies use the “Other Accounts” category when the cash re-
ceipt does not involve a cash sale or a collection of accounts receivable. Under a per-
petual inventory system, each sales entry also is accompanied by an entry that debits
Cost of Goods Sold and credits Merchandise Inventory for the cost of the merchan-
dise sold. Illustration E-8 (page E8) shows a six-column cash receipts journal.
E8 Appendix E Subsidiary Ledgers and Special Journals
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General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl
Date Ref. Debit Credit Balance
2008
May 3y
10
21
Abbot Sisters
10,600
15,400
10,600
——–
15,400
Date Ref. Debit Credit Balance
2008
May 7
17
27
Babson Co.
11,350
14,570
11,350
——–
14,570
Date Ref. Debit Credit Balance
2008
May 14
23
Carson Bros.
7,800 7,800
——-
The subsidiary ledger
is separate from the
general ledger.
Date Ref. Debit Credit Balance
2008
May 19
24
28
Deli Co.
9,300
21,210
9,300
30,510
21,210
S1
CR1
S1
S1
CR1
S1
S1
CR1
S1
S1
CR1
Accounts
Receivable
Cr.
Sales
Discounts
Dr.
Cash
Dr.
Sales
Cr.
Other
Accounts
Cr.
Cost of Goods
Sold Dr.
Mdse. Inv. Cr.Ref.
Account
CreditedDate
Common Stock
2008
Mayy 1
7
10
12
17
22
23
28
5,000
1,900
10,388
2,600
11,123
6,000
7,644
9,114,
200
311
53,769,
1,900
2,600
4,500
5,000
6,000
11,000,
(101) (414) (112) (401)
1,240
1,690
2,930
(505)/(120)(x(( )x
10,600
11,350
7,800
9,300
Date Ref. Debit Credit Balance
2008
May 31y
Cash
53,769
Date Ref. Debit Credit Balance
2008
May 31y
31
Accounts Receivable
90,230 90,230
51,180
Date Ref. Debit Credit Balance
2008
May 22y
Notes Payable
6,000
Date Ref. Debit Credit Balance
2008
May 1y
Common Stock
5,000
CR1
S1
CR1
CR1
CR1
39,050
6,000
5,000
53,769
Date Ref. Debit Credit Balance
2008
May 31
31
Sales
90,230
94,730
S1
CR1
90,230
4,500
Date Ref. Debit Credit Balance
2008
May 31
31
62,190
65,120
S1
CR1
62,190
2,930
Sales Discounts
No. 101
No. 112
No. 200
No. 311
No. 401
No. 414
Date Ref. Debit Credit Balance
2008
May 31y
31
Merchandise Inventory
62,190
65,120
S1
CR1
62,190
2,930
No. 120
Date Ref. Debit Credit Balance
2008
May 31y 781 781CR1
Cost of Goods Sold No. 505
Accounts Receivable
is a control account.
Abbot Sisters
Babson Co.
Notes Payabley
Carson Bros.
Deli Co.
212
227
156
186
781
10,600
11,350
7,800
9,300,
39,050,
The company posts individual
amounts to the subsidiary ledger daily.
At the end of the accounting period, the
company posts totals to the general ledger.
Illustration E-8
Journalizing and posting the
cash receipts journal
Companies may use additional credit columns if these columns significantly
reduce postings to a specific account. For example, a loan company, such as
Household International, receives thousands of cash collections from customers.
Using separate credit columns for Loans Receivable and Interest Revenue, rather
than the Other Accounts credit column, would reduce postings.
Journalizing Cash Receipts Transactions
To illustrate the journalizing of cash receipts transactions, we will continue with the
May transactions of Karns Wholesale Supply. Collections from customers relate to
the entries recorded in the sales journal in Illustration E-5. The entries in the cash
receipts journal are based on the following cash receipts.
May 1 Stockholders invested $5,000 in the business.
7 Cash sales of merchandise total $1,900 (cost, $1,240).
10 Received a check for $10,388 from Abbot Sisters in payment of invoice No. 101 for
$10,600 less a 2% discount.
12 Cash sales of merchandise total $2,600 (cost, $1,690).
17 Received a check for $11,123 from Babson Co. in payment of invoice No. 102 for
$11,350 less a 2% discount.
22 Received cash by signing a note for $6,000.
23 Received a check for $7,644 from Carson Bros. in full for invoice No. 103 for $7,800
less a 2% discount.
28 Received a check for $9,114 from Deli Co. in full for invoice No. 104 for $9,300 less a
2% discount.
Further information about the columns in the cash receipts journal is listed below.
Debit Columns:
1. Cash. Karns enters in this column the amount of cash actually received in each
transaction. The column total indicates the total cash receipts for the month.
2. Sales Discounts. Karns includes a Sales Discounts column in its cash receipts
journal. By doing so, it does not need to enter sales discount items in the gen-
eral journal. As a result, the cash receipts journal shows on one line the collec-
tion of an account receivable within the discount period.
Credit Columns:
3. Accounts Receivable. Karns uses the Accounts Receivable column to record
cash collections on account. The amount entered here is the amount to be
credited to the individual customer’s account.
4. Sales. The Sales column records all cash sales of merchandise. Cash sales of
other assets (plant assets, for example) are not reported in this column.
5. Other Accounts. Karns uses the Other Accounts column whenever the credit is
other than to Accounts Receivable or Sales. For example, in the first entry,
Karns enters $5,000 as a credit to Common Stock. This column is often referred
to as the sundry accounts column.
Debit and Credit Column:
6. Cost of Goods Sold and Merchandise Inventory. This column records debits to
Cost of Goods Sold and credits to Merchandise Inventory.
In a multi-column journal, generally only one line is needed for each entry.
Debit and credit amounts for each line must be equal. When Karns journalizes the
collection from Abbot Sisters on May 10, for example, three amounts are indicated.
Note also that the Account Credited column identifies both general ledger and
subsidiary ledger account titles. General ledger accounts are illustrated in the May 1
Cash Receipts Journal E9
H E L P F U L H I N T
When is an account title
entered in the “Account
Credited” column of the
cash receipts journal?
Answer: A subsidiary
ledger account is entered
when the entry involves a
collection of accounts
receivable. A general
ledger account is entered
when the account is not
shown in a special
column (and an amount
must be entered in the
Other Accounts column).
Otherwise, no account is
shown in the “Account
Credited” column.
and May 22 entries. A subsidiary account is illustrated in the May 10 entry for the
collection from Abbot Sisters.
When Karns has finished journalizing a multi-column journal, it totals the
amount columns and compares the totals to prove the equality of debits and
credits. Illustration E-9 shows the proof of the equality of Karns’s cash receipts
journal.
E10 Appendix E Subsidiary Ledgers and Special Journals
Illustration E-9
Proving the equality of the
cash receipts journal Debits Credits
$39,050
4,500
11,000
2,930
$57,480
Accounts Receivable
Sales
Other Accounts
Merchandise Inventory
$53,769
781
2,930
$57,480
Cash
Sales Discounts
Cost of Goods Sold
Totaling the columns of a journal and proving the equality of the totals is called
footing and cross-footing a journal.
Posting the Cash Receipts Journal
Posting a multi-column journal involves the following steps.
1. At the end of the month, the company posts all column totals, except
for the Other Accounts total, to the account title(s) specified in the
column heading (such as Cash or Accounts Receivable). The company
then enters account numbers below the column totals to show that
they have been posted. For example, Karns has posted cash to account No. 101,
accounts receivable to account No. 112, merchandise inventory to account
No. 120, sales to account No. 401, sales discounts to account No. 414, and cost of
goods sold to account No. 505.
2. The company separately posts the individual amounts comprising the
Other Accounts total to the general ledger accounts specified in the
Account Credited column. See, for example, the credit posting to Common
Stock: The total amount of this column has not been posted. The symbol (X) is
inserted below the total to this column to indicate that the amount has not
been posted.
3. The individual amounts in a column, posted in total to a control account
(Accounts Receivable, in this case), are posted daily to the subsidiary ledger
account specified in the Account Credited column. See, for example, the credit
posting of $10,600 to Abbot Sisters.
The symbol CR, used in both the subsidiary and general ledgers, identifies postings
from the cash receipts journal.
Proving the Ledgers
After posting of the cash receipts journal is completed, Karns proves the ledgers.
As shown in Illustration E-10 (next page), the general ledger totals agree. Also, the
sum of the subsidiary ledger balances equals the control account balance.
Indicate how companies post a
multi-column journal.
S T U D Y O B J E C T I V E 3
In the purchases journal, companies record all purchases of merchandise on ac-
count. Each entry in this journal results in a debit to Merchandise Inventory and a
credit to Accounts Payable. Illustration E-11 (page E12) shows the purchases jour-
nal for Karns Wholesale Supply.
When using a one-column purchases journal (as in Illustration E-11), a com-
pany cannot journalize other types of purchases on account or cash purchases in it.
For example, using the purchases journal shown in Illustration E-11, Karns would
have to record credit purchases of equipment or supplies in the general journal.
Likewise, all cash purchases would be entered in the cash payments journal. As il-
lustrated later, companies that make numerous credit purchases for items other
than merchandise often expand the purchases journal to a multi-column format.
(See Illustration E-14 on page E13.)
Journalizing Credit Purchases of Merchandise
The journalizing procedure is similar to that for a sales journal. Companies make
entries in the purchases journal from purchase invoices. In contrast to the sales
journal, the purchases journal may not have an invoice number column, because
invoices received from different suppliers will not be in numerical sequence. To en-
sure that they record all purchase invoices, some companies consecutively number
each invoice upon receipt and then use an internal document number column in
the purchases journal. The entries for Karns Wholesale Supply are based on the
assumed credit purchases listed in Illustration E-12 (page E12).
Posting the Purchases Journal
The procedures for posting the purchases journal are similar to those for the sales
journal. In this case, Karns makes daily postings to the accounts payable ledger; it
makes monthly postings to Merchandise Inventory and Accounts Payable in the
general ledger. In both ledgers, Karns uses P1 in the reference column to show that
the postings are from page 1 of the purchases journal.
Proof of the equality of the postings from the purchases journal to both ledgers
is shown in Illustration E-13 (page E13).
Purchases Journal E11
PURCHASES JOURNAL
Illustration E-10
Proving the ledgers after
posting the sales and the
cash receipts journals
$53,769
51,180
781
65,120
$170,850
Cash
Accounts Receivable
Sales Discounts
Cost of Goods Sold
$15,400
14,570
21,210
$51,180
Abbot Sisters
Babson Co.
Deli Co.
Accounts Receivable Subsidiary Ledger General Ledger
$ 6,000
5,000
94,730
65,120
$170,850
Notes Payable
Common Stock
Sales
Merchandise Inventory
Credits
Debits
H E L P F U L H I N T
Postings to subsidiary
ledger accounts are done
daily because it is often
necessary to know a
current balance for the
subsidiary accounts.
E12 Appendix E Subsidiary Ledgers and Special Journals
The company posts individual
amounts to the subsidiary ledger daily.
Date Ref. Debit Credit Balance
2008
May 10
29
Eaton and Howe Inc.
7,200
12,600
7,200
19,800
Date Ref. Debit Credit Balance
2008
May 14
26
Fabor and Son
6,900
8,700
6,900
15,600
Date Ref. Debit Credit Balance
2008
May 6
19
Jasper Manufacturing Inc.
11,000
28,500
P1
P1
P1
P1
P1
P1
11,000
17,500
At the end of the
accounting period,
the company posts
totals to the general
ledger.
Date Ref. Debit Credit Balance
2008
Accounts Payable
63,900 63,900
Date Ref. Debit Credit Balance
2008
May 31
31
31
Merchandise Inventory
63,900
62,190
65,120
1,220
62,190
2,930
Date Account Credited
Merchandise
Inventory Dr.
Accounts Payable Cr.Ref.
2008
6
10
14
19
26
29
2/10, n/30
3/10, n/30
1/10, n/30
2/10, n/30
1/10, n/30
3/10, n/30
11,000
7,200
6,900
17,500
8,700
12,600
63,900
P1
S1
CR1
P1
No. 201
No. 120
Terms
(120)/(201)
The subsidiary ledger
is separate from the
general ledger.
Accounts Payable
is a control account.
Jasper Manufacturing Inc.J p g
Eaton and Howe Inc.
Fabor and Son
Jasper Manufacturing Inc.J p g
Fabor and Son
Eaton and Howe Inc.
Mayy
,
May 31y
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General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl
Illustration E-11
Journalizing and posting the
purchases journal
Illustration E-12
Credit purchases
transactions
Date Supplier Amount
5/6 Jasper Manufacturing Inc. $11,000
5/10 Eaton and Howe Inc. 7,200
5/14 Fabor and Son 6,900
5/19 Jasper Manufacturing Inc. 17,500
5/26 Fabor and Son 8,700
5/29 Eaton and Howe Inc. 12,600
Illustration E-13
Proving the equality of the
purchases journal
Postings to
General Ledger
Credit Postings to
Accounts Payable Ledger
$19,800
15,600
28,500
$63,900
Eaton and Howe Inc.
Fabor and Son
Jasper Manufacturing Inc.
$63,900
$63,900
Merchandise Inventory (debit)
Accounts Payable (credit)
In a cash payments (cash disbursements) journal, companies record all disburse-
ments of cash. Entries are made from prenumbered checks. Because companies
make cash payments for various purposes, the cash payments journal has multiple
columns. Illustration E-15 (page E14) shows a four-column journal.
Journalizing Cash Payments Transactions
The procedures for journalizing transactions in this journal are similar to those for
the cash receipts journal. Karns records each transaction on one line, and for each
line there must be equal debit and credit amounts. The entries in the cash payments
Cash Payments Journal E13
Expanding the Purchases Journal
As noted earlier, some companies expand the purchases journal to include all types
of purchases on account. Instead of one column for merchandise inventory and
accounts payable, they use a multiple-column format. This format usually includes a
credit column for Accounts Payable and debit columns for purchases of Merchandise
Inventory, Office Supplies, Store Supplies, and Other Accounts. Illustration E-14
shows a multi-column purchases journal for Hanover Co. The posting procedures are
similar to those shown earlier for posting the cash receipts journal.
CASH PAYMENTS JOURNAL
H E L P F U L H I N T
A single-column purchases
journal needs only to be
footed to prove the
equality of debits and
credits.
Illustration E-14
Multi-column purchases
journal
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General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl
Date Account Credited
Accounts
Payable
Cr.
2008
June 1
3
5
30
2,000
1,500
2,600
800
56,600
800
1,200 4,900
2,000
Merchandise
Inventory
Dr.
Office
Supplies
Dr.
Store
Supplies
Dr.
Other Accounts
Dr.
Account Ref. Amount
Equipment 157 2,600
1,500
Ref.
Signe Audiog
Wight Co.g
Orange Tree Co.
Sue’s Business Forms
7,50043,000
E14 Appendix E Subsidiary Ledgers and Special Journals
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General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl
At the end of the accounting period, the
company posts totals to the general ledger.
The subsidiary ledger
is separate from the
general ledger.
Accounts Receivable
is a control account.
The company posts individual
amounts to the subsidiary ledger daily.
Date Ref. Debit Credit Balance
2008
May 10
19
29
Eaton and Howe Inc.
7,200
12,600
7,200
——-
12,600
Date Ref. Debit Credit Balance
2008
May 14
23
26
Fabor and Son
6,900
8,700
6,900
——-
8,700
Date Ref. Debit Credit Balance
2008
May 6
10
19
28
Jasper Manufacturing Inc.
11,000
——–
17,500
——–
Date Ref. Debit Credit Balance
2008
May 31
31
Accounts Payable
42,600
63,900
21,300
101
102
103
104
105
106
107
108
2008
May 1
3
8
10
19
23
28
30
130
120
120
332
1,200
100
4,400
10,780
6,984
6,831
17,150
500
47,945
P1
CP1
P1
P1
CP1
P1
P1
CP1
P1
CP1
P1
CP1
Date Ref. Debit Credit Balance
2008
May 31
31
Cash
47,945
53,769
5,824
CR1
CP1
No. 101
No. 201
11,000
17,500
(x(( )x
Date
Ck.
No. Account Debited Ref.
Other
Accounts Dr.
Accounts
Payable Dr.
Merchandise
Inventory Cr.
Cash
Cr.
1,200
100
4,400
500
6,200
11,000
7,200
6,900
17,500
42,600
220
216
69
350
855
(201) (120) (101)
7,200
6,900
11,000
17,500
Date Ref. Debit Credit Balance
2008
May 3
8
31
31
31
31
Merchandise Inventory
62,190
2,930
855
100
4,500
57,690
60,620
3,280
2,425
CPI
CPI
SI
CRI
Pl
CPI
100
4,400
63,900
No. 120
Date Ref. Debit Credit Balance
2008
May 1
Prepaid Insurance
1,200 1,200CP1
No. 130
Date Ref. Debit Credit Balance
2008
May 30
Dividends
500 500CP1
No. 332
53,769
63,900
Prepaid Insurancep
Mdse. Inventoryy
Mdse. Inventoryy
Jasper Manuf. Inc.
Eaton & Howe Inc.
Fabor and Son
Jasper Manuf. Inc.J p
Dividends
Illustration E-15
Journalizing and posting the
cash payments journal
journal in Illustration E-15 are based on the following transactions for Karns
Wholesale Supply.
May 1 Issued check No. 101 for $1,200 for the annual premium on a fire insurance policy.
3 Issued check No. 102 for $100 in payment of freight when terms were FOB shipping
point.
8 Issued check No. 103 for $4,400 for the purchase of merchandise.
10 Sent check No. 104 for $10,780 to Jasper Manufacturing Inc. in payment of May 6 in-
voice for $11,000 less a 2% discount.
19 Mailed check No. 105 for $6,984 to Eaton and Howe Inc. in payment of May 10
invoice for $7,200 less a 3% discount.
23 Sent check No. 106 for $6,831 to Fabor and Son in payment of May 14 invoice for
$6,900 less a 1% discount.
28 Sent check No. 107 for $17,150 to Jasper Manufacturing Inc. in payment of May 19
invoice for $17,500 less a 2% discount.
30 Issued check No. 108 for $500 to stockholders as a dividend.
Note that whenever Karns enters an amount in the Other Accounts column, it must
identify a specific general ledger account in the Account Debited column. The entries
for checks No. 101, 102, 103, and 108 illustrate this situation. Similarly, Karns must
identify a subsidiary account in the Account Debited column whenever it enters an
amount in the Accounts Payable column. See, for example, the entry for check No. 104.
After Karns journalizes the cash payments journal, it totals the columns. The
totals are then balanced to prove the equality of debits and credits.
Posting the Cash Payments Journal
The procedures for posting the cash payments journal are similar to those for the
cash receipts journal. Karns posts the amounts recorded in the Accounts Payable col-
umn individually to the subsidiary ledger and in total to the control account. It posts
Merchandise Inventory and Cash only in total at the end of the month. Transactions
in the Other Accounts column are posted individually to the appropriate account(s)
affected. The company does not post totals for the Other Accounts column.
Illustration E-15 shows the posting of the cash payments journal. Note that Karns
uses the symbol CP as the posting reference. After postings are completed, the com-
pany proves the equality of the debit and credit balances in the general ledger. In ad-
dition, the control account balances should agree with the subsidiary ledger total bal-
ance. Illustration E-16 shows the agreement of these balances.
Cash Payments Journal E15
5,824
51,180
2,425
1,200
500
781
65,120
$127,030
Cash
Accounts Receivable
Merchandise Inventory
Prepaid Insurance
Dividends
Sales Discounts
Cost of Goods Sold
$12,600
8,700
$21,300
Eaton and Howe Inc.
Fabor and Son
Accounts Payable Subsidiary Ledger General Ledger
Debits
6,000
21,300
5,000
94,730
$127,030
Notes Payable
Accounts Payable
Common Stock
Sales
Credits
$
$
Illustration E-16
Proving the ledgers after
postings from the sales,
cash receipts, purchases,
and cash payments journals
Special journals for sales, purchases, and cash substantially reduce the number of
entries that companies make in the general journal. Only transactions that cannot
be entered in a special journal are recorded in the general journal. For example, a
company may use the general journal to record such transactions as granting of
credit to a customer for a sales return or allowance, granting of credit from a sup-
plier for purchases returned, acceptance of a note receivable from a customer, and
purchase of equipment by issuing a note payable. Also, correcting, adjusting, and
closing entries are made in the general journal.
The general journal has columns for date, account title and explanation, refer-
ence, and debit and credit amounts. When control and subsidiary accounts are not
involved, the procedures for journalizing and posting of transactions are the same
as those described in earlier chapters. When control and subsidiary accounts are in-
volved, companies make two changes from the earlier procedures:
1. In journalizing, they identify both the control and the subsidiary accounts.
2. In posting, there must be a dual posting: once to the control account and once
to the subsidiary account.
E16 Appendix E Subsidiary Ledgers and Special Journals
EFFECTS OF SPECIAL JOURNALS
ON THE GENERAL JOURNAL
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General Ledger General Jrnl Sales Jrnl Cash Receipts Jrnl Purchases Jrnl
Date Ref. Debit Credit Balance
2008
May 14
23
26
31
Fabor and Son
6,900
8,700
6,900
——-
8,700
8,200
Date Ref. Debit Credit Balance
2008
May 31
31
31
Accounts Payable
63,900 63,900
21,300
20,800
Date Ref. Debit Credit Balance
2008
May 31
Merchandise Inventory
500 500
Date Account Title and Explanation Ref.
Accounts Payable–Fabor and Son
Merchandise Inventory
(Received credit for returned goods)
2008
May 31 500
P1
CP1
P1
G1
P1
CP1
G1
G1
No. 201
No. 120
CreditDebit
500
201/
120
6,900
500
42,600
500
,
Illustration E-17
Journalizing and posting the
general journal
To illustrate, assume that on May 31, Karns Wholesale Supply returns $500 of
merchandise for credit to Fabor and Son. Illustration E-17 shows the entry in the
general journal and the posting of the entry. Note that if Karns receives cash
instead of credit on this return, then it would record the transaction in the cash
receipts journal.
Note that the general journal indicates two accounts (Accounts Payable, and
Fabor and Son) for the debit, and two postings (“201/✓”) in the reference column.
One debit is posted to the control account and another debit to the creditor’s
account in the subsidiary ledger.
Effects of Special Journals on the General Journal E17
REVIEW IT
1. What types of special journals do companies frequently use to record trans-
actions? Why do they use special journals?
2. Explain how companies post transactions recorded in the sales journal and
the cash receipts journal.
3. Indicate the types of transactions that companies record in the general jour-
nal when they use special journals.
Before You Go On…
Demonstration Problem
Cassandra Wilson Company uses a six-column cash receipts journal with the following
columns:
July 3 Cash sales total $5,800 (cost, $3,480).
5 Received a check for $6,370 from Jeltz Company in payment of an invoice dated
June 26 for $6,500, terms 2/10, n/30.
9 Stockholders made an additional investment of $5,000 cash in the business.
10 Cash sales total $12,519 (cost, $7,511).
12 Received a check for $7,275 from R. Eliot & Co. in payment of a $7,500 invoice
dated July 3, terms 3/10, n/30.
15 Received a customer advance of $700 cash for future sales.
20 Cash sales total $15,472 (cost, $9,283).
22 Received a check for $5,880 from Beck Company in payment of $6,000 invoice
dated July 13, terms 2/10, n/30.
29 Cash sales total $17,660 (cost, $10,596).
31 Received cash of $200 on interest earned for July.
Instructions
(a) Journalize the transactions in the cash receipts journal.
(b) Contrast the posting of the Accounts Receivable and Other Accounts columns.
Cash (Dr.)
Sales Discounts (Dr.)
Accounts Receivable (Cr.)
Sales (Cr.)
Cash receipts transactions for the month of July 2008 are as follows.
Other Accounts (Cr.)
Cost of Goods Sold (Dr.) and
Merchandise Inventory (Cr.)
action plan
✔ Record all cash receipts in
the cash receipts journal.
✔ The “account credited”
indicates items posted indi-
vidually to the subsidiary
ledger or general ledger.
✔ Record cash sales in the
cash receipts journal—not
in the sales journal.
✔ The total debits must
equal the total credits.
1 Describe the nature and purpose of a subsidiary
ledger. A subsidiary ledger is a group of accounts with a
common characteristic. It facilitates the recording process by
freeing the general ledger from details of individual balances.
2 Explain how companies use special journals in journal-
izing. Companies use special journals to group similar
types of transactions. In a special journal, generally only
one line is used to record a complete transaction.
3 Indicate how companies post a multi-column journal.
In posting a multi-column journal:
(a) Companies post all column totals except for the Other
Accounts column once at the end of the month to the
account title specified in the column heading.
(b) Companies do not post the total of the Other Accounts
column. Instead, the individual amounts comprising
the total are posted separately to the general ledger
accounts specified in the Account Credited (Debited)
column.
(c) The individual amounts in a column posted in total to a
control account are posted daily to the subsidiary ledger
accounts specified in the Account Credited (Debited)
column.
Accounts payable (creditors’) subsidiary ledger A sub-
sidiary ledger that collects transaction data of individual
creditors. (p. E1).
Accounts receivable (customers’) subsidiary ledger A
subsidiary ledger that collects transaction data of individual
customers. (p. E1).
Cash payments (disbursements) journal A special journal
that records all cash paid. (p. E13).
Cash receipts journal A special journal that records all
cash received. (p. E7).
Control account An account in the general ledger that sum-
marizes subsidiary ledger. (p. E1).
E18 Appendix E Subsidiary Ledgers and Special Journals
Solution
(a) CASSANDRA WILSON COMPANY
Cash Receipts Journal CR1
(b) The Accounts Receivable column is posted as a credit to Accounts Receivable. The
individual amounts are credited to the customers’ accounts identified in the Account
Credited column, which are maintained in the accounts receivable subsidiary ledger.
The amounts in the Other Accounts column are posted individually. They are cred-
ited to the account titles identified in the Account Credited column.
Sales Accounts Other Cost of Goods
Cash Discounts Receivable Sales Accounts Sold Dr.
Date Account Credited Ref. Dr. Dr. Cr. Cr. Cr. Mdse. Inv. Cr.
2008
7/3 5,800 5,800 3,480
5 Jeltz Company 6,370 130 6,500
9 Common Stock 5,000 5,000
10 12,519 12,519 7,511
12 R. Eliot & Co. 7,275 225 7,500
15 Unearned Revenue 700 700
20 15,472 15,472 9,283
22 Beck Company 5,880 120 6,000
29 17,660 17,660 10,596
31 Interest Revenue 200 200
76,876 475 20,000 51,451 5,900 30,870
SUMMARY OF STUDY OBJECTIVES
GLOSSARY
Questions E19
Purchases journal A special journal that records all pur-
chases of merchandise on account. (p. E11).
Sales journal A special journal that records all sales of mer-
chandise on account. (p. E5).
Special journal A journal that records similar types of
transactions, such as all credit sales. (p. E4).
Subsidiary ledger A group of accounts with a common
characteristic. (p. E1).
1. What are the advantages of using subsidiary ledgers?
2. (a) When do companies normally post to (1) the sub-
sidiary accounts and (2) the general ledger control ac-
counts? (b) Describe the relationship between a control
account and a subsidiary ledger.
3. Identify and explain the four special journals discussed in
the chapter. List an advantage of using each of these jour-
nals rather than using only a general journal.
4. Thogmartin Company uses special journals. It recorded in
a sales journal a sale made on account to R. Peters for
$435. A few days later, R. Peters returns $70 worth of mer-
chandise for credit. Where should Thogmartin Company
record the sales return? Why?
5. A $500 purchase of merchandise on account from Lore
Company was properly recorded in the purchases journal.
When posted, however, the amount recorded in the
Answers are at the end of the chapter.
1. Which of the following is incorrect concerning subsidiary
ledgers?
a. The purchases ledger is a common subsidiary ledger for
creditor accounts.
b. The accounts receivable ledger is a subsidiary ledger.
c. A subsidiary ledger is a group of accounts with a com-
mon characteristic.
d. An advantage of the subsidiary ledger is that it permits
a division of labor in posting.
2. A sales journal will be used for:
Credit Cash Sales
Sales Sales Discounts
a. no yes yes
b. yes no yes
c. yes no no
d. yes yes no
3. Which of the following statements is correct?
a. The sales discount column is included in the cash re-
ceipts journal.
b. The purchases journal records all purchases of mer-
chandise whether for cash or on account.
c. The cash receipts journal records sales on account.
d. Merchandise returned by the buyer is recorded by the
seller in the purchases journal.
4. Which of the following is incorrect concerning the posting
of the cash receipts journal?
a. The total of the Other Accounts column is not posted.
b. All column totals except the total for the Other
Accounts column are posted once at the end of the
month to the account title(s) specified in the column
heading.
c. The totals of all columns are posted daily to the
accounts specified in the column heading.
d. The individual amounts in a column posted in total
to a control account are posted daily to the subsidiary
ledger account specified in the Account Credited
column.
5. Postings from the purchases journal to the subsidiary
ledger are generally made:
a. yearly.
b. monthly.
c. weekly.
d. daily.
6. Which statement is incorrect regarding the general journal?
a. Only transactions that cannot be entered in a special
journal are recorded in the general journal.
b. Dual postings are always required in the general journal.
c. The general journal may be used to record accept-
ance of a note receivable in payment of an account
receivable.
d. Correcting, adjusting, and closing entries are made in
the general journal.
7. When companies use special journals:
a. they record all purchase transactions in the purchases
journal.
b. they record all cash received, except from cash sales, in
the cash receipts journal.
c. they record all cash disbursements in the cash pay-
ments journal.
d. a general journal is not necessary.
8. If a customer returns goods for credit, the selling company
normally makes an entry in the:
a. cash payments journal.
b. sales journal.
c. general journal.
d. cash receipts journal.
Go to the book’s website,
www.wiley.com/college/weygandt,
for Additional Self-Study questions.
SELF-STUDY QUESTIONS
(SO 1)
(SO 2)
(SO 2, 3)
(SO 3)
(SO 3)
(SO 2)
(SO 2)
(SO 2)
QUESTIONS
E20 Appendix E Subsidiary Ledgers and Special Journals
subsidiary ledger was $50. How might this error be
discovered?
6. Why would special journals used in different businesses
not be identical in format? What type of business would
maintain a cash receipts journal but not include a column
for accounts receivable?
7. The cash and the accounts receivable columns in the cash
receipts journal were mistakenly overadded by $4,000 at
the end of the month. (a) Will the customers’ ledger agree
with the Accounts Receivable control account? (b)
Assuming no other errors, will the trial balance totals be
equal?
8. One column total of a special journal is posted at month-
end to only two general ledger accounts. One of these two
accounts is Accounts Receivable. What is the name of this
special journal? What is the other general ledger account
to which that same month-end total is posted?
9. In what journal would the following transactions be
recorded? (Assume that a two-column sales journal and a
single-column purchases journal are used.)
(a) Recording of depreciation expense for the year.
(b) Credit given to a customer for merchandise purchased
on credit and returned.
(c) Sales of merchandise for cash.
(d) Sales of merchandise on account.
(e) Collection of cash on account from a customer.
(f) Purchase of office supplies on account.
10. In what journal would the following transactions be
recorded? (Assume that a two-column sales journal and a
single-column purchases journal are used.)
(a) Cash received from signing a note payable.
(b) Investment of cash by stockholders.
(c) Closing of the expense accounts at the end of the year.
(d) Purchase of merchandise on account.
(e) Credit received for merchandise purchased and
returned to supplier.
(f) Payment of cash on account due a supplier.
11. What transactions might be included in a multiple-column
purchases journal that would not be included in a single-
column purchases journal?
12. Give an example of a transaction in the general journal
that causes an entry to be posted twice (i.e., to two ac-
counts), one in the general ledger, the other in the sub-
sidiary ledger. Does this affect the debit/credit equality of
the general ledger?
13. Give some examples of appropriate general journal trans-
actions for an organization using special journals.
BEE-1 Presented below is information related to Kienholz Company for its first month of op-
erations. Identify the balances that appear in the accounts receivable subsidiary ledger and the
accounts receivable balance that appears in the general ledger at the end of January.
BRIEF EXERCISES
BEE-2 Identify in what ledger (general or subsidiary) each of the following accounts is shown.
1. Rent Expense 3. Notes Payable
2. Accounts Receivable—Char 4. Accounts Payable—Thebeau
BEE-3 Identify the journal in which each of the following transactions is recorded.
1. Cash sales 4. Credit sales
2. Payment of dividends 5. Purchase of merchandise on account
3. Cash purchase of land 6. Receipt of cash for services performed
BEE-4 Indicate whether each of the following debits and credits is included in the cash receipts
journal. (Use “Yes” or “No” to answer this question.)
1. Debit to Sales 3. Credit to Accounts Receivable
2. Credit to Merchandise Inventory 4. Debit to Accounts Payable
BEE-5 Galindo Co. uses special journals and a general journal. Identify the journal in which
each of the following transactions is recorded.
(a) Purchased equipment on account.
(b) Purchased merchandise on account.
(c) Paid utility expense in cash.
(d) Sold merchandise on account.
Credit Sales Cash Collections
Jan. 7 Agler Co. $10,000 Jan. 17 Agler Co. $7,000
15 Barto Co. 6,000 24 Barto Co. 4,000
23 Maris Co. 9,000 29 Maris Co. 9,000
Identify subsidiary ledger
balances.
(SO 1)
Identify subsidiary ledger
accounts.
(SO 1)
Identify special journals.
(SO 2)
Identify entries to cash receipts
journal.
(SO 2)
Identify transactions for
special journals.
(SO 2)
BEE-6 Identify the special journal(s) in which the following column headings appear.
1. Sales Discounts Dr. 4. Sales Cr.
2. Accounts Receivable Cr. 5. Merchandise Inventory Dr.
3. Cash Dr.
BEE-7 Kidwell Computer Components Inc. uses a multi-column cash receipts journal. Indicate
which column(s) is/are posted only in total, only daily, or both in total and daily.
1. Accounts Receivable 3. Cash
2. Sales Discounts 4. Other Accounts
Exercises E21
Indicate postings to cash
receipts journal.
(SO 3)
Identify transactions for
special journals.
(SO 2)
EXERCISES
EE-1 Donahue Company uses both special journals and a general journal as described in this
chapter. On June 30, after all monthly postings had been completed, the Accounts Receivable
control account in the general ledger had a debit balance of $320,000; the Accounts Payable con-
trol account had a credit balance of $77,000.
The July transactions recorded in the special journals are summarized below. No entries af-
fecting accounts receivable and accounts payable were recorded in the general journal for July.
Sales journal Total sales $161,400
Purchases journal Total purchases $56,400
Cash receipts journal Accounts receivable column total $131,000
Cash payments journal Accounts payable column total $47,500
Instructions
(a) What is the balance of the Accounts Receivable control account after the monthly postings
on July 31?
(b) What is the balance of the Accounts Payable control account after the monthly postings on
July 31?
(c) To what account(s) is the column total of $161,400 in the sales journal posted?
(d) To what account(s) is the accounts receivable column total of $131,000 in the cash receipts
journal posted?
EE-2 Presented below is the subsidiary accounts receivable account of Jeremy Dody.
Date Ref. Debit Credit Balance
2008
Sept. 2 S31 61,000 61,000
9 G4 14,000 47,000
27 CR8 47,000 —
Instructions
Write a memo to Andrea Barden, chief financial officer, that explains each transaction.
EE-3 On September 1 the balance of the Accounts Receivable control account in the general
ledger of Seaver Company was $10,960. The customers’ subsidiary ledger contained account bal-
ances as follows: Ruiz $1,440, Kingston $2,640, Bannister $2,060, Crampton $4,820. At the end of
September the various journals contained the following information.
Sales journal: Sales to Crampton $800; to Ruiz $1,260; to Iman $1,330; to Bannister $1,100.
Cash receipts journal: Cash received from Bannister $1,310; from Crampton $2,300; from Iman
$380; from Kingston $1,800; from Ruiz $1,240.
General journal: An allowance is granted to Crampton $220.
Instructions
(a) Set up control and subsidiary accounts and enter the beginning balances. Do not construct
the journals.
(b) Post the various journals. Post the items as individual items or as totals, whichever would be
the appropriate procedure. (No sales discounts given.)
Determine control account
balances, and explain posting
of special journals.
(SO 1, 3)
Explain postings to subsidiary
ledger.
(SO 1)
Post various journals to
control and subsidiary
accounts.
(SO 1, 3)
(c) Prepare a list of customers and prove the agreement of the controlling account with the
subsidiary ledger at September 30, 2008.
EE-4 Yu Suzuki Company has a balance in its Accounts Receivable control account of $11,000
on January 1, 2008. The subsidiary ledger contains three accounts: Smith Company, balance
$4,000; Green Company, balance $2,500; and Koyan Company. During January, the following
receivable-related transactions occurred.
Credit Sales Collections Returns
Smith Company $9,000 $8,000 $ -0-
Green Company 7,000 2,500 3,000
Koyan Company 8,500 9,000 -0-
Instructions
(a) What is the January 1 balance in the Koyan Company subsidiary account?
(b) What is the January 31 balance in the control account?
(c) Compute the balances in the subsidiary accounts at the end of the month.
(d) Which January transaction would not be recorded in a special journal?
EE-5 Nobo Uematsu Company has a balance in its Accounts Payable control account of
$8,250 on January 1, 2008. The subsidiary ledger contains three accounts: Jones Company, bal-
ance $3,000; Brown Company, balance $1,875; and Aatski Company. During January, the follow-
ing receivable-related transactions occurred.
Purchases Payments Returns
Jones Company $6,750 $6,000 $ -0-
Brown Company 5,250 1,875 2,250
Aatski Company 6,375 6,750 -0-
Instructions
(a) What is the January 1 balance in the Aatski Company subsidiary account?
(b) What is the January 31 balance in the control account?
(c) Compute the balances in the subsidiary accounts at the end of the month.
(d) Which January transaction would not be recorded in a special journal?
EE-6 Montalvo Company uses special journals and a general journal. The following transac-
tions occurred during September 2008.
Sept. 2 Sold merchandise on account to T. Hossfeld, invoice no. 101, $720, terms n/30. The cost
of the merchandise sold was $420.
10 Purchased merchandise on account from L. Rincon $600, terms 2/10, n/30.
12 Purchased office equipment on account from R. Press $6,500.
21 Sold merchandise on account to P. Lowther, invoice no. 102 for $800, terms 2/10, n/30.
The cost of the merchandise sold was $480.
25 Purchased merchandise on account from W. Barone $860, terms n/30.
27 Sold merchandise to S. Miller for $700 cash. The cost of the merchandise sold was
$400.
Instructions
(a) Prepare a sales journal (see Illustration E-6) and a single-column purchase journal (see
Illustration E-11). (Use page 1 for each journal.)
(b) Record the transaction(s) for September that should be journalized in the sales journal and
the purchases journal.
EE-7 Pherigo Co. uses special journals and a general journal. The following transactions oc-
curred during May 2008.
May 1 I. Pherigo invested $50,000 cash in the business in exchange for common stock.
2 Sold merchandise to B. Sherrick for $6,300 cash. The cost of the merchandise sold was
$4,200.
3 Purchased merchandise for $7,200 from J. DeLeon using check no. 101.
14 Paid salary to H. Potter $700 by issuing check no. 102.
E22 Appendix E Subsidiary Ledgers and Special Journals
Determine control and
subsidiary ledger balances
for accounts receivable.
(SO 1)
Determine control and
subsidiary ledger balances
for accounts payable.
(SO 1)
Record transactions in sales
and purchases journal.
(SO 1, 2)
Record transactions in cash
receipts and cash payments
journal.
(SO 1, 2)
16 Sold merchandise on account to K. Kimbell for $900, terms n/30. The cost of the mer-
chandise sold was $630.
22 A check of $9,000 is received from M. Moody in full for invoice 101; no discount
given.
Instructions
(a) Prepare a multiple-column cash receipts journal (see Illustration E-8) and a multiple-
column cash payments journal (see Illustration E-15). (Use page 1 for each journal.)
(b) Record the transaction(s) for May that should be journalized in the cash receipts journal
and cash payments journal.
EE-8 Wick Company uses the columnar cash journals illustrated in the textbook. In April, the
following selected cash transactions occurred.
1. Made a refund to a customer for the return of damaged goods.
2. Received collection from customer within the 3% discount period.
3. Purchased merchandise for cash.
4. Paid a creditor within the 3% discount period.
5. Received collection from customer after the 3% discount period had expired.
6. Paid freight on merchandise purchased.
7. Paid cash for office equipment.
8. Received cash refund from supplier for merchandise returned.
9. Paid cash dividend to stockholders.
10. Made cash sales.
Instructions
Indicate (a) the journal, and (b) the columns in the journal that should be used in recording each
transaction.
EE-9 Velasquez Company has the following selected transactions during March.
Mar. 2 Purchased equipment costing $9,400 from Chang Company on account.
5 Received credit of $410 from Lyden Company for merchandise damaged in ship-
ment to Velasquez.
7 Issued credit of $400 to Higley Company for merchandise the customer returned.
The returned merchandise had a cost of $260.
Velasquez Company uses a one-column purchases journal, a sales journal, the columnar cash
journals used in the text, and a general journal.
Instructions
(a) Journalize the transactions in the general journal.
(b) In a brief memo to the president of Velasquez Company, explain the postings to
the control and subsidiary accounts from each type of journal.
EE-10 Below are some typical transactions incurred by Kwun Company.
1. Payment of creditors on account.
2. Return of merchandise sold for credit.
3. Collection on account from customers.
4. Sale of land for cash.
5. Sale of merchandise on account.
6. Sale of merchandise for cash.
7. Received credit for merchandise purchased on credit.
8. Sales discount taken on goods sold.
9. Payment of employee wages.
10. Payment of cash dividend to stockholders.
11. Depreciation on building.
12. Purchase of office supplies for cash.
13. Purchase of merchandise on account.
Instructions
For each transaction, indicate whether it would normally be recorded in a cash receipts journal,
cash payments journal, sales journal, single-column purchases journal, or general journal.
Exercises E23
Explain journalizing in cash
journals.
(SO 2)
Journalize transactions in
general journal and post.
(SO 1, 3)
Indicate journalizing in special
journals.
(SO 2)
EE-11 The general ledger of Sanchez Company contained the following Accounts Payable
control account (in T-account form). Also shown is the related subsidiary ledger.
E24 Appendix E Subsidiary Ledgers and Special Journals
GENERAL LEDGER
Accounts Payable
Feb. 15 General journal 1,400 Feb. 1 Balance 26,025
28 ? ? 5 General journal 265
11 General journal 550
28 Purchases 13,400
Feb. 28 Balance 9,500
ACCOUNTS PAYABLE LEDGER
Perez Tebbetts
Feb. 28 Bal. 4,600 Feb. 28 Bal. ?
Zerbe
Feb. 28 Bal. 2,300
Instructions
(a) Indicate the missing posting reference and amount in the control account, and the missing
ending balance in the subsidiary ledger.
(b) Indicate the amounts in the control account that were dual-posted (i.e., posted to the
control account and the subsidiary accounts).
EE-12 Selected accounts from the ledgers of Lockhart Company at July 31 showed the
following.
Store Equipment No. 153
Date Explanation Ref. Debit Credit Balance
July 1 G1 3,900 3,900
Accounts Payable No. 201
Date Explanation Ref. Debit Credit Balance
July 1 G1 3,900 3,900
15 G1 400 4,300
18 G1 100 4,200
25 G1 200 4,000
31 P1 8,300 12,300
Merchandise Inventory No. 120
Date Explanation Ref. Debit Credit Balance
July 15 G1 400 400
18 G1 100 300
25 G1 200 100
31 P1 8,300 8,400
GENERAL LEDGER
Drago Co.
Date Explanation Ref. Debit Credit Balance
July 14 P1 1,100 1,100
25 G1 200 900
Erik Co.
Date Explanation Ref. Debit Credit Balance
July 12 P1 500 500
21 P1 600 1,100
Heinen Inc.
Date Explanation Ref. Debit Credit Balance
July 15 G1 400 400
Albin Equipment Co.
Date Explanation Ref. Debit Credit Balance
July 1 G1 3,900 3,900
Brian Co.
Date Explanation Ref. Debit Credit Balance
July 3 P1 2,400 2,400
20 P1 700 3,100
Chacon Corp
Date Explanation Ref. Debit Credit Balance
July 17 P1 1,400 1,400
18 G1 100 1,300
29 P1 1,600 2,900
ACCOUNTS PAYABLE LEDGER
Explain posting to control
account and subsidiary ledger.
(SO 1, 3)
Prepare purchases and general
journals.
(SO 1, 2)
Instructions
From the data prepare:
(a) the single-column purchases journal for July.
(b) the general journal entries for July.
EE-13 Kansas Products uses both special journals and a general journal as described in this
chapter. Kansas also posts customers’ accounts in the accounts receivable subsidiary ledger. The
postings for the most recent month are included in the subsidiary T accounts below.
Problems: Set A E25
Instructions
Determine the correct amount of the end-of-month posting from the sales journal to the
Accounts Receivable control account.
EE-14 Selected account balances for Matisyahu Company at January 1, 2008, are presented
below.
Accounts Payable $14,000
Accounts Receivable 22,000
Cash 17,000
Inventory 13,500
Matisyahu’s sales journal for January shows a total of $100,000 in the selling price column,
and its one-column purchases journal for January shows a total of $72,000.
The column totals in Matisyahu’s cash receipts journal are: Cash Dr. $61,000; Sales Discounts
Dr. $1,100; Accounts Receivable Cr. $45,000; Sales Cr. $6,000; and Other Accounts Cr. $11,100.
The column totals in Matisyahu’s cash payments journal for January are: Cash Cr. $55,000;
Inventory Cr. $1,000; Accounts Payable Dr. $46,000; and Other Accounts Dr. $10,000.
Matisyahu’s total cost of goods sold for January is $63,600.
Accounts Payable, Accounts Receivable, Cash, Inventory, and Sales are not involved in the
“Other Accounts” column in either the cash receipts or cash payments journal, and are not in-
volved in any general journal entries.
Instructions
Compute the January 31 balance for Matisyahu in the following accounts.
(a) Accounts Payable.
(b) Accounts Receivable.
(c) Cash.
(d) Inventory.
(e) Sales.
Bargo Leary
Bal. 340 250 Bal. 150 150
200 240
Carol Paul
Bal. –0– 145 Bal. 120 120
145 190
150
Determine correct posting
amount to control account.
(SO 3)
Compute balances in various
accounts.
(SO 3)
EXERCISES: SET B
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Visit the book’s website at www.wiley.com/college/weygandt, and choose the Student Companion
site, to access Exercise Set B.
PROBLEMS: SET A
PE-1A Grider Company’s chart of accounts includes the following selected accounts.
101 Cash 401 Sales
112 Accounts Receivable 414 Sales Discounts
120 Merchandise Inventory 505 Cost of Goods Sold
311 Common Stock
Journalize transactions in cash
receipts journal; post to control
account and subsidiary ledger.
(SO 1, 2, 3)
On April 1 the accounts receivable ledger of Grider Company showed the following balances:
Ogden $1,550, Chelsea $1,200, Eggleston Co. $2,900, and Baez $1,800. The April transactions in-
volving the receipt of cash were as follows.
Apr. 1 Stockholders invested $7,200 additional cash in the business, in exchange for common
stock.
4 Received check for payment of account from Baez less 2% cash discount.
5 Received check for $920 in payment of invoice no. 307 from Eggleston Co.
8 Made cash sales of merchandise totaling $7,245. The cost of the merchandise sold was
$4,347.
10 Received check for $600 in payment of invoice no. 309 from Ogden.
11 Received cash refund from a supplier for damaged merchandise $740.
23 Received check for $1,500 in payment of invoice no. 310 from Eggleston Co.
29 Received check for payment of account from Chelsea.
Instructions
(a) Journalize the transactions above in a six-column cash receipts journal with columns for
Cash Dr., Sales Discounts Dr., Accounts Receivable Cr., Sales Cr., Other Accounts Cr., and
Cost of Goods Sold Dr./Merchandise Inventory Cr. Foot and crossfoot the journal.
(b) Insert the beginning balances in the Accounts Receivable control and subsidiary accounts,
and post the April transactions to these accounts.
(c) Prove the agreement of the control account and subsidiary account balances.
PE-2A Ming Company’s chart of accounts includes the following selected accounts.
101 Cash 201 Accounts Payable
120 Merchandise Inventory 332 Dividends
130 Prepaid Insurance 505 Cost of Goods Sold
157 Equipment
On October 1 the accounts payable ledger of Ming Company showed the following balances:
Bovary Company $2,700, Nyman Co. $2,500, Pyron Co. $1,800, and Sims Company $3,700. The
October transactions involving the payment of cash were as follows.
Oct. 1 Purchased merchandise, check no. 63, $300.
3 Purchased equipment, check no. 64, $800.
5 Paid Bovary Company balance due of $2,700, less 2% discount, check no. 65, $2,646.
10 Purchased merchandise, check no. 66, $2,250.
15 Paid Pyron Co. balance due of $1,800, check no. 67.
16 Paid cash dividend of $400, check no. 68.
19 Paid Nyman Co. in full for invoice no. 610, $1,600 less 2% cash discount, check no. 69,
$1,568.
29 Paid Sims Company in full for invoice no. 264, $2,500, check no. 70.
Instructions
(a) Journalize the transactions above in a four-column cash payments journal with columns for
Other Accounts Dr., Accounts Payable Dr., Merchandise Inventory Cr., and Cash Cr. Foot
and crossfoot the journal.
(b) Insert the beginning balances in the Accounts Payable control and subsidiary accounts, and
post the October transactions to these accounts.
(c) Prove the agreement of the control account and the subsidiary account balances.
PE-3A The chart of accounts of Lopez Company includes the following selected accounts.
112 Accounts Receivable 401 Sales
120 Merchandise Inventory 412 Sales Returns and Allowances
126 Supplies 505 Cost of Goods Sold
157 Equipment 610 Advertising Expense
201 Accounts Payable
In July the following selected transactions were completed. All purchases and sales were on ac-
count. The cost of all merchandise sold was 70% of the sales price.
July 1 Purchased merchandise from Fritz Company $8,000.
2 Received freight bill from Wayward Shipping on Fritz purchase $400.
3 Made sales to Pinick Company $1,300, and to Wayne Bros. $1,500.
E26 Appendix E Subsidiary Ledgers and Special Journals
(a) Balancing totals $21,205
(c) Accounts Receivable $1,430
Journalize transactions in cash
payments journal; post to con-
trol account and subsidiary
ledgers.
(SO 1, 2, 3)
(a) Balancing totals $12,350
(c) Accounts Payable $2,100
Journalize transactions in
multi-column purchases
journal; post to the general and
subsidiary ledgers.
(SO 1, 2, 3)
5 Purchased merchandise from Moon Company $3,200.
8 Received credit on merchandise returned to Moon Company $300.
13 Purchased store supplies from Cress Supply $720.
15 Purchased merchandise from Fritz Company $3,600 and from Anton Company $3,300.
16 Made sales to Sager Company $3,450 and to Wayne Bros. $1,570.
18 Received bill for advertising from Lynda Advertisements $600.
21 Made sales to Pinick Company $310 and to Haddad Company $2,800.
22 Granted allowance to Pinick Company for merchandise damaged in shipment $40.
24 Purchased merchandise from Moon Company $3,000.
26 Purchased equipment from Cress Supply $900.
28 Received freight bill from Wayward Shipping on Moon purchase of July 24, $380.
30 Made sales to Sager Company $5,600.
Instructions
(a) Journalize the transactions above in a purchases journal, a sales journal, and a general
journal. The purchases journal should have the following column headings: Date,
Account Credited (Debited), Ref., Accounts Payable Cr., Merchandise Inventory Dr., and
Other Accounts Dr.
(b) Post to both the general and subsidiary ledger accounts. (Assume that all accounts have zero
beginning balances.)
(c) Prove the agreement of the control and subsidiary accounts.
PE-4A Selected accounts from the chart of accounts of Boyden Company are shown below.
101 Cash 401 Sales
112 Accounts Receivable 412 Sales Returns and Allowances
120 Merchandise Inventory 414 Sales Discounts
126 Supplies 505 Cost of Goods Sold
157 Equipment 726 Salaries Expense
201 Accounts Payable
The cost of all merchandise sold was 60% of the sales price. During January, Boyden completed
the following transactions.
Jan. 3 Purchased merchandise on account from Wortham Co. $10,000.
4 Purchased supplies for cash $80.
4 Sold merchandise on account to Milam $5,250, invoice no. 371, terms 1/10, n/30.
5 Returned $300 worth of damaged goods purchased on account from Wortham Co. on
January 3.
6 Made cash sales for the week totaling $3,150.
8 Purchased merchandise on account from Noyes Co. $4,500.
9 Sold merchandise on account to Connor Corp. $6,400, invoice no. 372, terms 1/10, n/30.
11 Purchased merchandise on account from Betz Co. $3,700.
13 Paid in full Wortham Co. on account less a 2% discount.
13 Made cash sales for the week totaling $6,260.
15 Received payment from Connor Corp. for invoice no. 372.
15 Paid semi-monthly salaries of $14,300 to employees.
17 Received payment from Milam for invoice no. 371.
17 Sold merchandise on account to Bullock Co. $1,200, invoice no. 373, terms 1/10, n/30.
19 Purchased equipment on account from Murphy Corp. $5,500.
20 Cash sales for the week totaled $3,200.
20 Paid in full Noyes Co. on account less a 2% discount.
23 Purchased merchandise on account from Wortham Co. $7,800.
24 Purchased merchandise on account from Forgetta Corp. $5,100.
27 Made cash sales for the week totaling $4,230.
30 Received payment from Bullock Co. for invoice no. 373.
31 Paid semi-monthly salaries of $13,200 to employees.
31 Sold merchandise on account to Milam $9,330, invoice no. 374, terms 1/10, n/30.
Boyden Company uses the following journals.
1. Sales journal.
2. Single-column purchases journal.
Problems: Set A E27
(a) Purchases journal—
Accounts Payable $24,100
Sales column total $16,530
(c) Accounts Receivable
$16,490
Accounts Payable
$23,800
Journalize transactions in
special journals.
(SO 1, 2, 3)
3. Cash receipts journal with columns for Cash Dr., Sales Discounts Dr., Accounts Receivable
Cr., Sales Cr., Other Accounts Cr., and Cost of Goods Sold Dr./Merchandise Inventory Cr.
4. Cash payments journal with columns for Other Accounts Dr., Accounts Payable
Dr., Merchandise Inventory Cr., and Cash Cr.
5. General journal.
Instructions
Using the selected accounts provided:
(a) Record the January transactions in the appropriate journal noted.
(b) Foot and crossfoot all special journals.
(c) Show how postings would be made by placing ledger account numbers and checkmarks as
needed in the journals. (Actual posting to ledger accounts is not required.)
PE-5A Presented below are the purchases and cash payments journals for Reyes Co. for its
first month of operations.
E28 Appendix E Subsidiary Ledgers and Special Journals
(a) Sales journal $22,180
Purchases journal $31,100
Cash receipts journal
balancing total $29,690
Cash payments journal
balancing total $41,780
Journalize in sales and cash
receipts journals; post; prepare
a trial balance; prove control to
subsidiary; prepare adjusting
entries; prepare an adjusted
trial balance.
(SO 1, 2, 3)
PURCHASES JOURNAL P1
Merchandise Inventory Dr.
Date Account Credited Ref. Accounts Payable Cr.
July 4 G. Clemens 6,800
5 A. Ernst 8,100
11 J. Happy 5,920
13 C. Tabor 15,300
20 M. Sneezy 7,900
44,020
CASH PAYMENTS JOURNAL CP1
Other Accounts Merchandise
Account Accounts Payable Inventory Cash
Date Debited Ref. Dr. Dr. Cr. Cr.
July 4 Store Supplies 600 600
10 A. Ernst 8,100 81 8,019
11 Prepaid Rent 6,000 6,000
15 G. Clemens 6,800 6,800
19 Dividends 2,500 2,500
21 C. Tabor 15,300 153 15,147
9,100 30,200 234 39,066
In addition, the following transactions have not been journalized for July. The cost of all mer-
chandise sold was 65% of the sales price.
July 1 D. Reyes invested $80,000 in cash in exchange for common stock.
6 Sold merchandise on account to Ewing Co. $6,200 terms 1/10, n/30.
7 Made cash sales totaling $6,000.
8 Sold merchandise on account to S. Beauty $3,600, terms 1/10, n/30.
10 Sold merchandise on account to W. Pitts $4,900, terms 1/10, n/30.
13 Received payment in full from S. Beauty.
16 Received payment in full from W. Pitts.
20 Received payment in full from Ewing Co.
21 Sold merchandise on account to H. Prince $5,000, terms 1/10, n/30.
29 Returned damaged goods to G. Clemens and received cash refund of $420.
Instructions
(a) Open the following accounts in the general ledger.
101 Cash 127 Store Supplies
112 Accounts Receivable 131 Prepaid Rent
120 Merchandise Inventory 201 Accounts Payable
311 Common Stock 505 Cost of Goods Sold
332 Dividends 631 Supplies Expense
401 Sales 729 Rent Expense
414 Sales Discounts
(b) Journalize the transactions that have not been journalized in the sales journal, the cash re-
ceipts journal (see Illustration E-8), and the general journal.
(c) Post to the accounts receivable and accounts payable subsidiary ledgers. Follow the sequence
of transactions as shown in the problem.
(d) Post the individual entries and totals to the general ledger.
(e) Prepare a trial balance at July 31, 2008.
(f ) Determine whether the subsidiary ledgers agree with the control accounts in the general
ledger.
(g) The following adjustments at the end of July are necessary.
(1) A count of supplies indicates that $140 is still on hand.
(2) Recognize rent expense for July, $500.
Prepare the necessary entries in the general journal. Post the entries to the general ledger.
(h) Prepare an adjusted trial balance at July 31, 2008.
PE-6A The post-closing trial balance for Cortez Co. is as follows.
Problems: Set A E29
(b) Sales journal total
$19,700
Cash receipts journal
balancing totals $101,120
(e) Totals $119,520
(f) Accounts Receivable
$5,000
Accounts Payable $13,820
(h) Totals $119,520
Journalize in special journals;
post; prepare a trial balance.
(SO 1, 2, 3)CORTEZ CO.
Post-Closing Trial Balance
December 31, 2008
Debit Credit
Cash $ 41,500
Accounts Receivable 15,000
Notes Receivable 45,000
Merchandise Inventory 23,000
Equipment 6,450
Accumulated Depreciation—Equipment $ 1,500
Accounts Payable 43,000
Common Stock 86,450
$130,950 $130,950
The subsidiary ledgers contain the following information: (1) accounts receivable—J. Anders
$2,500, F. Cone $7,500, T. Dudley $5,000; (2) accounts payable—J. Feeney $10,000, D. Goodman
$18,000, and K. Inwood $15,000. The cost of all merchandise sold was 60% of the sales price.
The transactions for January 2009 are as follows.
Jan. 3 Sell merchandise to M. Rensing $5,000, terms 2/10, n/30.
5 Purchase merchandise from E. Vietti $2,000, terms 2/10, n/30.
7 Receive a check from T. Dudley $3,500.
11 Pay freight on merchandise purchased $300.
12 Pay rent of $1,000 for January.
13 Receive payment in full from M. Rensing.
14 Post all entries to the subsidiary ledgers. Issued credit of $300 to J. Aders for returned
merchandise.
15 Send K. Inwood a check for $14,850 in full payment of account, discount $150.
17 Purchase merchandise from G. Marley $1,600, terms 2/10, n/30.
18 Pay sales salaries of $2,800 and office salaries $2,000.
20 Give D. Goodman a 60-day note for $18,000 in full payment of account payable.
23 Total cash sales amount to $9,100.
24 Post all entries to the subsidiary ledgers. Sell merchandise on account to F. Cone $7,400,
terms 1/10, n/30.
27 Send E. Vietti a check for $950.
29 Receive payment on a note of $40,000 from B. Lemke.
30 Post all entries to the subsidiary ledgers. Return merchandise of $300 to G. Marley for
credit.
Instructions
(a) Open general and subsidiary ledger accounts for the following.
101 Cash 311 Common Stock
112 Accounts Receivable 401 Sales
115 Notes Receivable 412 Sales Returns and Allowances
120 Merchandise Inventory 414 Sales Discounts
157 Equipment 505 Cost of Goods Sold
158 Accumulated Depreciation—Equipment 726 Sales Salaries Expense
200 Notes Payable 727 Office Salaries Expense
201 Accounts Payable 729 Rent Expense
(b) Record the January transactions in a sales journal, a single-column purchases journal, a cash
receipts journal (see Illustration E-8), a cash payments journal (see Illustration E-15), and a
general journal.
(c) Post the appropriate amounts to the general ledger.
(d) Prepare a trial balance at January 31, 2009.
(e) Determine whether the subsidiary ledgers agree with controlling accounts in the general ledger.
E30 Appendix E Subsidiary Ledgers and Special Journals
(b) Sales journal $12,400
Purchases journal $3,600
Cash receipts journal
(balancing) $57,600
Cash payments journal
(balancing) $22,050
(d) Totals $139,800
(e) Accounts Receivable
$18,600
Accounts Payable
$12,350
PROBLEMS: SET B
PE-1B Darby Company’s chart of accounts includes the following selected accounts.
101 Cash 401 Sales
112 Accounts Receivable 414 Sales Discounts
120 Merchandise Inventory 505 Cost of Goods Sold
311 Common Stock
On June 1 the accounts receivable ledger of Darby Company showed the following balances:
Deering & Son $2,500, Farley Co. $1,900, Grinnell Bros. $1,600, and Lenninger Co. $1,300. The
June transactions involving the receipt of cash were as follows.
June 1 Stockholders invested $10,000 additional cash in the business, in exchange for common
stock.
3 Received check in full from Lenninger Co. less 2% cash discount.
6 Received check in full from Farley Co. less 2% cash discount.
7 Made cash sales of merchandise totaling $6,135. The cost of the merchandise sold was
$4,090.
9 Received check in full from Deering & Son less 2% cash discount.
11 Received cash refund from a supplier for damaged merchandise $320.
15 Made cash sales of merchandise totaling $4,500. The cost of the merchandise sold was
$3,000.
20 Received check in full from Grinnell Bros. $1,600.
Instructions
(a) Journalize the transactions above in a six-column cash receipts journal with columns for
Cash Dr., Sales Discounts Dr., Accounts Receivable Cr., Sales Cr., Other Accounts Cr., and
Cost of Goods Sold Dr./Merchandise Inventory Cr. Foot and crossfoot the journal.
(b) Insert the beginning balances in the Accounts Receivable control and subsidiary accounts,
and post the June transactions to these accounts.
(c) Prove the agreement of the control account and subsidiary account balances.
PE-2B Gonya Company’s chart of accounts includes the following selected accounts.
101 Cash 157 Equipment
120 Merchandise Inventory 201 Accounts Payable
130 Prepaid Insurance 332 Dividends
On November 1 the accounts payable ledger of Gonya Company showed the following balances:
A. Hess & Co. $4,500, C. Kimberlin $2,350, G. Ruttan $1,000, and Wex Bros. $1,500. The
November transactions involving the payment of cash were as follows.
Nov. 1 Purchased merchandise, check no. 11, $1,140.
3 Purchased store equipment, check no. 12, $1,700.
Journalize transactions in cash
receipts journal; post to control
account and subsidiary ledger.
(SO 1, 2, 3)
(a) Balancing totals $28,255
(c) Accounts Receivable $0
Journalize transactions in cash
payments journal; post to the
general and subsidiary ledgers.
(SO 1, 2, 3)
5 Paid Wex Bros. balance due of $1,500, less 1% discount, check no. 13, $1,485.
11 Purchased merchandise, check no. 14, $2,000.
15 Paid G. Ruttan balance due of $1,000, less 3% discount, check no. 15, $970.
16 Paid cash dividend of $500, check no. 16.
19 Paid C. Kimberlin in full for invoice no. 1245, $1,150 less 2% discount, check no. 17,
$1,127.
25 Paid premium due on one-year insurance policy, check no. 18, $3,000.
30 Paid A. Hess & Co. in full for invoice no. 832, $3,500, check no. 19.
Instructions
(a) Journalize the transactions above in a four-column cash payments journal with columns for
Other Accounts Dr., Accounts Payable Dr., Merchandise Inventory Cr., and Cash Cr. Foot
and crossfoot the journal.
(b) Insert the beginning balances in the Accounts Payable control and subsidiary accounts, and
post the November transactions to these accounts.
(c) Prove the agreement of the control account and the subsidiary account balances.
PE-3B The chart of accounts of Emley Company includes the following selected accounts.
112 Accounts Receivable 401 Sales
120 Merchandise Inventory 412 Sales Returns and Allowances
126 Supplies 505 Cost of Goods Sold
157 Equipment 610 Advertising Expense
201 Accounts Payable
In May the following selected transactions were completed. All purchases and sales were on ac-
count except as indicated. The cost of all merchandise sold was 65% of the sales price.
May 2 Purchased merchandise from Younger Company $7,500.
3 Received freight bill from Ruden Freight on Younger purchase $360.
5 Made sales to Ellie Company $1,980, DeShazer Bros. $2,700, and Liu Company $1,500.
8 Purchased merchandise from Utley Company $8,000 and Zeider Company $8,700.
10 Received credit on merchandise returned to Zeider Company $500.
15 Purchased supplies from Rodriquez Supply $900.
16 Purchased merchandise from Younger Company $4,500, and Utley Company $7,200.
17 Returned supplies to Rodriquez Supply, receiving credit $100. (Hint: Credit Supplies.)
18 Received freight bills on May 16 purchases from Ruden Freight $500.
20 Returned merchandise to Younger Company receiving credit $300.
23 Made sales to DeShazer Bros. $2,400 and to Liu Company $3,600.
25 Received bill for advertising from Amster Advertising $900.
26 Granted allowance to Liu Company for merchandise damaged in shipment $200.
28 Purchased equipment from Rodriquez Supply $500.
Instructions
(a) Journalize the transactions above in a purchases journal, a sales journal, and a general
journal. The purchases journal should have the following column headings: Date,
Account Credited (Debited), Ref., Accounts Payable Cr., Merchandise Inventory Dr., and
Other Accounts Dr.
(b) Post to both the general and subsidiary ledger accounts. (Assume that all accounts have zero
beginning balances.)
(c) Prove the agreement of the control and subsidiary accounts.
PE-4B Selected accounts from the chart of accounts of Litke Company are shown below.
101 Cash 201 Accounts Payable
112 Accounts Receivable 401 Sales
120 Merchandise Inventory 414 Sales Discounts
126 Supplies 505 Cost of Goods Sold
140 Land 610 Advertising Expense
145 Buildings
The cost of all merchandise sold was 70% of the sales price. During October, Litke Company
completed the following transactions.
Problems: Set B E31
(a) Balancing totals $15,490
(c) Accounts Payable $2,200
Journalize transactions in
multi-column purchases
journal; post to the general and
subsidiary ledgers.
(SO 1, 2, 3)
(a) Purchases journal—
Accounts Payable, Cr.
$39,060
Sales column total
$12,180
(c) Accounts Receivable
$11,980
Accounts Payable
$38,160
Journalize transactions in
special journals.
(SO 1, 2, 3)
Oct. 2 Purchased merchandise on account from Camacho Company $16,500.
4 Sold merchandise on account to Enos Co. $7,700. Invoice no. 204, terms 2/10, n/30.
5 Purchased supplies for cash $80.
7 Made cash sales for the week totaling $9,160.
9 Paid in full the amount owed Camacho Company less a 2% discount.
10 Purchased merchandise on account from Finn Corp. $3,500.
12 Received payment from Enos Co. for invoice no. 204.
13 Returned $210 worth of damaged goods purchased on account from Finn Corp. on
October 10.
14 Made cash sales for the week totaling $8,180.
16 Sold a parcel of land for $27,000 cash, the land’s original cost.
17 Sold merchandise on account to G. Richter & Co. $5,350, invoice no. 205, terms 2/10, n/30.
18 Purchased merchandise for cash $2,125.
21 Made cash sales for the week totaling $8,200.
23 Paid in full the amount owed Finn Corp. for the goods kept (no discount).
25 Purchased supplies on account from Robinson Co. $260.
25 Sold merchandise on account to Hunt Corp. $5,220, invoice no. 206, terms 2/10, n/30.
25 Received payment from G. Richter & Co. for invoice no. 205.
26 Purchased for cash a small parcel of land and a building on the land to use as a storage fa-
cility.The total cost of $35,000 was allocated $21,000 to the land and $14,000 to the building.
27 Purchased merchandise on account from Kudro Co. $8,500.
28 Made cash sales for the week totaling $7,540.
30 Purchased merchandise on account from Camacho Company $14,000.
30 Paid advertising bill for the month from the Gazette, $400.
30 Sold merchandise on account to G. Richter & Co. $4,600, invoice no. 207, terms 2/10, n/30.
Litke Company uses the following journals.
1. Sales journal.
2. Single-column purchases journal.
3. Cash receipts journal with columns for Cash Dr., Sales Discounts Dr., Accounts
Receivable Cr., Sales Cr., Other Accounts Cr., and Cost of Goods Sold Dr./Merchandise
Inventory Cr.
4. Cash payments journal with columns for Other Accounts Dr., Accounts Payable Dr.,
Merchandise Inventory Cr., and Cash Cr.
5. General journal.
Instructions
Using the selected accounts provided:
(a) Record the October transactions in the appropriate journals.
(b) Foot and crossfoot all special journals.
(c) Show how postings would be made by placing ledger account numbers and check marks as
needed in the journals. (Actual posting to ledger accounts is not required.)
PE-5B Presented below are the sales and cash receipts journals for Wyrick Co. for its first
month of operations.
E32 Appendix E Subsidiary Ledgers and Special Journals
SALES JOURNAL S1
Accounts Receivable Dr. Cost of Goods Sold Dr.
Date Account Debited Ref. Sales Cr. Merchandise Inventory Cr.
Feb. 3 S. Arndt 5,500 3,630
9 C. Boyd 6,500 4,290
12 F. Catt 8,000 5,280
26 M. Didde 7,000 4,620
27,000 17,820
(b) Sales journal $22,870
Purchases journal
$42,500
Cash receipts journal—
Cash, Dr. $72,869
Cash payments journal,
Cash, Cr. $57,065
Journalize in purchases and
cash payments journals; post;
prepare a trial balance; prove
control to subsidiary; prepare
adjusting entries; prepare an
adjusted trial balance.
(SO 1, 2, 3)
In addition, the following transactions have not been journalized for February 2008.
Feb. 2 Purchased merchandise on account from J. Vopat for $4,600, terms 2/10, n/30.
7 Purchased merchandise on account from P. Kneiser for $30,000, terms 1/10, n/30.
9 Paid cash of $1,250 for purchase of supplies.
12 Paid $4,508 to J. Vopat in payment for $4,600 invoice, less 2% discount.
15 Purchased equipment for $7,000 cash.
16 Purchased merchandise on account from J. Nunez $2,400, terms 2/10, n/30.
17 Paid $29,700 to P. Kneiser in payment of $30,000 invoice, less 1% discount.
20 Paid cash dividend of $1,100.
21 Purchased merchandise on account from G. Reedy for $7,800, terms 1/10, n/30.
28 Paid $2,400 to J. Nunez in payment of $2,400 invoice.
Instructions
(a) Open the following accounts in the general ledger.
101 Cash 311 Common Stock
112 Accounts Receivable 332 Dividends
120 Merchandise Inventory 401 Sales
126 Supplies 414 Sales Discounts
157 Equipment 505 Cost of Goods Sold
158 Accumulated Depreciation—Equipment 631 Supplies Expense
201 Accounts Payable 711 Depreciation Expense
(b) Journalize the transactions that have not been journalized in a one-column purchases jour-
nal and the cash payments journal (see Illustration E-15).
(c) Post to the accounts receivable and accounts payable subsidiary ledgers. Follow the sequence
of transactions as shown in the problem.
(d) Post the individual entries and totals to the general ledger.
(e) Prepare a trial balance at February 29, 2008.
(f) Determine that the subsidiary ledgers agree with the control accounts in the general ledger.
(g) The following adjustments at the end of February are necessary.
(1) A count of supplies indicates that $300 is still on hand.
(2) Depreciation on equipment for February is $200.
Prepare the adjusting entries and then post the adjusting entries to the general ledger.
(h) Prepare an adjusted trial balance at February 29, 2008.
Comprehensive Problem: Chapters 3 to 6 and Appendix E E33
CASH RECEIPTS JOURNAL CR1
Sales Accounts Other
Cash Discounts Receivable Sales Accounts Cost of Goods Sold Dr.
Date Account Credited Ref. Dr. Dr. Cr. Cr. Cr. Merchandise Inventory Cr.
Feb. 1 Common Stock 30,000 30,000
2 6,500 6,500 4,290
13 S. Arndt 5,445 55 5,500
18 Merchandise Inventory 150 150
26 C. Boyd 6,500 6,500
48,595 55 12,000 6,500 30,150 4,290
PROBLEMS: SET C
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COMPREHENSIVE PROBLEM: CHAPTERS 3 TO 6
AND APPENDIX E
Packard Company has the following opening account balances in its general and subsidiary ledgers on
January 1 and uses the periodic inventory system.All accounts have normal debit and credit balances.
(b) Purchases journal total
$44,800
Cash payments journal—
Cash, Cr. $45,958
(e) Totals $71,300
(f) Accounts Receivable
$15,000
Accounts Payable $7,800
(h) Totals $71,500
Visit the book’s website at www.wiley.com/college/weygandt, and choose the Student Companion
site, to access Problem Set C.
Jan. 3 Sell merchandise on account to B. Remy $3,100, invoice no. 510, and J. Fine $1,800,
invoice no. 511.
5 Purchase merchandise on account from S. Yost $3,000 and D. Laux $2,700.
7 Receive checks for $4,000 from S. Ingles and $2,000 from B. Hachinski.
8 Pay freight on merchandise purchased $180.
9 Send checks to S. Kosko for $9,000 and D. Moreno for $11,000.
9 Issue credit of $300 to J. Fine for merchandise returned.
10 Summary cash sales total $15,500.
11 Sell merchandise on account to R. Draves for $1,900, invoice no. 512, and to S. Ingles
$900, invoice no. 513.
Post all entries to the subsidiary ledgers.
12 Pay rent of $1,000 for January.
13 Receive payment in full from B. Remy and J. Fine.
15 Pay cash dividend of $800.
16 Purchase merchandise on account from D. Moreno for $15,000, from S. Kosko for
$13,900, and from S. Yost for $1,500.
17 Pay $400 cash for office supplies.
18 Return $200 of merchandise to S. Kosko and receive credit.
20 Summary cash sales total $17,500.
21 Issue $15,000 note to R. Mikush in payment of balance due.
21 Receive payment in full from S. Ingles.
Post all entries to the subsidiary ledgers.
22 Sell merchandise on account to B. Remy for $3,700, invoice no. 514, and to R. Draves for
$800, invoice no. 515.
23 Send checks to D. Moreno and S. Kosko in full payment.
25 Sell merchandise on account to B. Hachinski for $3,500, invoice no. 516, and to J. Fine
for $6,100, invoice no. 517.
27 Purchase merchandise on account from D. Moreno for $12,500, from D. Laux for $1,200,
and from S. Yost for $2,800.
28 Pay $200 cash for office supplies.
31 Summary cash sales total $22,920.
31 Pay sales salaries of $4,300 and office salaries of $3,600.
E34 Appendix E Subsidiary Ledgers and Special Journals
General Ledger
Account January 1
Number Account Title Opening Balance
101 Cash $33,750
112 Accounts Receivable 13,000
115 Notes Receivable 39,000
120 Merchandise Inventory 20,000
125 Office Supplies 1,000
130 Prepaid Insurance 2,000
157 Equipment 6,450
158 Accumulated Depreciation 1,500
201 Accounts Payable 35,000
311 Common Stock 70,000
320 Retained Earnings 8,700
Accounts Payable Subsidiary Ledger
January 1
Opening
Creditor Balance
S. Kosko $ 9,000
R. Mikush 15,000
D. Moreno 11,000
Accounts Receivable Subsidiary Ledger
January 1
Opening
Customer Balance
R. Draves $1,500
B. Hachinski 7,500
S. Ingles 4,000
Instructions
(a) Record the January transactions in the appropriate journal—sales, purchases, cash receipts,
cash payments, and general.
(b) Post the journals to the general and subsidiary ledgers. Add and number new accounts in an
orderly fashion as needed.
(c) Prepare a trial balance at January 31, 2008, using a worksheet. Complete the worksheet using
the following additional information.
(1) Office supplies at January 31 total $700.
(2) Insurance coverage expires on October 31, 2008.
(3) Annual depreciation on the equipment is $1,500.
(4) Interest of $30 has accrued on the note payable.
(5) Merchandise inventory at January 31 is $15,000.
(d) Prepare a multiple-step income statement and a retained earnings statement for January and
a classified balance sheet at the end of January.
(e) Prepare and post the adjusting and closing entries.
(f) Prepare a post-closing trial balance, and determine whether the subsidiary ledgers agree with
the control accounts in the general ledger.
Broadening Your Perspective E35
(c) Trial balance totals
$196,820;
Adj. T/B totals $196,975
(d) Net income $9,685
Total assets $126,315
(f) Post-closing T/B totals
$127,940
B R O A D E N I N G Y O U R P E R S P E C T I V E
FINANCIAL REPORTING AND ANALYSIS
Financial Reporting Problem—Mini Practice Set
BYPE-1 (You will need the working papers that accompany this textbook in order to work
this mini practice set.)
Bluma Co. uses a perpetual inventory system and both an accounts receivable and an accounts
payable subsidiary ledger. Balances related to both the general ledger and the subsidiary ledger
for Bluma are indicated in the working papers. Presented below are a series of transactions for
Bluma Co. for the month of January. Credit sales terms are 2/10, n/30. The cost of all merchan-
dise sold was 60% of the sales price.
Jan. 3 Sell merchandise on account to B. Richey $3,100, invoice no. 510, and to J. Forbes $1,800,
invoice no. 511.
5 Purchase merchandise from S. Vogel $5,000 and D. Lynch $2,200, terms n/30.
7 Receive checks from S. LaDew $4,000 and B. Garcia $2,000 after discount period has lapsed.
8 Pay freight on merchandise purchased $235.
9 Send checks to S. Hoyt for $9,000 less 2% cash discount, and to D. Omara for $11,000
less 1% cash discount.
9 Issue credit of $300 to J. Forbes for merchandise returned.
10 Summary daily cash sales total $15,500.
11 Sell merchandise on account to R. Dvorak $1,600, invoice no. 512, and to S. LaDew
$900, invoice no. 513.
12 Pay rent of $1,000 for January.
13 Receive payment in full from B. Richey and J. Forbes less cash discounts.
14 Pay an $800 cash dividend.
15 Post all entries to the subsidiary ledgers.
16 Purchase merchandise from D. Omara $18,000, terms 1/10, n/30; S. Hoyt $14,200, terms
2/10, n/30; and S. Vogel $1,500, terms n/30.
17 Pay $400 cash for office supplies.
18 Return $200 of merchandise to S. Hoyt and receive credit.
20 Summary daily cash sales total $20,100.
21 Issue $15,000 note, maturing in 90 days, to R. Moses in payment of balance due.
21 Receive payment in full from S. LaDew less cash discount.
22 Sell merchandise on account to B. Richey $2,700, invoice no. 514, and to R. Dvorak
$1,300, invoice no. 515.
22 Post all entries to the subsidiary ledgers.
23 Send checks to D. Omara and S. Hoyt in full payment less cash discounts.
25 Sell merchandise on account to B. Garcia $3,500, invoice no. 516, and to J. Forbes $6,100,
invoice no. 517.
27 Purchase merchandise from D. Omara $14,500, terms 1/10, n/30; D. Lynch $1,200, terms
n/30; and S. Vogel $5,400, terms n/30.
27 Post all entries to the subsidiary ledgers.
28 Pay $200 cash for office supplies.
31 Summary daily cash sales total $21,300.
31 Pay sales salaries $4,300 and office salaries $3,800.
Instructions
(a) Record the January transactions in a sales journal, a single-column purchases journal, a cash
receipts journal as shown on page E8, a cash payments journal as shown on page E14, and a
two-column general journal.
(b) Post the journals to the general ledger.
(c) Prepare a trial balance at January 31, 2008, in the trial balance columns of the worksheet.
Complete the worksheet using the following additional information.
(1) Office supplies at January 31 total $900.
(2) Insurance coverage expires on October 31, 2008.
(3) Annual depreciation on the equipment is $1,500.
(4) Interest of $50 has accrued on the note payable.
(d) Prepare a multiple-step income statement and a retained earnings statement for January and
a classified balance sheet at the end of January.
(e) Prepare and post adjusting and closing entries.
(f) Prepare a post-closing trial balance, and determine whether the subsidiary ledgers agree with
the control accounts in the general ledger.
Exploring the Web
BYPE-2 Great Plains’ Accounting is one of the leading accounting software packages. Infor-
mation related to this package is found at its website.
Address: www.microsoft.com/dynamics/gp/product/demos.mspx, or go to
www.wiley.com/college/weygandt
Steps
1. Go to the site shown above.
2. Choose General Ledger. Perform instruction (a).
3. Choose Accounts Payable. Perform instruction (b).
Instructions
(a) What are three key features of the general ledger module highlighted by the company?
(b) What are three key features of the payables management module highlighted by the company?
E36 Appendix E Subsidiary Ledgers and Special Journals
CRITICAL THINKING
Decision Making Across the Organization
BYPE-3 Hughey & Payne is a wholesaler of small appliances and parts. Hughey & Payne is
operated by two owners, Rich Hughey and Kristen Payne. In addition, the company has one
employee, a repair specialist, who is on a fixed salary. Revenues are earned through the sale of
appliances to retailers (approximately 75% of total revenues), appliance parts to do-it-yourselfers
(10%), and the repair of appliances brought to the store (15%). Appliance sales are made on
both a credit and cash basis. Customers are billed on prenumbered sales invoices. Credit terms
are always net/30 days. All parts sales and repair work are cash only.
Merchandise is purchased on account from the manufacturers of both the appliances and
the parts. Practically all suppliers offer cash discounts for prompt payments, and it is company
policy to take all discounts. Most cash payments are made by check. Checks are most fre-
quently issued to suppliers, to trucking companies for freight on merchandise purchases, and
to newspapers, radio, and TV stations for advertising. All advertising bills are paid as received.
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Rich and Kristen each make a monthly drawing in cash for personal living expenses. The
salaried repairman is paid twice monthly. Hughey & Payne currently has a manual account-
ing system.
Instructions
With the class divided into groups, answer the following.
(a) Identify the special journals that Hughey & Payne should have in its manual system. List the
column headings appropriate for each of the special journals.
(b) What control and subsidiary accounts should be included in Hughey & Payne manual
system? Why?
Communication Activity
BYPE-4 Barb Doane, a classmate, has a part-time bookkeeping job. She is concerned about
the inefficiencies in journalizing and posting transactions. Jim Houser is the owner of the com-
pany where Barb works. In response to numerous complaints from Barb and others, Jim hired
two additional bookkeepers a month ago. However, the inefficiencies have continued at an even
higher rate. The accounting information system for the company has only a general journal and
a general ledger. Jim refuses to install an electronic accounting system.
Instructions
Now that Barb is an expert in manual accounting information systems, she decides to send a
letter to Jim Houser explaining (1) why the additional personnel did not help and (2) what
changes should be made to improve the efficiency of the accounting department. Write the let-
ter that you think Barb should send.
Ethics Case
BYPE-5 Roniger Products Company operates three divisions, each with its own manufactur-
ing plant and marketing/sales force. The corporate headquarters and central accounting office
are in Roniger, and the plants are in Freeport, Rockport, and Bayport, all within 50 miles of
Roniger. Corporate management treats each division as an independent profit center and en-
courages competition among them. They each have similar but different product lines. As a com-
petitive incentive, bonuses are awarded each year to the employees of the fastest growing and
most profitable division.
Jose Molina is the manager of Roniger’s centralized computer accounting operation that
enters the sales transactions and maintains the accounts receivable for all three divisions. Jose
came up in the accounting ranks from the Bayport division where his wife, several relatives, and
many friends still work.
As sales documents are entered into the computer, the originating division is identified
by code. Most sales documents (95%) are coded, but some (5%) are not coded or are coded
incorrectly. As the manager, Jose has instructed the data-entry personnel to assign the Bayport
code to all uncoded and incorrectly coded sales documents. This is done he says, “in order to
expedite processing and to keep the computer files current since they are updated daily.” All
receivables and cash collections for all three divisions are handled by Roniger as one subsidiary
accounts receivable ledger.
Instructions
(a) Who are the stakeholders in this situation?
(b) What are the ethical issues in this case?
(c) How might the system be improved to prevent this situation?
Answers to Self-Study Questions
1. a 2. c 3. a 4. c 5. d 6. b 7. c 8. c
Broadening Your Perspective E37
F1
Other Significant Liabilities
Appendix F
In addition to the current and long-term liabilities discussed in Chapter 11, several
more types of liabilities may exist that could have a significant impact on a com-
pany’s financial position and future cash flows. These other significant liabilities
will be discussed in this appendix. They are: (a) contingent liabilities, (b) lease lia-
bilities, and (c) additional liabilities for employee fringe benefits (paid absences
and postretirement benefits).
After studying this appendix, you should be able to:
1. Describe the accounting and disclosure requirements for
contingent liabilities.
2. Contrast the accounting for operating and capital leases.
3. Identify additional fringe benefits associated with employee
compensation.
S T U D Y O B J E C T I V E
CONTINGENT LIABILITIES
With notes payable, interest payable, accounts payable, and sales taxes
payable, we know that an obligation to make a payment exists. But sup-
pose that your company is involved in a dispute with the Internal Revenue
Service (IRS) over the amount of its income tax liability. Should you re-
port the disputed amount as a liability on the balance sheet? Or suppose
your company is involved in a lawsuit which, if you lose, might result in bankruptcy.
How should you report this major contingency? The answers to these questions are
difficult, because these liabilities are dependent—contingent—upon some future
event. In other words, a contingent liability is a potential liability that may become
an actual liability in the future.
How should companies report contingent liabilities? They use the following
guidelines:
1. If the contingency is probable (if it is likely to occur) and the amount can be
reasonably estimated, the liability should be recorded in the accounts.
2. If the contingency is only reasonably possible (if it could happen), then it needs
to be disclosed only in the notes that accompany the financial statements.
3. If the contingency is remote (if it is unlikely to occur), it need not be recorded
or disclosed.
Recording a Contingent Liability
Product warranties are an example of a contingent liability that companies should
record in the accounts. Warranty contracts result in future costs that companies
may incur in replacing defective units or repairing malfunctioning units. Generally,
Describe the accounting and
disclosure requirements for
contingent liabilities.
S T U D Y O B J E C T I V E 1
a manufacturer, such as Black & Decker, knows that it will incur some warranty
costs. From prior experience with the product, the company usually can reasonably
estimate the anticipated cost of servicing (honoring) the warranty.
The accounting for warranty costs is based on the matching principle. The esti-
mated cost of honoring product warranty contracts should be recognized as an ex-
pense in the period in which the sale occurs. To illustrate, assume that in 2008
Denson Manufacturing Company sells 10,000 washers and dryers at an average
price of $600 each. The selling price includes a one-year warranty on parts. Denson
expects that 500 units (5%) will be defective and that warranty repair costs will av-
erage $80 per unit. In 2008, the company honors warranty contracts on 300 units, at
a total cost of $24,000.
At December 31, it is necessary to accrue the estimated warranty costs on the
2008 sales. Denson computes the estimated warranty liability as follows.
F2 Appendix F Other Significant Liabilities
Number of units sold 10,000
Estimated rate of defective units � 5%
Total estimated defective units 500
Average warranty repair cost � $80
Estimated product warranty liability $40,000
Illustration F-1
Computation of estimated
product warranty liability
The company makes the following adjusting entry.
Dec. 31 Warranty Expense 40,000
Estimated Warranty Liability 40,000
(To accrue estimated warranty costs)
Denson records those repair costs incurred in 2008 to honor warranty contracts
on 2008 sales as shown below.
Jan. 1� Estimated Warranty Liability 24,000
Dec. 31 Repair Parts 24,000
(To record honoring of 300 warranty
contracts on 2008 sales)
The company reports warranty expense of $40,000 under selling expenses in the
income statement. It classifies estimated warranty liability of $16,000 ($40,000 �
$24,000) as a current liability on the balance sheet.
In the following year, Denson should debit to Estimated Warranty Liability
all expenses incurred in honoring warranty contracts on 2008 sales. To illustrate,
assume that the company replaces 20 defective units in January 2009, at an aver-
age cost of $80 in parts and labor. The summary entry for the month of January
2009 is:
Jan. 31 Estimated Warranty Liability 1,600
Repair Parts 1,600
(To record honoring of 20 warranty
contracts on 2008 sales)
Disclosure of Contingent Liabilities
When it is probable that a company will incur a contingent liability but it cannot
reasonably estimate the amount, or when the contingent liability is only reasonably
possible, only disclosure of the contingency is required. Examples of contingencies
Cash Flows
no effect
A � L � SE
�40,000 Exp
�40,000
Cash Flows
no effect
A � L � SE
�24,000
�24,000
Cash Flows
no effect
A � L � SE
�1,600
�1,600
that may require disclosure are pending or threatened lawsuits and assessment of
additional income taxes pending an IRS audit of the tax return.
The disclosure should identify the nature of the item and, if known, the amount
of the contingency and the expected outcome of the future event. Disclosure is usu-
ally accomplished through a note to the financial statements, as illustrated by the
following.
Lease Liabilities F3
The required disclosure for contingencies is a good example of the use of the
full-disclosure principle. The full-disclosure principle requires that companies dis-
close all circumstances and events that would make a difference to financial state-
ment users. Some important financial information, such as contingencies, is not eas-
ily reported in the financial statements. Reporting information on contingencies in
the notes to the financial statements will help investors be aware of events that can
affect the financial health of a company.
YAHOO! INC.
Notes to the Financial Statements
Contingencies. From time to time, third parties assert patent infringement claims against
the company. Currently the company is engaged in several lawsuits regarding patent issues
and has been notified of a number of other potential patent disputes. In addition, from time
to time the company is subject to other legal proceedings and claims in the ordinary course
of business, including claims for infringement of trademarks, copyrights and other intellectual
property rights…. The Company does not believe, based on current knowledge, that any of
the foregoing legal proceedings or claims are likely to have a material adverse effect on the
financial position, results of operations or cash flows.
Illustration F-2
Disclosure of contingent
liability
LEASE LIABILITIES
A lease is a contractual arrangement between a lessor (owner of a property)
and a lessee (renter of the property). It grants the right to use specific
property for a period of time in return for cash payments. Leasing is big
business. U.S. companies leased an estimated $125 billion of capital equip-
ment in a recent year. This represents approximately one-third of equipment
financed that year. The two most common types of leases are operating leases and
capital leases.
Operating Leases
The renting of an apartment and the rental of a car at an airport are examples of
operating leases. In an operating lease the intent is temporary use of the property
by the lessee, while the lessor continues to own the property.
In an operating lease, the lessee records the lease (or rental) payments as an
expense. The lessor records the payments as revenue. For example, assume that a
sales representative for Western Inc. leases a car from Hertz Car Rental at the Los
Angeles airport and that Hertz charges a total of $275. Western, the lessee, records
the rental as follows:
Car Rental Expense 275
Cash 275
(To record payment of lease rental charge)
Contrast the accounting for
operating and capital leases.
S T U D Y O B J E C T I V E 2
A � L � SE
�275 Exp
�275
Cash Flows
�275
The lessee may incur other costs during the lease period. For example, in the case
above, Western will generally incur costs for gas. Western would report these costs
as an expense.
Capital Leases
In most lease contracts, the lessee makes a periodic payment and records that
payment in the income statement as rent expense. In some cases, however, the
lease contract transfers to the lessee substantially all the benefits and risks of
ownership. Such a lease is in effect a purchase of the property. This type of lease
is a capital lease. Its name comes from the fact that the company capitalizes the
present value of the cash payments for the lease and records that amount as an
asset. Illustration F-3 indicates the major difference between operating and
capital leases.
F4 Appendix F Other Significant Liabilities
If any one of the following conditions exists, the lessee must record a lease as
an asset—that is, as a capital lease:
1. The lease transfers ownership of the property to the lessee. Rationale: If during
the lease term the lessee receives ownership of the asset, the lessee should re-
port the leased asset as an asset on its books.
2. The lease contains a bargain purchase option. Rationale: If during the term of
the lease the lessee can purchase the asset at a price substantially below its fair
market value, the lessee will exercise this option. Thus, the lessee should report
the lease as a leased asset on its books.
3. The lease term is equal to 75% or more of the economic life of the leased prop-
erty. Rationale: If the lease term is for much of the asset’s useful life, the lessee
should report the asset as a leased asset on its books.
4. The present value of the lease payments equals or exceeds 90% of the fair mar-
ket value of the leased property. Rationale: If the present value of the lease
payments is equal to or almost equal to the fair market value of the asset, the
lessee has essentially purchased the asset. As a result, the lessee should report
the leased asset as an asset on its books.
H E L P F U L H I N T
A capital lease situation
is one that, although
legally a rental case, is in
substance an installment
purchase by the lessee.
Accounting standards re-
quire that substance over
form be used in such a
situation.
Illustration F-3
Types of leases
Operating
lease
Lessee has substantially all of the
benefits and risks of ownership
Capital
lease
“Have it back
by 6:00 Sunday.”
“OK!”
Lessor has substantially all of the
benefits and risks of ownership
“Only 3 more
payments and this baby
is ours!”
To illustrate, assume that Gonzalez Company decides to lease new equipment.
The lease period is four years; the economic life of the leased equipment is esti-
mated to be five years. The present value of the lease payments is $190,000, which
is equal to the fair market value of the equipment. There is no transfer of owner-
ship during the lease term, nor is there any bargain purchase option.
In this example, Gonzalez has essentially purchased the equipment. Conditions
3 and 4 have been met. First, the lease term is 75% or more of the economic life of
the asset. Second, the present value of cash payments is equal to the equipment’s
fair market value. Gonzalez records the transaction as follows.
Leased Asset—Equipment 190,000
Lease Liability 190,000
(To record leased asset and lease liability)
The lessee reports a leased asset on the balance sheet under plant assets. It re-
ports the lease liability on the balance sheet as a liability. The portion of the lease
liability expected to be paid in the next year is a current liability. The remainder is
classified as a long-term liability.
Most lessees do not like to report leases on their balance sheets. Why?
Because the lease liability increases the company’s total liabilities. This, in
turn, may make it more difficult for the company to obtain needed funds
from lenders. As a result, companies attempt to keep leased assets and
lease liabilities off the balance sheet by structuring leases so as not to meet
any of the four conditions mentioned on page F4. The practice of keeping
liabilities off the balance sheet is referred to as off-balance-sheet financing.
Additional Liabilities for Employee Fringe Benefits F5
E T H I C S N O T E
Accounting standard setters
are attempting to rewrite
rules on lease accounting because
of concerns that abuse of the cur-
rent standards is reducing the
usefulness of financial statements.
A � L � SE
�190,000
�190,000
Cash Flows
no effect
ADDITIONAL LIABILITIES FOR EMPLOYEE
FRINGE BENEFITS
In addition to the three payroll tax fringe benefits discussed in Appendix
D (FICA taxes and state and federal unemployment taxes), employers in-
cur other substantial fringe benefit costs. Indeed, fringe benefits have been
growing faster than pay. In a recent year, benefits equaled 38 percent of
wages and salaries. While vacations and other forms of paid leave still take
the biggest bite out of the benefits pie, as shown in Illustration F-4, medical costs
are the fastest-growing item.
Illustration F-4
The fringe benefits pieBENEFITS
3% Disability and life insurance
23% Legally required benefits
such as Social Security
24% Medical benefits
37% Vacation and other benefits
such as parental and sick leaves, child care
13% Retirement income
such as pensions
We discuss two of the most important fringe benefits—paid absences and
postretirement benefits—in this section.
Identify additional fringe benefits
associated with employee
compensation.
S T U D Y O B J E C T I V E 3
Paid Absences
Employees often are given rights to receive compensation for absences when cer-
tain conditions of employment are met. The compensation may be for paid vaca-
tions, sick pay benefits, and paid holidays. When the payment for such absences is
probable and the amount can be reasonably estimated, a liability should be ac-
crued for paid future absences. When the amount cannot be reasonably estimated,
companies should instead disclose the potential liability. Ordinarily, vacation pay is
the only paid absence that is accrued. The other types of paid absences are only
disclosed.1
To illustrate, assume that Academy Company employees are entitled to one
day’s vacation for each month worked. If 30 employees earn an average of $110 per
day in a given month, the accrual for vacation benefits in one month is $3,300. The
liability is recognized at the end of the month by the following adjusting entry.
Jan. 31 Vacation Benefits Expense 3,300
Vacation Benefits Payable 3,300
(To accrue vacation benefits expense)
This accrual is required by the matching principle. Academy would report Vacation
Benefits Expense as an operating expense in the income statement, and Vacation
Benefits Payable as a current liability in the balance sheet.
Later, when Academy pays vacation benefits, it debits Vacation Benefits
Payable and credits Cash. For example, if the above benefits for 10 employees are
paid in July, the entry is:
July 31 Vacation Benefits Payable 1,100
Cash 1,100
(To record payment of vacation benefits)
The magnitude of unpaid absences has gained employers’ attention. Consider
the case of an assistant superintendent of schools who worked for 20 years and
rarely took a vacation or sick day. A month or so before she retired, the school dis-
trict discovered that she was due nearly $30,000 in accrued benefits. Yet the school
district had never accrued the liability.
Postretirement Benefits
Postretirement benefits are benefits provided by employers to retired employees
for (1) health care and life insurance and (2) pensions. For many years the
accounting for postretirement benefits was on a cash basis. Companies now ac-
count for both types of postretirement benefits on the accrual basis. The cost of
postretirement benefits is getting steep. For example, General Motor’s pension and
health-care costs for retirees in a recent year totaled $6.2 billion, or approximately
$1,784 per vehicle produced.
The average American has debt of approximately $10,000 (not counting the
mortgage on their home) and has little in the way of savings. What will happen at
retirement for these people? The picture is not pretty—people are living longer,
the future of Social Security is unclear, and companies are cutting back on post-
retirement benefits. This situation may lead to one of the great social and moral
dilemmas this country faces in the next 40 years. The more you know about post-
F6 Appendix F Other Significant Liabilities
A � L � SE
�3,300 Exp
�3,300
A � L � SE
�1,100
�1,100
Cash Flows
�1,100
Cash Flows
no effect
1
The typical U.S. company provides an average of 12 days of paid vacation for its employees, at an
average cost of 5% of gross earnings.
retirement benefits, the better you will understand the issues involved in this
dilemma.
POSTRETIREMENT HEALTH-CARE AND LIFE INSURANCE BENEFITS
Providing medical and related health-care benefits for retirees was at one time an
inexpensive and highly effective way of generating employee goodwill. This prac-
tice has now turned into one of corporate America’s most worrisome financial
problems. Runaway medical costs, early retirement, and increased longevity are
sending the liability for retiree health plans through the roof.
Many companies began offering retiree health-care coverage in the form of
Medicare supplements in the 1960s. Almost all plans operated on a pay-as-you-go
basis. The companies simply paid for the bills as they came in, rather than setting
aside funds to meet the cost of future benefits. These plans were accounted for on
the cash basis. But, the FASB concluded that shareholders and creditors should
know the amount of the employer’s obligations. As a result, employers must now
use the accrual basis in accounting for postretirement health-care and life insur-
ance benefits.
PENSION PLANS
A pension plan is an agreement whereby an employer provides benefits (pay-
ments) to employees after they retire. Over 50 million workers currently partici-
pate in pension plans in the United States. The need for good accounting for pen-
sion plans becomes apparent when one appreciates the size of existing pension
funds. Most pension plans are subject to the provisions of ERISA (Employee
Retirement Income Security Act), a law enacted to curb abuses in the administra-
tion and funding of such plans.
Three parties are generally involved in a pension plan. The employer (com-
pany) sponsors the pension plan. The plan administrator receives the contributions
from the employer, invests the pension assets, and makes the benefit payments to
the pension recipients (retired employees). Illustration F-5 indicates the flow of
cash among the three parties involved in a pension plan.
Additional Liabilities for Employee Fringe Benefits F7
Illustration F-5
Parties in a pension plan
Contributions Benefits
Fund Assets:
Investments and Earnings
Employer Plan Administrator Pension Recipients
Kear Trust Co.
An employer-financed pension is part of the employees’ compensation.
ERISA establishes the minimum contribution that a company must make each
year toward employee pensions. The most popular type of pension plan used is the
401(k) plan. A 401(k) plan works as follows: As an employee, you can contribute up
to a certain percentage of your pay into a 401(k) plan, and your employer will match
a percentage of your contribution. These contributions are then generally invested in
stocks and bonds through mutual funds. These funds will grow without being taxed
and can be withdrawn beginning at age 59-1/2. If you must access the funds earlier,
you may be able to do so, but a penalty usually occurs along with a payment of tax
on the proceeds. Any time you have the opportunity to be involved in a 401(k)
plan, you should avail yourself of this benefit!
Companies record pension costs as an expense while the employees are work-
ing because that is when the company receives benefits from the employees’ serv-
ices. Generally the pension expense is reported as an operating expense in the
company’s income statement. Frequently, the amount contributed by the company
to the pension plan is different from the amount of the pension expense. A liability
is recognized when the pension expense to date is more than the company’s con-
tributions to date. An asset is recognized when the pension expense to date is less
than the company’s contributions to date. Further consideration of the accounting
for pension plans is left for more advanced courses.
The two most common types of pension arrangements for providing benefits
to employees after they retire are defined-contribution plans and defined-benefit
plans.
Defined-Contribution Plan. In a defined-contribution plan, the plan defines the
employer’s contribution but not the benefit that the employee will receive at re-
tirement. That is, the employer agrees to contribute a certain sum each period
based on a formula. A 401(k) plan is typically a defined-contribution plan.
The accounting for a defined-contribution plan is straightforward: The em-
ployer simply makes a contribution each year based on the formula established in
the plan. As a result, the employer’s obligation is easily determined. It follows that
the company reports the amount of the contribution required each period as pen-
sion expense. The employer reports a liability only if it has not made the contribu-
tion in full.
To illustrate, assume that Alba Office Interiors Corp. has a defined-contribution
plan in which it contributes $200,000 each year to the pension fund for its employees.
The entry to record this transaction is:
Pension Expense 200,000
Cash 200,000
(To record pension expense and contribution to
pension fund)
To the extent that Alba did not contribute the $200,000 defined contribution, it
would record a liability. Pension payments to retired employees are made from the
pension fund by the plan administrator.
Defined-Benefit Plan. In a defined-benefit plan, the benefits that the employee
will receive at the time of retirement are defined by the terms of the plan. Benefits
are typically calculated using a formula that considers an employee’s compensation
level when he or she nears retirement and the employee’s years of service. Because
the benefits in this plan are defined in terms of uncertain future variables, an ap-
propriate funding pattern is established to ensure that enough funds are available
at retirement to meet the benefits promised. This funding level depends on a num-
ber of factors such as employee turnover, length of service, mortality, compensation
levels, and investment earnings. The proper accounting for these plans is complex
and is considered in more advanced accounting courses.
POSTRETIREMENT BENEFITS AS LONG-TERM LIABILITIES
While part of the liability associated with (1) postretirement health-care and life in-
surance benefits and (2) pension plans is generally a current liability, the greater
portion of these liabilities extends many years into the future. Therefore, many
companies are required to report significant amounts as long-term liabilities for
postretirement benefits.
F8 Appendix F Other Significant Liabilities
A � L � SE
�200,000
�200,000
Cash Flows
�200,000
1 Describe the accounting and disclosure requirements
for contingent liabilities. If it is probable that the contin-
gency will happen (if it is likely to occur) and the amount
can be reasonably estimated, the liability should be
recorded in the accounts. If the contingency is only reason-
ably possible (it could occur), then it should be disclosed
only in the notes to the financial statements. If the possibil-
ity that the contingency will happen is remote (unlikely to
occur), it need not be recorded or disclosed.
2 Contrast the accounting for operating and capital
leases. For an operating lease, lease (or rental) payments
Self-Study Questions F9
REVIEW IT
1. What is a contingent liability?
2. How are contingent liabilities reported in financial statements?
3. What accounts are involved in accruing and paying vacation benefits?
4. What basis should be used in accounting for postretirement benefits?
Before You Go On…
SUMMARY OF STUDY OBJECTIVES
are recorded as an expense by the lessee (renter). For a
capital lease, the lessee records the asset and related obli-
gation at the present value of the future lease payments.
3 Identify additional fringe benefits associated with em-
ployee compensation. Additional fringe benefits associ-
ated with wages are paid absences (paid vacations, sick pay
benefits, and paid holidays), postretirement health care and
life insurance, and pensions. The two most common types
of pension arrangements are a defined-contribution plan
and a defined-benefit plan.
GLOSSARY
Capital lease A contractual arrangement that transfers
substantially all the benefits and risks of ownership to the
lessee so that the lease is in effect a purchase of the prop-
erty. (p. F4).
Contingent liability A potential liability that may become
an actual liability in the future. (p. F1).
Defined-benefit plan A pension plan in which the bene-
fits that the employee will receive at retirement are defined
by the terms of the plan. (p. F8).
Defined-contribution plan A pension plan in which the
employer’s contribution to the plan is defined by the terms
of the plan. (p. F8).
Lease A contractual arrangement between a lessor (owner
of a property) and a lessee (renter of the property). (p. F3).
Operating lease A contractual arrangement giving the les-
see temporary use of the property, with continued owner-
ship of the property by the lessor. (p. F3).
Pension plan An agreement whereby an employer
provides benefits to employees after they retire. (p. F7).
Postretirement benefits Payments by employers to retired
employees for health care, life insurance, and pensions.
(p. F6).
SELF-STUDY QUESTIONS
Answers are at the end of the appendix.
1. A contingency should be recorded in the accounts when:
a. It is probable the contingency will happen but the
amount cannot be reasonably estimated.
b. It is reasonably possible the contingency will happen
and the amount can be reasonably estimated.
c. It is reasonably possible the contingency will happen
but the amount cannot be reasonably estimated.
d. It is probable the contingency will happen and the
amount can be reasonably estimated.
2. At December 31, Anthony Company prepares an adjust-
ing entry for a product warranty contract. Which of the
following accounts are included in the entry?
a. Warranty Expense.
b. Estimated Warranty Liability.
c. Repair Parts/Wages Payable.
d. Both (a) and (b).
3. Lease A does not contain a bargain purchase option, but
the lease term is equal to 90 percent of the estimated
economic life of the leased property. Lease B does not
(SO 1)
(SO 1)
(SO 2)
transfer ownership of the property to the lessee by the end
of the lease term, but the lease term is equal to 75 percent
of the estimated economic life of the lease property. How
should the lessee classify these leases?
Lease A Lease B
a. Operating lease Capital lease
b. Operating lease Operating lease
c. Capital lease Capital lease
d. Capital lease Operating lease
4. Which of the following is not an additional fringe benefit?
a. Salaries.
b. Paid absences.
c. Paid vacations.
d. Postretirement pensions.
F10 Appendix F Other Significant Liabilities
(SO 3)
QUESTIONS
1. What is a contingent liability? Give an example of a con-
tingent liability that is usually recorded in the accounts.
2. Under what circumstances is a contingent liability dis-
closed only in the notes to the financial statements?
Under what circumstances is a contingent liability not
recorded in the accounts nor disclosed in the notes to
the financial statements?
3. (a) What is a lease agreement? (b) What are the two
most common types of leases? (c) Distinguish between
the two types of leases.
4. Orbison Company rents a warehouse on a month-to-
month basis for the storage of its excess inventory. The
company periodically must rent space when its production
greatly exceeds actual sales. What is the nature of this type
of lease agreement, and what accounting treatment should
be accorded it?
5. Costello Company entered into an agreement to lease
12 computers from Estes Electronics Inc. The present
value of the lease payments is $186,300. Assuming that
this is a capital lease, what entry would Costello Company
make on the date of the lease agreement?
6. Identify three additional types of fringe benefits associ-
ated with employees’ compensation.
7. Often during job interviews, the candidate asks the poten-
tial employer about the firm’s paid absences policy. What
are paid absences? How are they accounted for?
8. What are the two types of postretirement benefits?
During what years does the FASB advocate expensing the
employer’s costs of these postretirement benefits?
9. What basis of accounting for the employer’s cost of
postretirement health-care and life insurance benefits
has been used by most companies, and what basis does the
FASB advocate in the future? Explain the basic difference
between these methods in recognizing postretirement
benefit costs.
10. Identify the three parties in a pension plan. What role
does each party have in the plan?
11. Brenna Ottare and Caitlin Wilkes are reviewing pension
plans. They ask your help in distinguishing between a
defined-contribution plan and a defined-benefit plan.
Explain the principal difference to Brenna and Caitlin.
Go to the book’s website,
www.wiley.com/college/weygandt,
for Additional Self-Study questions.
BRIEF EXERCISES
BEF-1 On December 1, Vina Company introduces a new product that includes a 1-year war-
ranty on parts. In December 1,000 units are sold. Management believes that 5% of the units will
be defective and that the average warranty costs will be $60 per unit. Prepare the adjusting entry
at December 31 to accrue the estimated warranty cost.
BEF-2 Prepare the journal entries that the lessee should make to record the following
transactions.
1. The lessee makes a lease payment of $80,000 to the lessor in an operating lease transaction.
2. Zander Company leases a new building from Joel Construction, Inc. The present value of the
lease payments is $900,000. The lease qualifies as a capital lease.
BEF-3 In Alomar Company, employees are entitled to 1 day’s vacation for each month
worked. In January, 50 employees worked the full month. Record the vacation pay liability for
January assuming the average daily pay for each employee is $120.
Record estimated vacation
benefits.
(SO 3)
Prepare entries for operating
and capital leases.
(SO 2)
Prepare adjusting entry for
warranty costs.
(SO 1)
Exercises: Set B F11
EXERCISES
EF-1 Boone Company sells automatic can openers under a 75-day warranty for defective mer-
chandise. Based on past experience, Boone Company estimates that 3% of the units sold will
become defective during the warranty period. Management estimates that the average cost of
replacing or repairing a defective unit is $15. The units sold and units defective that occurred
during the last 2 months of 2006 are as follows.
Units Units Defective
Month Sold Prior to December 31
November 30,000 600
December 32,000 400
Instructions
(a) Determine the estimated warranty liability at December 31 for the units sold in November
and December.
(b) Prepare the journal entries to record the estimated liability for warranties and the costs (assume
actual costs of $15,000) incurred in honoring 1,000 warranty claims.
(c) Give the entry to record the honoring of 500 warranty contracts in January at an average cost
of $15.
EF-2 Larkin Online Company has the following liability accounts after posting adjusting
entries: Accounts Payable $63,000, Unearned Ticket Revenue $24,000, Estimated Warranty
Liability $18,000, Interest Payable $8,000, Mortgage Payable $120,000, Notes Payable $80,000,
and Sales Taxes Payable $10,000. Assume the company’s operating cycle is less than 1 year, ticket
revenue will be earned within 1 year, warranty costs are expected to be incurred within 1 year,
and the notes mature in 3 years.
Instructions
(a) Prepare the current liabilities section of the balance sheet, assuming $40,000 of the mortgage
is payable next year.
(b) Comment on Larkin Online Company’s liquidity, assuming total current assets are
$300,000.
EF-3 Presented below are two independent situations.
1. Speedy Car Rental leased a car to Rundgren Company for 1 year. Terms of the operating lease
agreement call for monthly payments of $500.
2. On January 1, 2008, Miles Inc. entered into an agreement to lease 20 computers from Halo
Electronics. The terms of the lease agreement require three annual rental payments of
$40,000 (including 10% interest) beginning December 31, 2008. The present value of the
three rental payments is $99,474. Miles considers this a capital lease.
Instructions
(a) Prepare the appropriate journal entry to be made by Rundgren Company for the first lease
payment.
(b) Prepare the journal entry to record the lease agreement on the books of Miles Inc. on
January 1, 2008.
EF-4 Bunill Company has two fringe benefit plans for its employees:
1. It grants employees 2 days’ vacation for each month worked. Ten employees worked the
entire month of March at an average daily wage of $80 per employee.
2. It has a defined contribution pension plan in which the company contributes 10% of
gross earnings. Gross earnings in March were $30,000. The payment to the pension fund has
not been made.
Instructions
Prepare the adjusting entries at March 31.
Record estimated liability and
expense for warranties.
(SO 1)
Prepare the current liabilities
section of the balance sheet.
(SO 1)
Prepare journal entries for op-
erating lease and capital lease.
(SO 2)
Prepare adjusting entries for
fringe benefits.
(SO 3)
EXERCISES: SET B
Visit the book’s website at www.wiley.com/college/weygandt, and choose the Student Companion
site, to access Exercise Set B.
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PF-1A On January 1, 2008, the ledger of Shumway Software Company contains the following
liability accounts.
Accounts Payable $42,500
Sales Taxes Payable 5,800
Unearned Service Revenue 15,000
During January the following selected transactions occurred.
Jan. 1 Borrowed $15,000 in cash from Amsterdam Bank on a 4-month, 8%, $15,000 note.
5 Sold merchandise for cash totaling $10,400 which includes 4% sales taxes.
12 Provided services for customers who had made advance payments of $9,000. (Credit
Service Revenue.)
14 Paid state treasurer’s department for sales taxes collected in December 2007 ($5,800).
20 Sold 700 units of a new product on credit at $52 per unit, plus 4% sales tax. This new
product is subject to a 1-year warranty.
25 Sold merchandise for cash totaling $12,480, which includes 4% sales taxes.
Instructions
(a) Journalize the January transactions.
(b) Journalize the adjusting entries at January 31 for (1) the outstanding notes payable, and (2)
estimated warranty liability, assuming warranty costs are expected to equal 5% of sales of
the new product.
(c) Prepare the current liabilities section of the balance sheet at January 31, 2008. Assume no
change in accounts payable.
PF-2A Presented below are three different lease transactions in which Ortiz Enterprises
engaged in 2008. Assume that all lease transactions start on January 1, 2008. In no case does Ortiz
receive title to the properties leased during or at the end of the lease term.
Lessor
Schoen Inc. Casey Co. Lester Inc.
Type of property Bulldozer Truck Furniture
Bargain purchase option None None None
Lease term 4 years 6 years 3 years
Estimated economic life 8 years 7 years 5 years
Yearly rental $13,000 $15,000 $4,000
Fair market value of leased
asset $80,000 $72,000 $27,500
Present value of the lease
rental payments $48,000 $62,000 $12,000
Instructions
(a) Identify the leases above as operating or capital leases. Explain.
(b) How should the lease transaction with Casey Co. be recorded on January 1, 2008?
(c) How should the lease transactions for Lester Inc. be recorded in 2008?
F12 Appendix F Other Significant Liabilities
PROBLEMS: SET A
Prepare current liability entries,
adjusting entries, and current
liabilities section.
(SO 1)
Analyze three different lease
situations and prepare journal
entries.
(SO 2)
PROBLEMS: SET B
PF-1B On January 1, 2008, the ledger of Zaur Company contains the following liability
accounts.
Accounts Payable $52,000
Sales Taxes Payable 7,700
Unearned Service Revenue 16,000
During January the following selected transactions occurred.
Jan. 5 Sold merchandise for cash totaling $17,280, which includes 8% sales taxes.
12 Provided services for customers who had made advance payments of $10,000.
(Credit Service Revenue.)
Prepare current liability entries,
adjusting entries, and current
liabilities section.
(SO 1)
14 Paid state revenue department for sales taxes collected in December 2007 ($7,700).
20 Sold 600 units of a new product on credit at $50 per unit, plus 8% sales tax. This new
product is subject to a 1-year warranty.
21 Borrowed $18,000 from UCLA Bank on a 3-month, 9%, $18,000 note.
25 Sold merchandise for cash totaling $12,420, which includes 8% sales taxes.
Instructions
(a) Journalize the January transactions.
(b) Journalize the adjusting entries at January 31 for (1) the outstanding notes payable, and (2)
estimated warranty liability, assuming warranty costs are expected to equal 7% of sales of
the new product. (Hint: Use one-third of a month for the UCLA Bank note.)
(c) Prepare the current liabilities section of the balance sheet at January 31, 2008. Assume no
change in accounts payable.
PF-2B Presented below are three different lease transactions that occurred for Milo Inc. in
2008. Assume that all lease contracts start on January 1, 2008. In no case does Milo receive title
to the properties leased during or at the end of the lease term.
Lessor
Gibson Delivery Eller Co. Louis Auto
Type of property Computer Delivery equipment Automobile
Yearly rental $ 8,000 $ 4,200 $ 3,700
Lease term 6 years 4 years 2 years
Estimated economic life 7 years 7 years 5 years
Fair market value of leased asset $44,000 $19,000 $11,000
Present value of the lease rental
payments $41,000 $13,000 $6,400
Bargain purchase option None None None
Instructions
(a) Which of the leases above are operating leases and which are capital leases? Explain.
(b) How should the lease transaction with Eller Co. be recorded in 2008?
(c) How should the lease transaction for Gibson Delivery be recorded on January 1, 2008?
Broadening Your Perspective F13
Analyze three different lease
situations and prepare journal
entries.
(SO 2)
PROBLEMS: SET C
Visit the book’s website at www.wiley.com/college/weygandt, and choose the Student
Companion site, to access Problem Set C.
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B R O A D E N I N G Y O U R P E R S P E C T I V E
FINANCIAL REPORTING AND ANALYSIS
Financial Reporting Problems
BYPF-1 Refer to the financial statements of PepsiCo and the Notes to Consolidated Financial
Statements in Appendix A to answer the following questions about contingent liabilities, lease
liabilities, and pension costs.
(a) Where does PepsiCo report its contingent liabilities?
(b) What is management’s opinion as to the ultimate effect of the “various claims and legal pro-
ceedings” pending against the company?
(c) Where did PepsiCo report the details of its lease obligations? What amount of rent expense
from operating leases did PepsiCo incur in 2005? What was PepsiCo’s total future minimum
annual rental commitment under noncancelable operating leases as of December 31, 2005?
(d) What type of employee pension plan does PepsiCo have?
(e) What is the amount of postretirement benefit expense (other than pensions) for 2005?
BYPF-2 Presented below is the lease portion of the notes to the financial statements of CF In-
dustries, Inc.
CF INDUSTRIES, INC.
Notes to the Financial Statements
Leases The present value of future minimum capital lease payments and the future minimum
lease payments under noncancelable operating leases at December 31, 2006, are:
(in millions)
Capital Lease Operating Lease
Payments Payments
2007 $ 7,733 $3,067
2008 6,791 2,052
2009 6,730 1,056
2010 6,788 918
2011 6,785 86
Thereafter 13,441 6
Future minimum lease payments 48,268 $7,185
Less: Equivalent interest 11,391
Present value 36,877
Less: Current portion 5,570
$31,307
Rent expense for operating leases was $7.0 million for the year ended December 31, 2006, $5.3
million for 2005, and $5.6 million for 2004.
Instructions
What type of leases does CF Industries, Inc. use? What is the amount of the current portion of
the capital lease obligation?
F14 Appendix F Other Significant Liabilities
CRITICAL THINKING
Decision Making Across the Organization
BYPF-3 Presented below is the condensed balance sheet for Express, Inc. as of December 31,
2008.
EXPRESS, INC.
Balance Sheet
December 31, 2008
Current assets $ 800,000 Current liabilities $1,200,000
Plant assets 1,600,000 Long-term liabilities 700,000
Common stock 400,000
Retained earnings 100,000
Total $2,400,000 Total $2,400,000
Express has decided that it needs to purchase a new crane for its operations. The new crane
costs $900,000 and has a useful life of 15 years. However, Express’s bank has refused to provide
any help in financing the purchase of the new equipment, even though Express is willing to pay
an above-market interest rate for the financing.
The chief financial officer for Express, Lisa Colder, has discussed with the manufacturer of
the crane the possibility of a lease agreement. After some negotiation, the crane manufacturer
agrees to lease the crane to Express under the following terms: length of the lease 7 years; pay-
ments $100,000 per year. The present value of the lease payments is $548,732.
The board of directors at Express is delighted with this new lease. They reason they have
the use of the crane for the next 7 years. In addition, Lisa Colder notes that this type of fi-
nancing is a good deal because it will keep debt off the balance sheet.
Instructions
With the class divided into groups, answer the following.
(a) Why do you think the bank decided not to lend money to Express, Inc.?
(b) How should this lease transaction be reported in the financial statements?
(c) What did Lisa Colder mean when she said “leasing will keep debt off the balance sheet”?
Answers to Self-Study Questions
1. d 2. d 3. c 4. a
Broadening Your Perspective F15
Chapter 9 Page 385: Jorg Greuel/AFP/Getty Images.
Page 388: Alice Millikan/iStockphoto. Page 394: Joe
Polillio/Getty Images, Inc. Page 397: Michael Braun/
iStockphoto. Page 402: Jamie Evans/iStockphoto.
Chapter 10 Page 425: David Trood/Getty Images, Inc. Page
429: iStockphoto. Page 438: AFP/Getty Images. Page 445: Andy
Lions/Photonica/Getty Images, Inc.
Chapter 11 Page 473: Cary Westfall/iStockphoto. Page 478:
Catherine dee Auvil/iStockphoto. Page 486: iStockphoto.
Page 494: Greg Nicholas/iStockphoto. Page 495: Corbis Stock
Market.
Chapter 12 Page 533: David Young-Wolf/PhotoEdit.
Page 537: Reuters NewMedia Inc/Corbis Images. Page 541:
Brandon Laufenberg/iStockphoto. Page 548: Alex Fevzer/Corbis
Images. Page 555 Tomasz Resiak/iStockphoto. Page 561: Arpad
Benedek/iStockphoto.
Chapter 13 Page 595: Warner Bros. David James/The
Kobal Collection, Ltd. Page 608: John Lamb/Stone/Getty
Images, Inc.
Chapter 14 Page 637: Rudi Von Briel/PhotoEdit. Page 641:
Elle Wagner and Lisa Gee/John Wiley & Sons. Page 644: Corbis
Digital Stock. Page 655: PhotoDisc, Inc./Getty Images.
Chapter 15 Page 697: Jeremy Edwards/iStockphoto.
Page 700. Don Wilkie/iStockphoto 700 Don Wilkie/iStockphoto.
Page 707: Nora Good/Masterfile. Page 715: Royalty-Free/Corbis
Images. Page 720: Martina Misar/iStockphoto. Page 724:
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Chapter 1 Page 3: Dinodia Images/Alamy Limited. Page 9:
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Chapter 2 Page 47: NBAE/Getty Images. Page 56: Koichi
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Chapter 3 Page 93: Witte Thomas E/Gamma Presse, Inc.
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Chapter 4 Page 143: Brian Bahr/Getty Images, Inc.
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Chapter 5 Page 195: Stone/Getty Images, Inc. Page 199:
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Chapter 6 Page 245: Pathaithai Chungyam/iStockphoto.
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PC-1
P H O T O C R E D I T S
A
ABC, 445
Ace Hardware, 271
Adelphia, 10
Advanced Micro, 540
AIG, 8
Alcatel-Alsthom, 298
Alliance Atlantis Communications Inc., 676
Altria Group, 470, 603, 634
Aluminum Company of America
(Alcoa), 581
Amazon.com, 560, 696
America Bank, 412
American Airlines, 102, 479
American Cancer Society, 534
American Eagle Outfitters, 350
American Express, 396, 473
American Standard, 707
America Online (AOL), 470, 595, 597
Anaheim Angels, 604
AOL Time Warner, 597
Apple Computer, 6, 115, 298, 443, 715
Arthur Andersen, 537
AT&T, 4, 603
Avis, 425, 431, 604
B
Babies “R” Us, 604
BankAmerica, 314
Bank of America, 11
Bank One Corporation, 70
Batten Ltd., 325–326
Baylor University, 514
Berkshire Hathaway, 470
Best Buy, 9, 104, 140
Bill and Melinda Gates Foundation, 29, 534
Black & Decker Manufacturing
Company, 255
Boeing Capital Corporation, 429
Boeing Company, 440, 470, 485, 552, 710
Boise Cascade, 434
Book-of-the-Month Club, 595
Breyer, 470
Bristol-Myers Squibb, 215, 255, 722
Budget, 425
C
Cadbury-Schweppes, 10
Campbell Soup Company, 255, 433, 707
Capital Cities/ABC, Inc., 604
Cargill Inc., 535
Caterpillar Inc., 244–246, 257, 480, 481, 535
Caterpillar Logistics Services, Inc., 245
Cendant Corp., 314, 604
Century 21, 604
Chase, 70
Chevron, 434
Cisco Systems, 155, 193, 289, 404, 470, 722
Citibank, 409
Citigroup, 11
CNN, 595
Coca-Cola Amatil Limited, B2
The Coca-Cola Company, 3, 5, 10, 11, 42, 43,
87, 100, 137, 163, 191, 215, 240, 243, 289, 333,
381, 421, 468, 470, 480, 528, 589, 618, 632, 692,
744, B1–B4
Coca-Cola Enterprises Inc., B2
Coca-Cola FEMSA, S.A. de C.V., B2
Coca-Cola Hellenic Bottling Company
S.A., B2
Coldwell Banker, 604
Columbia Sportswear Company, 676
Computer Associates International, 106
ConAgra Foods, 212
Consolidated Edison, 711
Continental Bank, 429
Costco Wholesale Corp., 641, D1
Craig Consumer Electronics, 249
Crane Company, 551
Cypress Semiconductor Corporation, 676
D
DaimlerChrysler Corporation, 296, 491
Dairy Queen, 470
DeKalb Genetics Corporation, 626
Dell Computer, 60, 247, 298, 605
Dell Financial Services, 429
Delta Air Lines, 23, 45, 95, 102, 440
Discover, 395
Disney Company, see The Walt Disney
Company
Disneyland, 604
DisneyWorld, 604
Dun & Bradstreet, 309, 699
Dunkin’ Donuts, 23, 45
DuPont, 484, 485
Dynegy, Inc., 644, 694
E
EarthLink, 552
Eastman Kodak Company, 346, 363, 606, 638
eBay, 357
Enron, 8, 29, 213, 301, 314, 340, 537, 591,
722, 746
ESPN, 445, 470, 604
Estée Lauder Companies, Inc., 724–725
ExxonMobil, 11, 296, 298, 470, 547
F
Fannie Mae, 70, 108
Fidelity Investments, 47, 48
First National Bank, 12
Florida Citrus Company, 718
Ford Motor Company, 4, 11, 198, 258, 296,
532–536, 547
Frito-Lay, 315, A9, A10, A12, A13
G
GE, see General Electric
General Dynamics, 745
General Electric (GE), 7, 10, 204, 213, 298, 301,
341, 470, 535, 597
General Mills, 433
General Motors (GM), 6–7, 11, 194, 296, 302,
410, 538, 650, 695, 721, 728
Global Crossing, 301, 340
GM, see General Motors
Goldman Sachs, 11
Google, 29, 534, 540
Gulf Oil, 538
H
Harley-Davidson, 215
Harold’s Club, 301, 335
HBO, 595
HealthSouth, 8
Hershey Foods Corp., 552
Hertz, 425, F3
Hewlett-Packard, 298
Hilton, 429
Home Depot, 4, 247, 271, 428
Howard Johnson, 604
I
IBM, 71, 213, 242, 298, 535, 539n.2
Imaginarium, 604
Intel Corporation, 325, 535, 555, 560
InterContinental, 429
International Harvester, 3
IT&T, 2
J
J. Crew, 350
J.C. Penney Company, Inc., 349, 387, 412–413,
641, 698–700, 704–715
John Deere Capital Corporation, 429
Johnson & Johnson, 310, 325
J.P. Morgan Leasing, 429
K
Kellogg Company, 12, 29, 495, 560, 565, 566
Kids “R” Us, 604
Kmart, 196, 310, 699, 710, 717
Kodak, see Eastman Kodak Company
Kohl’s Corporation, 641
KPMG LLP, A27, A29
Kraft Foods, Inc., 597, 603, 634
Krispy Kreme Doughnuts, 215
Kroger Stores, 198, 255, 310, 710, 711
K2, Inc., 164
L
Leslie Fay Cos., 248, 290
The Limited, 296
Limited Brands, 100
Little, Brown & Co., 595
L.L. Bean, 296
Lockheed Martin Corporation, 155, 440, 561
Long Beach City College, 334
Lotus, 71
Lucent Technologies, 314
M
McDonald’s Corporation, 11, 443, 455, 470,
493, 534
McKesson Corporation, 196, 290
Major League Baseball Players Association, 7
Marriott, 429, 433
Marshall Farms, 626
Massachusetts General Hospital, 11
MasterCard, 395–397, 412, 416
Merck, 310
Merrill Lynch, 11
Microsoft Corporation, 6, 11, 56, 89, 204, 295,
302, 443, 470, 547, 555, 636–637, 655, 728
Mighty Ducks, 604
Minnesota Mining and Manufacturing Company,
see 3M
Mitsubishi Motors, 402, 423
Moody’s, 529, 699
Morgan Stanley, 608
Morrow Snowboards, Inc., 199
Motorola, 255, 325, 720
N
NationsBank, 314
NBC, 470
New York Stock Exchange, 609
Nike, Inc., 4, 100, 542, 552, 553, 558, 705–706
Nordstrom, Inc., 166, 397, 423, 732–733
Nortel Networks, 394, 715
North American Van Lines, 542
Northern Virginia Community College, 11
Northwest Airlines, 94, 166
C O M PA N Y I N D E X
I-1
O
Office Depot, 196
Oracle Corporation, 655
Owens-Illinois, 446, 447
P
PACE Membership Warehouse, 717
PayLess Drug Stores Northwest, 717
PayPal, 357
PepsiAmericas, A20
Pepsi Bottling Group, A19–A20, A22, A23
PepsiCo, Inc., 3–6, 10, 13, 42–43, 45, 53, 86–87,
90, 95, 100, 104, 137, 140, 168, 190–191, 193,
213, 214, 239–240, 243, 257, 258, 288–289, 291,
298, 315, 333, 336, 365, 380–381, 383, 394, 421,
423, 430, 468, 471, 480, 481, 492, 528, 531, 534,
541, 546, 550, 551, 559, 565, 588–589, 592,
604, 632, 635, 642, 692, 695, 743–744, 747,
A1–A30, F13
PepsiCo Beverages North America, A9, A10,
A12, A13
PepsiCo International, A9, A10, A12, A13
Pfizer, 310
P&G, see Procter & Gamble Company
Philip Morris, 470, 597, 603
Pizza Hut, 470
Planet Hollywood, 514
PNC Financial Services Group Inc., 567
Policy Management Systems, 292
Procter & Gamble Company (P&G), 11, 446,
447, 470, 542, 720
Prudential Real Estate, 11
Q
Quaker, A24
Quaker Foods, 257, A9, A10, A12, A13, A30
Qualcomm, 538
Qwest, 310
R
Radio Shack, 71, 90
Ramada Inn, 604
Red Cross, 29
Reebok International Ltd., 255, 541, 548
Regions Financial Corp., 567
Rent-A-Wreck, 425–428, 431, 433, 443, 445,
448, 470
Rent-Way Inc., 293
Republic Carloading, 160
Reynolds Company, 653–654
Rhino Foods, Inc., 142–144
Robert Half and Co., 30
Royal Dutch/Shell Group, 442, 445
S
Safeway, 310, 710
Salvation Army, 534
SAM’S CLUB, 261
Samsung Electronics Co., 262, 291
Sears, Roebuck, and Company, 195, 349, 387
Sears Holdings, 296
Shell, see Royal Dutch/Shell Group
Snack Ventures Europe, A5
Southern Company, 325
Sports Illustrated, 479
Springfield ReManufacturing Corporation, 2–4
Standard & Poor’s, 699
Starbucks, 29, 255, 695
Stephanie’s Gourmet Coffee and More,
338–341, 344, 345
Sunbeam Corporation, 243, 292–293
Sunset Books, 595
SunTrust Banks Inc., 346
T
Taco Bell, 445, 470
Target Corporation, 196, 247, 355, 641, 739
Tektronix Inc., 561
Texaco Oil Company, 409
3M Company, 411, 518
Tiffany & Co., 710
Time-Life Books, 595
Time Warner, Inc., 7, 164, 298, 470, 547,
594–597, 601, 603
TNT, 595
Toys “R” Us, Inc., 325, 346, 604
Trek, 11
True Value Hardware, 247
Turner Broadcasting, 597, 601, 603
Twentieth Century Fox, 96
Tyco, 340
U
U.S. Olympic Committee, 71
United Airlines, 7, 102, 479, 638
United Stationers, 196
USAir, 491
US Bancorp Equipment Finance, 429
USX Corp., 491
V
Veritas Software, 71
Verizon Communications, 310
Visa, 395–397, 406, 409, 411, 413, 419
W
Walgreen Drugs, 196, 255
Wall Street Journal, 8, 537, 541
Wal-Mart Stores, Inc., 11, 58, 90, 194–196, 199,
200, 204, 247, 248, 261–262, 271, 291, 310, 349,
355, 555, 641, 710, 739, A11
The Walt Disney Company, 7, 23, 45, 95, 295,
470, 560, 603, 604
Warner Bros., 595
Waste Management Company, 70
Wells Fargo Bank, 340
Wendy’s International, 255, 470
Weyerhaeuser Co., 718
Whirlpool, 707
Whitehall-Robins, 384–385, 393
WorldCom, Inc., 8, 29, 93, 301, 314, 340, 438,
470, 644, 694, 722
X
Xerox, 93
Y
Yahoo! Inc., 163, 696, F3
Yale Express, 160, 193
YUM! Brands, 470, A22
I-2 Company Index
A
Absences, paid, F6
Accelerated-depreciation method, 435
Account(s), 48–53
chart of, 60–61
control, E1–E2
T, 48
three-column form of, 58
Accounting:
basic activities of, 4–5
career opportunities in, 29–30
Accounting cycle:
optional steps in, 162–164
required steps in, 161–162
Accounting cycle tutorial
adjusting entries, 97
preparing financial statements and closing
the books, 148
recording process, 61
Accounting data, users of, 6–7
Accounting principle, changes in, 720
Accounts payable subsidiary ledger, E1
Accounts receivable, 386–398
defined, 386
disposing of, 395–398
recognizing, 387
types of, 386
valuing, 388–395
Accounts receivable subsidiary ledger, E1
Accounts receivable turnover ratio,
403–404. See also Receivables turnover
Accruals, adjusting entries for, 97, 105–110
expenses, accrued, 106–109
revenues, accrued, 105–106
Accrual-basis accounting, cash-basis vs., 95
Accrued expenses, 106–109
Accrued interest, 107–108
Accrued revenues, 105–106
Acid-test (quick) ratio, 707–708
Additional paid-in capital, 564
Additions and improvements, 438
Adjustable-rate mortgages, 493
Adjusted trial balance:
preparation of, 112
preparing financial statements from,
113–114, 116
Adjusting entries, 97–111
for accruals, 105–110
expenses, accrued, 106–109
revenues, accrued, 105–106
classes of, 97–98
for deferrals, 98–105
prepaid expenses, 98–102
unearned revenues, 102–103
example of journalizing/posting, 110–111
for merchandising operations, 207
preparing, from worksheets, 148, 150, 152, 154
purpose of, 97
Administrative expenses, 211
Affiliated (subsidiary) company, 602
Agents:
collection, 476
of corporations, 535
Aging schedule, 393
Aging the accounts receivable, 393
Allowance for Doubtful Accounts, 390, 393
Allowance method, 389–394
Alternative accounting methods, 721–722
Amortization, 443
of bonds, 506–513
straight-line method, 509–513
Annual report(s), 71, A1
Annuity(-ies):
defined, C5, C10
future value of an, C5–C7
present value of an, 502–503, C10–C12, C16
Assets, 12
depreciable, 431
in double-entry system, 49
return on, 311, 711
Asset turnover ratio, 446–447, 710–711
Assumptions, accounting, 9–11, 298–299
Auditing, as area of public accounting, 29
Auditors, internal, 345–346
Authorized stock, 540
Auto loans, calculating, C17
Available-for-sale securities, 605, 607–608
Averages, industry, 699
Average collection period, 404
Average-cost method, 254–255, 267–268
B
Bad Debts Expense, 388, 391
Balance sheet, 21–23. See also Classified
balance sheet
consolidated, 615–618
effects of cost flow methods on, 257
effects of inventory errors on, 260–261
horizontal analysis of, 700–701
investments on, 608–609
stockholders’ equity section of, 564–565
vertical analysis of, 703
Bank(s), 355–362
deposits to, 355
and writing checks, 355–357
Bank accounts, reconciling, 359–362
Banking, investment, 540
Bank reconciliation, 355, 359–362
entries from, 361–362
example of, 360–361
procedure for, 359–360
Bank service charges, 357
Bank statements, 357–358
Basic accounting equation, 11–13
expansion of, 52–53
using, 14–20
Bearer (coupon) bonds, 484
Best-efforts contracts, 540n.3
Blank, Arthur, 4
Bond(s), 482–492, 500–513
amortization of, 506–513
effective-interest method, 506–509
straight-line method, 509–513
bearer, 484
callable, 484
conversion of, to common stock, 491–492
defined, 482
determining market value of, 486
discounting of, 487–488, 503–504
issuance of:
accounting for, 487–490
at discount, 488–489
at face value, 487
at premium, 489–490
procedures for, 484
premiums on, 487–488
present value of, 504–505
and present value of annuity, 502–503
present value of face value of, 500–502
pricing of, 500–505
recording acquisition of, 598
recording interest from, 598
recording sale of, 598–599
redemption of:
at maturity, 491
before maturity, 491
registered, 484
retirement of, 489–492
secured, 483
trading of, 484–485
Bond discount, 488–489
amortization of, 506–508, 510–511
defined, 488
Bonding, 346
Bond premium, 489–490
amortization of, 508–509, 511–513
defined, 488
Bonuses, D4
Bookkeeping, 5
Book value, 102, 431
Book value per share, 571–572
Buildings, 428
Business documents, 54, 203
By-laws, 538
C
Calculator, using a, C16–C17
Calendar year, 95
Callable bonds, 484
Canceled checks, 357
Capital, 305
ability of corporations to acquire, 535
corporate, 542
paid-in, 542
working, 309–310, 481, 707
Capital expenditures, 438
Capital leases, F4–F5
Capital stock, 564
Careers, accounting, 29–30
Carrying (book) value:
of convertible bonds, 491–492
defined, 489
Carrying (book) value method, 492
Cash:
defined, 348
net change in:
direct method, 671
indirect method, 652–654
reporting, 363, 365–366
restricted, 363
Cash-basis accounting, accrual-basis vs., 95
Cash controls, 347–355
disbursements, 351–355
receipts, 348–351
Cash disbursements journal, see Cash
payments journal
Cash dividends, 51, 552–555
Cash equivalents, 363
Cash flow(s):
classification of, 639–640
free, 654–655
statement of, see Statement of cash flows
Cash payments journal, E13–E15
Cash (net) realizable value, 389, 400
Cash receipts journal, E7–E11
Cash register tapes, 203
Cash sales, credit card sales as, 396–397
Castle, Ted, 142–143
CEO (chief executive officer), 536
Certified public accountants (CPAs), 29
Changes in accounting principle, 720
Channel stuffing, 215, 722
Charter, 538
S U B J E C T I N D E X
I-3
Chart of accounts, 60–61
Check(s):
canceled, 357
outstanding, 359
paying payroll via, D4
writing, 355–357
Check register, 352
Chief executive officer (CEO), 536
Classified balance sheet, 161–166, 168–170,
305–306
current assets on, 162–163
current liabilities on, 165–166
examples of, 168–170
intangible assets on, 164
long-term investments on, 163
long-term liabilities on, 166
for merchandising operations, 213, 214
property, plant, and equipment on, 164
stockholders’ equity on, 166
valuing/reporting of investments on, 610–611
Classified financial statements, 305–308
Classified income statement, 306–308
Closing entries:
for merchandising operations, 207
posting of, 153–154, 157–158
preparation of, 151–153, 155–157
Closing the books, 154–161
defined, 154
and posting of closing entries, 157–158
and preparation of closing entries, 155–157
and preparation of post-closing trial balance,
159–161
Collection agents, 476
Collection period, average, 404
Collusion, 347
Common stock, 50, 538–546
cash dividend allocation, 554, 555
issuance of, 540–546
and owners’ equity, 542–543
and ownership rights of stockholders, 538–539
par-value vs. no-par-value, 544–546
for services or noncash assets, 545–546
Common stockholders’ equity, return on, 311,
566, 711–712
Comparability of accounting information, 296
Comparative analysis, 698–699
Compensating balances, 363
Compound entries, 55–56
Compound interest, C2–C3
Comprehensive income, 610, 720
Computer controls, 344
Conceptual framework, 295
Conservatism, 258, 304
Consigned goods, 249
Consistency, of accounting information, 296
Consistency principle, 257–258
Consolidated balance sheet, 615–618
Consolidated income statement, 618
Constraints, accounting, 303–304
Consumerism, 194, 195
Consumption, 194–195
Contingent liabilities, F1–F3
Continuous life (of corporation), 536
Contra asset accounts, 101, 488
Contracts, best-efforts, 540n.3
Contractual interest rate, 484, 488
Contra-revenue accounts, 204
Contra stockholders’ equity account, 547–548
Controls, internal, see Internal control(s)
Control accounts, E1–E2
Controller, 536
Controlling interest, 603
Convertible bonds, 484, 491–492
Copyrights, 444
Corporate capital, 542
Corporation(s), 532–543
book value per share of, 571–572
characteristics of, 535–537
classification of, 534–535
defined, 10, 534
formation of, 538
issuance of stock by, 540–542
owners’ equity in, 542–543
ownership of, 538–539
Correcting entries, 158–160
Cost(s):
depreciable, 432
expired/unexpired, 300
organization, 538
of plant assets, 427–430
research and development, 446
Cost flow assumptions, 251–255, 266–269
Cost method:
and stock investments, 600
for valuation of treasury stock, 547
Cost of goods sold:
defined, 196
determining, under periodic system, 216–218
and matching principle, 300
Cost principle, 302, 598
Coupon (bearer) bonds, 484
CPAs (certified public accountants), 29
Credit, 49
Credit cards:
sales via, 396–397
using, 405
Credit memoranda, 358
Creditors, long- vs. short-term, 698
Creditors’ subsidiary ledger, E1
Credit sales, journalizing, E5
Credit terms, 201–202
Cumulative dividend, 551–552
Current assets:
on classified balance sheet, 162–163
and current liabilities, 474
Current liabilities, 474–482
changes in, 649
on classified balance sheet, 165–166
and current assets, 474
defined, 474
long-term debt, current maturities of, 479–480
notes payable, 475–476
payroll and payroll taxes payable, 476–478
sales taxes payable, 476
statement presentation/analysis of, 480–482
unearned revenues, 479
Current maturities of long-term debt, 479–480
Current ratio, 309, 706–707
Current replacement cost, 258
Customers’ subsidiary ledger, E1
D
Days in inventory, 262
Debenture bonds, 484
Debit, 49
Debit memoranda, 357
Debt investments, 597–598
Debt to total assets ratio, 311–312, 495, 714–715
Declaration date, 553
Declining-balance method, 434–435
Deferrals, adjusting entries for, 97–105
prepaid expenses, 98–102
unearned revenues, 102–103
Deficits, 560
Defined-benefit plans, F8
Defined-contribution plans, F8
Depletion, 442
Deposits, bank, 355
Deposits in transit, 359
Depreciable assets, 431
Depreciable cost, 432
Depreciation:
declining-balance method of, 434–435
defined, 101, 430
of plant assets, 430–438
computation, 431–432
and income taxes, 436
methods, 432–436
revisions in estimate of, 436–437
as prepaid expense, 101
straight-line method of, 432–433
units-of-activity method of, 433–434
Depreciation expense, 646–647
Direct method (of preparing statement of cash
flows), 644, 665–671
investing/financing activities, 670–671
net change in cash, 671
operating activities, cash provided/used by,
666–670
Direct write-off method, 388–389
Disbursements, cash, 351–355
and EFT system, 352–353
and petty cash fund, 353–355
and voucher system, 351–352
Discontinued operations, 717–718
Discount(s):
bonds issued at, 488–489, 506–508, 510–511
purchase, 201–202
sales, 205
Discounting the future amount, C7, C12
Discount period, 202
Dishonored notes, 401–402
Disposal:
of accounts receivable, 395–398
of notes receivable, 401–402
of plant assets, 439–441
retirement, 439–440
sale, 440–441
of treasury stock, 548–550
Dividend(s), 51, 558
cash, 552–555
cumulative, 551–552
defined, 13, 552
preferred, 712
stock, 556–558
stock splits, 558–559
Dividends in arrears, 551–552
Documentation procedures, 344
Double-declining-balance method, 435
Double-entry system, 49
Dunlap, “Chainsaw” Al, 292–293
Duties, segregation of, 342–343
E
Earnings:
gross, D4
statement of, D10
Earning power, 717
Earnings management, 300
Earnings per share (EPS), 307–308, 712–713
Economic entity assumption, 10
Effective-interest amortization method,
506–509
EFT, see Electronic funds transfers
Egypt, ancient, 343
Electronic controls, 344, 345
Electronic funds transfers (EFT), 352–353
Employee earnings record, D8
Employee fringe benefits, liabilities for, F5–F8
Employee Retirement Income Security Act
(ERISA), F7
Employees:
bonding of, 346
hiring of, D2
Employee’s Withholding Allowance Certificate
(W-4), D6
The End of Work (Jeremy Rifkin), 194
Endorsements, restrictive, 350
Environmental liabilities, 115
EPS, see Earnings per share
Equipment, 428–429, 647
I-4 Subject Index
Equity:
stockholders’, 12–13
trading on the, 712
Equity method, 601–602
ERISA (Employee Retirement Income
Security Act), F7
Errors:
on bank statements, 359–360
in inventory, 259–261
balance sheet effects, 260–261
income statement effects, 259–260
Ethics:
in financial reporting, 8–9
in personal financial reporting, 25
Exchange of intangible assets, 452–454
gain treatment, 453–454
loss treatment, 452–453
Expense(s), 51
accrued, 106–109
administrative, 211
defined, 13
operating, 210–211
prepaid, 98–102, 118–119
selling, 211
Expired costs, 300
External transactions, 14
External users of accounting data, 6
Extraordinary operations, 718–720
F
Face value, 488
of bonds, 484, 487
of notes receivable, 400
present value of, 500–502
Factors, 395–396
FAFSA form, 25
Fair value, 605–607
FASB, see Financial Accounting Standards
Board
Federal Bureau of Investigation (FBI), 4
Federal Insurance Contribution Act (FICA), D5
Federal unemployment taxes, D11–D12
Federal Unemployment Tax Act (FUTA), D11
FICA (Federal Insurance Contribution
Act), D5
FICA taxes:
employer contribution for, D11
payroll deduction for, D5–D6
FIFO method, see First-in, first-out method
Financial accounting, database concept of, 302
Financial Accounting Standards Board
(FASB), 9, 294–295, 297, 313
Financial calculator, using a, C16–C17
Financial statement presentation and analysis:
of intangible assets, 446–447
Financial statements, 5, 21–24, 294
analysis of, 308–312, 698–726
classified, 305–308
for Coca-Cola Company, B1–B4
current liabilities on, 480–482
and determination of earning power, 717
elements of, 297
and global economy, 312–313
horizontal analysis of, 699–703
inventories on:
cost flow methods, 255–257
presentation and analysis, 261–262, 264
irregular items on, 717–720
long-term liabilities on, 494–495, 497–498
for merchandising operations, 209–214
classified balance sheet, 213, 214
multiple-step income statement, 209–213
single-step income statement, 213, 214
operating guidelines for preparation of, 297
for PepsiCo, Inc., A1–A30
preparing, from adjusted trial balance,
113–114, 116
preparing, from worksheets, 148, 152, 153
and quality of earnings, 721–722, 724–726
ratio analysis of, 705–717
receivables on, 403–404
retained earnings on, 564–566
retained earnings statement, 562–563
tools for, 699
vertical analysis of, 703–705
Financing activities, cash inflow/outflow from,
639, 640
direct method, 670–671
indirect method, 651–652
Finished goods inventory, 246
First-in, first-out (FIFO) method, 252–253, 266
Fiscal year, 95
Fixed assets, 426. See also Plant assets
Fixed-rate mortgages, 493
FOB (free on board), 200, 248
FOB destination, 200, 248, 249
FOB shipping point, 200, 248, 249
Ford, Henry, 533–534
“For Deposit Only,” 350
Forensic accounting, 30
Form W-2 (Wage and Tax Statement), D13–D14
Form W-4 (Employee’s Withholding Allowance
Certificate), D6
Franchises, 445
Free Application for Federal Student Aid
(FAFSA) form, 25
Free cash flow, 654–655
Free on board (FOB), 200, 248
Freight costs, 200–201
Fringe benefits, liabilities for, F5–F8
Full disclosure principle, 301, F3
FUTA (Federal Unemployment Tax Act), D11
Future value, C3–C7
of an annuity, C5–C7
of a single amount, C3–C5
G
GAAP, see Generally accepted accounting
principles
Geneen, Harold, 2
General journal, 54, E16–E17
General ledger (ledger), 57–61
Generally accepted accounting principles
(GAAP), 9, 294
and allowance method, 389
and alternative accounting methods,
721, 722
and cash-basis accounting, 95
and materiality, 303
Global economy, and financial statement
presentation, 312–313
Going concern assumption, 298–299, 431
Goods in transit, 248–249
Goodwill, 445–446
Government, accounting career opportunities
in, 30
Government regulation, of corporations, 537
Gross earnings, D4
Gross profit, 210
Gross profit method (for estimating
inventories), 270–271
Gross profit rate, 210
H
Health insurance, cost of, 496
Held-to-maturity securities, 605
Hiring employees, D2
Home-equity loans, 567
Honor (of notes receivable), 401
Horizontal analysis, 699–703
of balance sheet, 700–701
of income statement, 701–702
of retained earnings statement, 702–703
Human resources (HR), 344, D2
I
IASB, see International Accounting Standards
Board
Identity theft, 364
Imprest system, 353
Improper recognition, 722
Improvements:
additions and, 438
land, 427–428
Income:
comprehensive, 610, 720
pro forma, 722
Income statement, 21, 22
classified, 306–308
consolidated, 618
effects of cost flow methods on, 255–257
effects of inventory errors on, 259–260
horizontal analysis of, 701–702
for merchandising operations, 209–214
multiple-step income statement, 209–213
single-step income statement, 213, 214
vertical analysis of, 703–705
Income taxes (income taxation):
on classified income statement, 306–307
of corporations, 537
and depreciation of plant assets, 436
effects of cost flow methods on, 257
payroll deduction for, D6
remitting, D13
Independent internal verification, 344–346
Indirect method (of preparing statement of
cash flows), 643–654
investing/financing activities, 651–652
net change in cash, 652–654
operating activities, cash provided/used by,
646–650
worksheets, using, 659–664
Industry averages (norms), 699
Information, accounting, 295–297
Insurance, as prepaid expense, 100
Intangible assets, 443–447
accounting for, 443–446
amortization of, 443
on classified balance sheet, 164
copyrights, 444
exchange of, 452–454
gain treatment, 453–454
loss treatment, 452–453
franchises and licenses, 445
goodwill, 445–446
patents, 444
research and development costs, 446
statement presentation/analyis of, 446–447
trademarks and trade names, 444
Intercompany comparisons, 699
Intercompany eliminations, 615, 616, 618
Intercompany transactions, 615, 618
Interest, C1–C3
accrued, 107–108
on checking accounts, 358
compound, C2–C3
defined, C1
on notes receivable, 400
simple, C1–C2
Interest rate, C1
Interim periods, 95
Internal auditors, 345–346
Internal control(s), 340–347
defined, 340
and documentation procedures, 344
and establishment of responsibility, 341, 342
and independent internal verification, 344–346
limitations of, 346–347
for payroll, D1–D4
physical/mechanical/electronic controls, 344, 345
and Sarbanes-Oxley Act, 341
and segregation of duties, 342–343
Subject Index I-5
Internal Revenue Service (IRS), 436
Internal transactions, 14
Internal users of accounting data, 6
International Accounting Standards Board
(IASB), 9, 313
Intracompany comparisons, 699
Inventory(-ies), 244–272
classification of, 246–247
costing of:
average-cost method for, 254–255,
267–268
balance sheet effects, 257
and consistency principle, 257
and cost flow assumption, 251–252
FIFO method for, 252–253, 266
financial statement effects, 255–257
LIFO method for, 253–254, 267
lower-of-cost-or-market method for, 258
and quality of earnings, 721
specific identification method for, 250–251
tax effects, 257
days in, 262
determining quantities of, 247–249
and ownership of goods, 248–249
physical inventory, 247–248
errors in, 259–261
balance sheet effects, 260–261
income statement effects, 259–260
estimating, 269–272
gross profit method for, 270–271
retail inventory method for, 271–272
finished goods, 246
just-in-time, 247
in merchandising operations, 197–199,
219–222
periodic inventory system, 198
perpetual inventory systems, 197–198,
219–222, 266–269
statement presentation and analysis of,
261–262, 264
taking, 247–248
theft of, 263
Inventory turnover, 261–262, 709–710
Investee, 600
Investing activities, cash inflow/outflow from,
639, 640
direct method, 670–671
indirect method, 651–652
Investments, 594–614
debt, 598–599
purchase of, by corporations, 596–597
short- vs. long-term, 608–609
stock, 600–605
between 20% and 50%, holdings, 601–602
less than 20%, holdings of, 600–601
more than 50%, holdings of, 602–603
valuing/reporting of, 605–611, 613
available-for-sale securities, 607–608
on balance sheet, 608–609
on classified balance sheet, 610–611
realized/unrealized gain/loss presentation,
609–610, 613
trading securities, 605–607
Investment banking, 540
Investment portfolio, 600
Investments, long-term, see Long-term
investments
Invoice(s):
purchase, 199, 200
sales, 203
Irregular items, 717–720
changes in accounting principle, 720
comprehensive income, 720
discontinued operations, 717–718
extraordinary operations, 718–720
IRS (Internal Revenue Service), 436
J
JIT (just-in-time) inventory, 247
Johnson, Matthew, 715
Journal, 54–57
Journalizing, 54–55, 67–68, 110–111
Just-in-time (JIT) inventory, 247
K
Knight, Phil, 4
L
Land, 427
Land improvements, 427–428
Large stock dividend, 556
Last-in, first-out (LIFO) method, 253–254, 267
LCM (lower-of-cost-or-market), 258
Leases, F3–F5
capital, F4–F5
operating, F3–F4
Lease liabilities, F3–F5
Ledger, see General ledger
Legal capital, 541
Letter to the stockholders, A2–A3
Leverage, 712
Leveraging, 712
Liabilities, 12, 472–499
contingent, F1–F3
current, 474–482
long-term debt, current maturities of,
479–480
notes payable, 475–476
payroll and payroll taxes payable, 476–478
sales taxes payable, 476
statement presentation/analysis of, 480–482
unearned revenues, 479
in double-entry system, 49
for employee fringe benefits, F5–F8
environmental, 115
lease, F3–F5
long-term, 482–495, 497–498
bonds, 482–492, 500–513
notes payable, long-term, 492–493
statement presentation/analysis of, 494–495,
497–498
Licenses, 445
LIFO conformity rule, 257
LIFO method, see Last-in, first-out method
Limited liability, of corporate stockholders, 535
Liquidating dividend, 553
Liquidation preference, 552
Liquidity, 309–310, 481
Liquidity ratios, 706–710
acid-test ratio, 707–708
current ratio, 706–707
inventory turnover, 709–710
receivables turnover, 708–709
Long-term debt, current maturities of, 479–480
Long-term debt due within one year, 480
Long-term investments, 163, 608, 609
Long-term liabilities, 482–495, 497–498
bonds, 482–492, 500–513
on classified balance sheet, 166
notes payable, long-term, 492–493
postretirement benefits as, F8
present value of, C12–C15
statement presentation/analysis of, 494–495,
497–498
Long-term notes payable, 492–493
Lower-of-cost-or-market (LCM), 258
Lucas, George, 96
M
MACRS (Modified Accelerated Cost
Recovery System), 436
Mail receipts, 350–351
Maker, 398
Management (of corporation), 536
Management consulting, as area of public
accounting, 29
Management’s discussion and analysis
(MD&A), A3
Managerial accounting, 6, 29
Market interest rate, 486, 488
Market value:
book value vs., 102, 572
of stock, 541
Marshall, John, 534
Matching principle, 95–96, 300
Materiality (materiality principle), 303, 438
Maturity date (of promissory note), 399
MD&A (management’s discussion and
analysis), A3
Mechanical controls, 344, 345
Medicare, D5n.1
Merchandising operations, 194–224
completing the accounting cycle for,
206–208
adjusting entries, 207
closing entries, 207
cost of goods sold in, 216–218
financial statements for, 209–214
classified balance sheet, 213, 214
multiple-step income statement, 209–213
single-step income statement, 213, 214
inventory systems in, 197–199
periodic system, 198
perpetual system, 197–198, 219–222
operating cycles in, 196–197
recording purchases of merchandise in,
199–203
freight costs, 200–201
purchase discounts, 201–202
purchase returns and allowances, 201
recording sales of merchandise in,
203–205
sales discounts, 205
sales returns and allowances, 204–205
Merchandising profit, 210
Mintenko, Stephanie, 338–339
MNCs (multinational corporations), 312
Modified Accelerated Cost Recovery System
(MACRS), 436
Monetary unit assumption, 10, 298
Mortgage bonds, 483
Mortgage loans, calculating, C17
Mortgage notes payable, 493
Multinational corporations (MNCs), 312
Multiple-step income statement, 209–213
N
Natural resources, 442–443
Net change in cash:
direct method, 671
indirect method, 652–654
Net pay, D7
Net (cash) realizable value, 389, 400
Net sales, 209–210
Net worth, 167
Noncash activities, significant, 640–641
Noncash current assets, changes in, 647–648
Nonoperating activities, 211–213
No-par-value stock, 542, 544–545
Norms, industry, 699
Normal balance, 50
Notes payable, 475–476
Notes receivable, 398–403
computing interest for, 400
defined, 386
disposing of, 401–402
maturity date of, 399
recognizing, 400
valuing, 400–401
Not-for-profit corporations, 534
NSF (not sufficient funds), 358
I-6 Subject Index
O
Obsolescence, 431
Off-balance-sheet financing, F5
“Open-book management,” 3
Operating activities, cash inflow/outflow from,
639, 640
direct method, 666–670
indirect method, 646–650
Operating cycles, in merchandising operations,
196–197
Operating expenses, 210–211, 300
Operating leases, F3–F4
Ordinary repairs, 438
Organization costs, 538
“Other expenses and losses,” 211
Other receivables, 386
“Other revenues and gains,” 211
Outstanding checks, 359
Outstanding stock, 548
Over-the counter receipts, 349–350
P
Paid absences, F6
Paid-in capital, 542, 564
Paper (phantom) profit, 256
Parent company, 602–603
Partnerships, 10
Par-value stock, 541, 544, 546
Passwords, computer, 344
Patents, 444
Payee, 398
Payment date (dividends), 554
Payout ratio, 713–714
Payroll, D1–D15
defined, D1
determining, D4–D7
internal control of, D1–D4
recording, D8–D10
Payroll and payroll taxes payable, 476–478
Payroll deductions, D5–D7
for FICA taxes, D5
for income taxes, D6
Payroll register, D8–D9
Payroll taxes, 476, D11–D15
federal unemployment taxes, D11–D12
FICA, D11
filing/remitting, D13–D15
recording, D12–D13
state unemployment taxes, D12
PCAOB (Public Company Accounting
Oversight Board), 341
Pension plans, F7–F8
P-E ratio, see Price-earnings ratio
Percentage-of-receivables basis, 393–394
Percentage-of-sales basis, 392–393
Periodic inventory system, 198, 219–222
merchandise purchases in, 220–221
merchandise sales in, 221–222
Permanent accounts, 150–151, 154–155
Perpetual inventory system(s), 197–198
inventory cost flow methods in, 266–269
periodic vs., 219–222
Personal annual report, 71
Personal financial reporting, ethics in, 25
Petty cash fund, 353–355
establishment of, 353
making payments from, 353–354
replenishment of, 354–355
Phantom (paper) profit, 256
Physical controls, 344, 345
Pickard, Thomas, 4
Plan administrator (pensions), F7
Plant and equipment, see Plant assets
Plant assets, 426–441
buildings, 428
defined, 426
depreciation of, 430–438
computation, 431–432
and income taxes, 436
methods, 432–436
revisions in estimate of, 436–437
determining cost of, 427–430
disposal of, 439–441
retirement, 439–440
sale, 440–441
equipment, 428–429
exchange of, 452–454
gain treatment, 453–454
loss treatment, 452–453
expenditures during useful life of, 438
land, 427
land improvements, 427–428
loss on sale of, 647
Post-closing trial balance, 155–157, 159–161
Posting, 59–60, 67–68, 110–111
Postretirement benefits, F6–F8
Preferred dividend, 712
Preferred stock, 550–552, 554–555
Premium, bonds issued at, 488–490
Prepaid expenses (prepayments), 98–102,
118–119
Present value, C7–C16
of an annuity, 502–503, C10–C12, C16
and bond pricing, 500–505
defined, C7
of a long-term note or bond, C12–C15
and market value of bonds, 486
of a single amount, C8–C10, C15–16
variables affecting, C7
Present value of 1 factors, C9
Price-earnings (P-E) ratio, 307n.4, 713
Principal, C1
Principle(s) of accounting, 294–295,
299–303
cost principle as, 302
full disclosure as, 301
matching as, 300
revenue recognition as, 299–300
Prior period adjustments, 562
Private accounting, 29. See also Managerial
accounting
Privately held corporations, 535
Profit:
gross, 210
as purpose of corporation, 534
Profitability, 310
Profitability ratios, 710–714
asset turnover, 710–711
earnings per share, 712–713
payout ratio, 713–714
price-earnings ratio, 713
profit margin, 710
return on assets, 711
return on common stockholders’ equity,
711–712
Profit margin (profit margin percentage),
310, 710
Pro forma income, 722
Promissory notes, 398
Property, plant, and equipment, 164. See also
Plant assets
Proprietorships, 10
Public accounting, 29
Public Company Accounting Oversight Board
(PCAOB), 341
Publicly held corporations, 534–535
Purchase allowances, 201
Purchase discounts, 201–202
Purchase invoices, 199, 200
Purchase returns, 201
Purchases, recording, 199–203
discounts, 201–202
freight costs, 200–201
returns and allowances, 201
Purchases journal, E11–E13
Purchasing activities, and segregation of
duties, 342
Q
Quality of earnings, 721–722, 724–726
and alternative accounting methods, 721–722
and improper recognition, 722
and pro forma income, 722
Quick (acid-test) ratio, 707–708
R
Ratio analysis, 699, 705–717
liquidity ratios, 706–710
profitability ratios, 710–714
solvency ratios, 714–715
summary of ratios, 716
Raw materials, 246
R&D (research and development) costs, 446
Receipts, cash, 348–351
mail receipts, 350–351
over-the counter receipts, 349–350
Receivables, 384–408
accounts receivable, 386–398
disposing of, 395–398
recognizing, 387
types of, 386
valuing, 388–395
defined, 386
notes receivable, 398–403
computing interest for, 400
disposing of, 401–402
maturity date of, 399
recognizing, 400
valuing, 400–401
statement presentation/analysis for, 403–404
trade, 386
Receivables turnover, 708–709. See also
Accounts receivable turnover ratio
Recessions, inventory fraud during, 260
Recognition, improper, 722
Reconciliation, see Bank reconciliation
Record date (dividends), 554
Recording process, 46–74
and accounts, 48–53
illustrated example of, 61–68
for payroll, D8–D10
for payroll taxes, D12–D13
steps in, 53–61
journalizing, 54–57
ledger, transfer to, 57–61
transaction analysis, 15–20
and trial balance, 68–70, 72–73
Registered bonds, 484
Relevance, of accounting information, 296
Reliability, of accounting information, 296
Reporting:
of cash, 363, 365–366
ethics in, 8–9
Research and development (R&D) costs, 446
Responsibility, establishment of, 341, 342
Restricted cash, 363
Restrictive endorsements, 350
Retailers, 196
Retail inventory method, 271–272
Retained earnings, 51, 542–543, 560–565
defined, 560
and prior period adjustments, 562
restrictions on, 560–561
statement of, 562–563
statement presentation/analysis of, 564–566
Retained earnings restrictions, 561
Retained earnings statement, 21–23, 562–563
horizontal analysis of, 702–703
statement presentation/analysis of,
564–565, 568
Retirement, of plant assets, 439–440
Subject Index I-7
Return on assets, 311, 711
Return on common stockholders’ equity, 311,
566, 711–712
Returns and allowances:
merchandise purchases, 201
for merchandise sales, 204–205
Revenue(s), 51
accrued, 105–106
defined, 13
sales, 196
unearned, 102–103, 119–120, 479
Revenue expenditures, 438
Revenue recognition principle, 95, 299–300
Reversing entries, 158, 171–173
Rifkin, Jeremy, 194
Rowling, J. K., 443
Rubino, Carlos, 696–697
S
Salaries, 108–109, D1, D4
Sale(s):
of bonds, 598–599
credit card, 396–397
net, 209–210
of plant assets, 440–441, 647
of receivables, 395–396
recording, 203–205
discounts, 205
returns and allowances, 204–205
Sales activities, and segregation of duties,
342–343
Sales invoices, 203
Sales journal, E5–E7
Sales revenue, 196
Sales taxes payable, 476
Salvage value, 431, 432
Sarbanes-Oxley Act of 2002 (SOX; Sarbox),
8, 29, 341
and human resources, 344
and identity theft, 364
and restatements, 159
Saving, personal, 612
SEC, see Securities and Exchange
Commission
Secured bonds, 483
Securities and Exchange Commission (SEC),
9, 294, 537
Segregation of duties, 342–343
Selling expenses, 211
Semiannually payable interest, C12, C13
Serial bonds, 484
Service charges, bank, 357
Short-term investments, 608–609
Short-term paper, 609n.4
Significant noncash activities, 640–641
Simple entries, 55
Simple interest, C1–C2
Single-step income statement, 213, 214
Sinking fund bond, 483
Small stock dividend, 556
Social Security taxes, see FICA taxes
Solvency, 311
Solvency ratios, 714–715
debt to total assets ratio, 714–715
times interest earned, 715
SOX, see Sarbanes-Oxley Act of 2002
Special journals, E4–E18
cash payments journal, E13–E15
cash receipts journal, E7–E11
effects of, on general journal, E16–E17
purchases journal, E11–E13
sales journal, E5–E7
usefulness of, E4
Specific identification method, 250–251
Stack, Jack, 2
Star Wars, 96
Stated value, 542, 544–545
State income taxes, D6
Statement of cash flows, 21, 22, 24, 638–671
classification of cash flows on, 639–640
direct method of preparing, 644, 665–671
investing/financing activities, 670–671
net change in cash, 671
operating activities, 666–670
evaluating a company using, 654–655,
657–658
format of, 641
indirect method of preparing, 643–654
investing/financing activities, 651–652
net change in cash, 652–654
operating activities, 646–650
worksheets, using, 659–664
preparation of, 642–643
preparing, from worksheets, 659–664
and significant noncash activities,
640–641
usefulness of, 638–639
Statement of earnings, D10
State unemployment taxes, D12
State unemployment tax acts (SUTA), D12
Stock:
authorized, 540
book value of, 571–572
deciding to invest in, 723
issuance of, 540–546
market value of, 541, 572
par vs. no-par-value, 541–542, 544–546
preferred, 550–552
treasury, 546–550
disposal of, 548–550
purchase of, 547–548
Stock certificate, 538
Stock dividends, 556–558
Stockholders:
financial statement analysis by, 698
letter to the, A2–A3
limited liability of, 535
ownership rights of, 538–539
Stockholders’ equity, 12–13
on classified balance sheet, 166
return on common stockholders’ equity,
311, 566, 711–712
Stockholders’ equity account, 557
Stockholders’ equity statement, 565,
570–571
Stock investments, 600–605
between 20% and 50%, holdings, 601–602
less than 20%, holdings of, 600–601
more than 50%, holdings of, 602–603
Stock splits, 558–559
Straight-line method, 432–433, 509–513
Su, Vivi, 384–385
Subsidiary (affiliated) company, 602
Subsidiary ledger(s), E1–E4
advantages of, E3
defined, E1
example, E1–E2
Supplies, as prepaid expense, 99
SUTA (state unemployment tax acts), D12
T
T account, 48
Taking inventory, 247–248
Taxes and taxation. See also Income taxes
(income taxation); Payroll taxes
as area of public accounting, 29
burden of, 478
corporate, 537
sales taxes payable, 476
Temporary accounts, 150, 154
Term bonds, 484
Theft, inventory, 263
Three-column form of account, 58
Time cards, D3
Timekeeping, D3
Time periods, and discounting of bonds,
503–504
Time period assumption, 94, 298
Times interest earned ratio, 495, 715
Time value of money, C1–C18
and discounting, C12
future value, C3–C7
and interest, C1–C3
and market value of bonds, 486
present value, C7–C16
and use of financial calculator, C16–C17
Timing issue(s), 94–96
accrual- vs. cash-basis accounting as, 95
fiscal/calendar years as, 95
recognizing revenues/expenses as, 95–96
selection of accounting time period as, 94
Trademarks and trade names, 444
Trade receivables, 386
Trading on the equity, 712
Trading securities, 605–607
Transactions, 14
Transaction analysis, 15–20
Transfer, of corporate ownership rights, 535
Transit, goods in, 248–249
Transposition errors, 70
Treasurer, 536
Treasury stock, 546–550
disposal of, 548–550
purchase of, 547–548
Trend analysis, see Horizontal analysis
Trial balance, 68–70, 72–73
defined, 68
limitations of, 69
locating errors in, 69–70
post-closing, 155–157, 159–161
steps in preparation of, 69
use of dollar signs in, 70
Trustee (of bond), 484
Turnover:
asset, 446–447, 710–711
inventory, 261–262, 709–710
receivables, 403–404, 708–709
U
Uncollectible accounts:
allowance method for, 389–394
direct write-off method for, 388–389
Underwriting, of stock issues, 540
Unearned revenues, 102–103, 119–120, 479
Unemployment taxes:
federal, D11–D12
state, D12
Unexpired costs, 300
Units-of-activity method, 433–434, 442
Unsecured bonds, 484
Useful life, 101, 431, 432, 438
V
Valuation:
of accounts receivable, 388–395
of notes receivable, 400–401
Vertical analysis, 699, 703–705
of balance sheet, 703
of income statement, 703–705
Virtual close, 155
Vouchers, 351, 352
Voucher register, 352
Voucher systems, 351–352
W
W-2 (Wage and Tax Statement), D13–D14
W-4 (Employee’s Withholding Allowance
Certificate), D6
Wages, D1
Wages and salaries payable, 476
Wage and Tax Statement (Form W-2), D13–D14
I-8 Subject Index
Wear and tear, 431
Weighted-average unit cost, 254
Wholesalers, 196
Withholding taxes, 476. See also Payroll taxes
Working capital, 309–310, 481, 707
Working capital ratio, 707
Work in process, 246
Worksheet(s), 144–154
defined, 144
for merchandising company, 222–224
preparing adjusting entries from, 148, 150,
152, 154
preparing consolidated balance sheets from,
616–617
preparing financial statements from,
148, 152, 153
preparing statement of cash flows from, 659–664
steps in preparation of, 144–152
Z
Zero-interest bonds, 486
Subject Index I-9
RAPID REVIEW
Chapter Content
BASIC ACCOUNTING EQUATION (Chapter 2) INVENTORY (Chapters 5 and 6)
Ownership
ADJUSTING ENTRIES (Chapter 3)
7
Prepare financial
statements:
Income statement
Retained earnings statement
Balance sheet
5
Journalize and post
adjusting entries:
Prepayments/Accruals
6
Prepare an adjusted
trial balance
Optional steps: If a worksheet is prepared, steps 4, 5, and 6 are incorporated in the worksheet.
If reversing entries are prepared, they occur between steps 9 and 1 as discussed below.
4
Prepare a
trial balance
3
Post to
ledger accounts
2
Journalize the
transactions
1
Analyze business
transactions
9
Prepare a post-closing
trial balance
8
Journalize and
post closing entries
Type Adjusting Entry
Deferrals 1. Prepaid expenses Dr. Expenses Cr. Assets
2. Unearned revenues Dr. Liabilities Cr. Revenues
Accruals 1. Accrued revenues Dr. Assets Cr. Revenues
2. Accrued expenses Dr. Expenses Cr. Liabilities
Note: Each adjusting entry will affect one or more income statement accounts and one or
more balance sheet accounts.
Interest Computation
Interest � Face value of note � Annual interest rate � Time in terms of one year
CLOSING ENTRIES (Chapter 4)
Purpose: (1) Update the Retained Earnings account in the ledger by transferring net
income (loss) and dividends to retained earnings. (2) Prepare the temporary accounts
(revenue, expense, dividends) for the next period’s postings by reducing their balances
to zero.
Process
1. Debit each revenue account for its balance (assuming normal balances), and
credit Income Summary for total revenues.
2. Debit Income Summary for total expenses, and credit each expense account for
its balance (assuming normal balances).
STOP AND CHECK: Does the balance in your Income Summary Account equal
the net income (loss) reported in the income statement?
3. Debit (credit) Income Summary, and credit (debit) Retained Earnings for the
amount of net income (loss).
4. Debit Retained Earnings for the balance in the Dividends account and credit
Dividends for the same amount.
STOP AND CHECK: Does the balance in your Retained Earnings account equal
the ending balance reported in the balance sheet and the retained earnings
statement? Are all of your temporary account balances zero?
ACCOUNTING CYCLE (Chapter 4)
Freight Terms Ownership of goods on public carrier resides with:
FOB Shipping point Buyer
FOB Destination Seller
Perpetual vs. Periodic Journal Entries
Event Perpetual Periodic*
Purchase of goods Inventory Purchases
Cash (A/P) Cash (A/P)
Freight (shipping point) Inventory Freight-In
Cash Cash
Return of goods Cash (or A/P) Cash (or A/P)
Inventory Purchase Returns and Allowances
Sale of goods Cash (or A/R) Cash (or A/R)
Sales Sales
Cost of Goods Sold No entry
Inventory
End of period No entry Closing or adjusting entry required
Cost Flow Methods
• Specific identification • Weighted average
• First-in, first-out (FIFO) • Last-in, first-out (LIFO)
CONCEPTUAL FRAMEWORK OF ACCOUNTING (Chapter 7)
Bank Books
Balance per bank statement Balance per books
Add: Deposit in transit Add: Unrecorded credit memoranda from bank
statement
Deduct: Outstanding checks Deduct: Unrecorded debit memoranda from
bank statement
Adjusted cash balance Adjusted cash balance
Note: 1. Errors should be offset (added or deducted) on the side that made the error.
2. Adjusting journal entries should only be made on the books.
STOP AND CHECK: Does the adjusted cash balance in the Cash account equal the
reconciled balance?
Characteristics Assumptions Principles Constraints
Relevance Monetary unit Revenue recognition Materiality
Comparability Economic entity Matching Conservatism
Reliability Time period Full disclosure
Going concern Cost
EP-1
INTERNAL CONTROL AND CASH (Chapter 8)
Principles of Internal Control
• Establishment of responsibility • Physical, mechanical, and electronic controls
• Segregation of duties • Independent internal verification
• Documentation procedures • Other controls
Bank Reconciliation
Assets Stockholders’ Equity+Basic
Equation
Expanded
Basic Equation = + – ++ –
Debit /Credit
Effects
Liabilities=
Dr.
+
Assets
Cr.
–
Dr.
–
Liabilities
Cr.
+
Dr.
–
Common
Stock
Cr.
+
Dr.
–
Retained
Earnings
Cr.
+
Dr.
+
Dividends
Cr.
–
Dr.
–
Revenues
Cr.
+
Dr.
+
Expenses
Cr.
–
⎧ ⎪ ⎪ ⎪ ⎪
⎪ ⎪ ⎪
⎪
⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎪ ⎨ ⎪ ⎪ ⎪ ⎪ ⎪
⎪ ⎪ ⎪
⎪ ⎪ ⎪
⎪ ⎪ ⎪ ⎪ ⎪ ⎩
*Items with an asterisk are covered in a chapter-end appendix.
EP-2
PLANT ASSETS (Chapter 10)
Presentation
INVESTMENTS (Chapter 13)
Comparison of Long-Term Bond Investment and Liability Journal Entries
Tangible Assets Intangible Assets
Property, plant, and equipment Intangible assets (Patents, copyrights,
trademarks, franchises, goodwill)
Natural resources
Computation of Annual Depreciation Expense
Straight-line
Units-of-activity � Units of activity during year
Declining-balance Book value at beginning of year � Declining balance rate*
*Declining-balance rate � 1 � Useful life (in years)
Depreciable cost
���
Useful life (in units)
Cost � Salvage value
���
Useful life (in years)
Straight-line amortization
Bond interest expense Bond interest paid
Carrying value of bonds Face amount of bonds �
at beginning of period � Contractual interest rate
Effective interest rate
Bond discount (premium)
Number of interest periods
Note: If depreciation is calculated for partial periods, the straight-line and declining-
balance methods must be adjusted for the relevant proportion of the year.
Multiply the annual depreciation expense by the number of months expired in
the year divided by 12 months.
Retained Earnings
Debits (Decreases) Credits (Increases)
1. Net loss 1. Net income
2. Prior period adjustments for 2. Prior period adjustments for
overstatement of net income Understatement of net income
3. Cash dividends and stock dividends
4. Some disposals of treasury stock
No-Par Value Par Value
Cash Cash
Common Stock Common Stock (par value)
Paid-in Capital in Excess of Par Value
Cash Common Stock Retained Earnings
Cash dividend ↓ No effect ↓
Stock dividend No effect ↑ ↓
Stock split No effect No effect No effect
BONDS (Chapter 11)
Premium Market interest rate � Contractual interest rate
Face Value Market interest rate � Contractual interest rate
Discount Market interest rate Contractual interest rate
Event Investor Investee
Purchase / issue of bonds Debt Investments Cash
Cash Bonds Payable
Interest receipt / payment Cash Interest Expense
Interest Revenue Cash
Comparison of Cost and Equity Methods of Accounting for Long-Term Stock Investments
Event Cost Equity
Acquisition Stock Investments Stock Investments
Cash Cash
Investee reports No entry Stock Investments
earnings Investment Revenue
Investee pays Cash Cash
dividends Dividend Revenue Stock Investments
RAPID REVIEW
Chapter Content
RECEIVABLES (Chapter 9)
Methods to Account for Uncollectible Accounts
Direct write-off method Record bad debts expense when the company
determines a particular account to be uncollectible.
Allowance methods: At the end of each period estimate the amount of
Percentage-of-sales credit sales uncollectible. Debit Bad Debts Expense
and credit Allowance for Doubtful Accounts for this
amount. As specific accounts become uncollectible,
debit Allowance for Doubtful Accounts and credit
Accounts Receivable.
Percentage-of-receivables At the end of each period estimate the amount of
uncollectible receivables. Debit Bad Debts Expense and
credit Allowance for Doubtful Accounts in an amount
that results in a balance in the allowance account equal
to the estimate of uncollectibles. As specific accounts
become uncollectible, debit Allowance for Doubtful
Accounts and credit Accounts Receivable.
STOCKHOLDERS’ EQUITY (Chapter 12)
No-Par Value vs. Par Value Stock Journal Entries
Comparison of Dividend Effects
Computation of Annual Bond Interest Expense
Interest expense � Interest paid (payable) � Amortization of discount
(OR � Amortization of premium)
Effective-interest
amortization
(preferred
method)
Debits and Credits to Retained Earnings
Trading Report at fair value with changes reported in net income.
Available-for- Report at fair value with changes reported in the stockholders’
sale equity section.
Trading and Available-for-Sale Securities
EP-3
RAPID REVIEW
Chapter Content
Prior period adjustments Statement of retained earnings (adjustment of
(Chapter 12) beginning retained earnings)
Discontinued operations Income statement (presented separately after
“Income from continuing operations”)
Extraordinary items Income statement (presented separately after
“Income before extraordinary items”)
Changes in accounting principle In most instances, use the new method in current
period and restate previous years results using
new method. For changes in depreciation and
amortization methods, use the new method in the
current period, but do not restate previous periods.
PRESENTATION OF NON-TYPICAL ITEMS (Chapter 15)
STATEMENT OF CASH FLOWS (Chapter 14)
Cash flows from operating activities (indirect method)
Net income
Add: Losses on disposals of assets $ X
Amortization and depreciation X
Decreases in noncash current assets X
Increases in current liabilities X
Deduct: Gains on disposals of assets (X)
Increases in noncash current assets (X)
Decreases in current liabilities (X)
Net cash provided (used) by operating activities $ X
Cash flows from operating activities (direct method)
Cash receipts
(Examples: from sales of goods and services to customers, from receipts
of interest and dividends on loans and investments) $ X
Cash payments
(Examples: to suppliers, for operating expenses, for interest, for taxes) (X)
Cash provided (used) by operating activities $ X
EP-4
RAPID REVIEW
Financial Statements
Order of Preparation
Statement Type Date
1. Income statement For the period ended
2. Retained earnings statement For the period ended
3. Balance sheet As of the end of the period
4. Statement of cash flows For the period ended
Income Statement (perpetual inventory system)
Name of Company
Income Statement
For the Period Ended
Sales revenues
Sales $ X
Less: Sales returns and allowances X
Sales discounts X
Net sales $ X
Cost of goods sold X
Gross profit X
Operating expenses
(Examples: store salaries, advertising, delivery, rent,
depreciation, utilities, insurance) X
Income from operations X
Other revenues and gains
(Examples: interest, gains) X
Other expenses and losses
(Examples: interest, losses) X X
Income before income taxes X
Income tax expense X
Net income $ X
Income Statement (periodic inventory system)
Name of Company
Income Statement
For the Period Ended
Sales revenues
Sales $ X
Less: Sales returns and allowances X
Sales discounts X
Net sales $ X
Cost of goods sold
Beginning inventory X
Purchases $ X
Less: Purchase returns and allowances X
Net purchases X
Add: Freight in X
Cost of goods purchased X
Cost of goods available for sale X
Less: Ending inventory X
Cost of goods sold X
Gross profit X
Operating expenses
(Examples: store salaries, advertising, delivery, rent,
depreciation, utilities, insurance) X
Income from operations X
Other revenues and gains
(Examples: interest, gains) X
Other expenses and losses
(Examples: interest, losses) X X
Income before income taxes X
Income tax expense X
Net income $ X
Retained Earnings Statement
Name of Company
Retained Earnings Statement
For the Period Ended
Retained earnings, beginning of period $ X
Add: Net income (or deduct net loss) X
X
Deduct: Dividends X
Retained earnings, end of period $ X
STOP AND CHECK: Net income (loss) presented on the retained earnings statement
must equal the net income (loss) presented on the income statement.
Balance Sheet
Name of Company
Balance Sheet
As of the End of the Period
Assets
Current assets
(Examples: cash, short-term investments, accounts
receivable, merchandise inventory, prepaid expenses) $ X
Long-term investments
(Examples: investments in bonds, investments in stocks) X
Property, plant, and equipment
Land $ X
Buildings and equipment $ X
Less: Accumulated depreciation X X X
Intangible assets X
Total assets $ X
Liabilities and Stockholders’ Equity
Liabilities
Current liabilities
(Examples: notes payable, accounts payable, accruals,
unearned revenues, current portion of notes payable) $ X
Long-term liabilities
(Examples: notes payable, bonds payable) X
Total liabilities X
Stockholders’ equity
Common stock X
Retained earnings X
Total liabilities and stockholders’ equity $ X
STOP AND CHECK: Total assets on the balance sheet must equal total liabilities and
stockholders’ equity; and, ending retained earnings on the balance sheet must equal
ending retained earnings on the retained earnings statement.
Statement of Cash Flows
Name of Company
Statement of Cash Flows
For the Period Ended
Cash flows from operating activities
Note: May be prepared using the direct or indirect method
Cash provided (used) by operating activities $ X
Cash flows from investing activities
(Examples: purchase / sale of long-term assets)
Cash provided (used) by investing activities X
Cash flows from financing activities
(Examples: issue / repayment of long-term liabilities,
issue of stock, payment of dividends)
Net cash provided (used) by financing activities X
Net increase (decrease) in cash X
Cash, beginning of the period X
Cash, end of the period $ X
STOP AND CHECK: Cash, end of the period, on the statement of cash flows must
equal cash presented on the balance sheet.
Ratio Formula Purpose or Use
Liquidity Ratios
1. Current ratio Measures short-term debt-paying ability.
2. Acid-test (quick) ratio Measures immediate short-term liquidity.
3. Receivables turnover Measures liquidity of receivables.
4. Inventory turnover Measures liquidity of inventory.
Profitability Ratios
5. Profit margin �
N
N
et
et
in
s
c
a
o
le
m
s
e
�
Measures net income generated by each
dollar of sales.
6. Asset turnover �Av
N
er
e
a
t
g
s
e
a
a
le
s
s
sets�
Measures how efficiently assets are used
to generate sales.
7. Return on assets Measures overall profitability of assets.
8. Return on common
stockholders’ equity
Measures profitability of stockholders’
investment.
9. Earnings per share (EPS) Measures net income earned on each
share of common stock.
10. Price-earnings (P-E) ratio Measures the ratio of the market price per
share to earnings per share.
11. Payout ratio Measures percentage of earnings distributed
in the form of cash dividends.
Solvency Ratios
12. Debt to total assets ratio Measures percentage of total assets provided
by creditors.
13. Times interest earned Measures ability to meet interest payments
as they come due.
14. Free cash flow Cash provided by operating activities � Measures the amount of cash generated
Capital expenditures � Cash dividends during the current year that is available for
the payment of additional dividends or for
expansion.
Income before income taxes and interest expense
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Interest expense
Total debt
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Total assets
Cash dividends
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Net income
Market price per share of stock
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Earnings per share
Net income
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Weighted average common shares outstanding
Net income
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Average common stockholders’ equity
Net income
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Average total assets
Cost of goods sold
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Average inventory
Net credit sales
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Average net receivables
Cash � Short-term investments � Receivables (net)
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Current liabilities
Current assets
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Current liabilities
RAPID REVIEW
Using the Information in the Financial Statements
EP-5
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