Montclair State University Accounting ABC Company Worksheet

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1
Assignment Question(S):
(Total 25 Marks- -5 Questions Each Carries 5 Marks)
In June 30, 2023, ABC Company has the following information (Amounts in Saudi Riyal)
Bank statement indicated a balance of 100,000
The cash general ledger account on that date shows a balance of 120,000
The ABC’s accountant provided Additional information necessary for preparing the ABC’s
reconciliation statement:
•
A 10,000 check sent to the bank for deposit but has not yet reached the bank at the
statement date.
•
The bank returned a customer’s NSF check for 26,000 received as payment on account
receivable.
•
A 500 deposit by Z Company was erroneously credited to ABC account by the bank.
•
The bank statement showed 500 interest earned during June.
•
Outstanding checks totalled 15,000.
Required:
a. Prepare a June 30 bank reconciliation statement for ABC Company.
b. Prepare adjusting entries
Answer:
2
Q2. On July 31, ABC Company discovered that it cannot collect SAR 5,000 from Z a credit
customer.
Required: pass journal entries to record bad debt expense using both Direct Write-Off Method
and Allowance Method.
Answer:
3
Q3. On January 1, 2022, equipment was purchased for SAR 1000,000 cash. The equipment useful
life is
10 years and has an estimated salvage value of SAR 50,000.
Required:
a. Compute the annual depreciation expense for year 2022 using straight line method and
Declining Balance Method.
b. Pass journal entries to record the annual depreciation using straight line method and
Declining Balance Method.
Answer
Q4. On July 1, 2022, an airline company received an amount of SAR 100,000 for international
flights that will take off on December 30, 2022.
4
Required:
a. Prepare journal entries On July 1, 2022
b. Prepare journal entries on December 30, 2022 assuming that the airline provided the
service to customers.
Answer:
Q5. Define and Discuss the Accounting Treatment for Contingent Liabilities
Answer:
5
6
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 06
Reporting and Analyzing
Cash and Internal Controls
Conceptual Learning Objectives
C1: Define internal control and identify its
purpose and principles.
C2: Define cash and cash equivalents
and explain how to report them.
6-3
Analytical Learning Objectives
A1: Compute the days’ sales uncollected
ratio and use it to assess liquidity.
6-4
Procedural Learning Objectives
P1: Apply internal control to cash receipts
and disbursements.
P2: Explain and record petty cash fund
transactions.
P3: Prepare a bank reconciliation.
P4: Appendix 6A – Describe the use of
documentation and verification to
control cash disbursements (see text for
details).
P5: Appendix 6B – Apply the net method to
control purchase discounts (see text for
details).
6-5
C1
Purpose of Internal Control
Managers use policies and procedures to:
Protect assets.
2. Ensure reliable accounting.
1.
Promote efficient operations.
4. Urge adherence to company
policies.
3.
6-6
C1
The Sarbanes-Oxley Act
The Sarbanes-Oxley Act, also known as SOX, requires
management and auditors of publicly held companies to
adhere to or perform specific requirements, such as:
1. Evaluation of internal controls.
2. Oversight of the Auditor’s work by the Public
Company Accounting Oversight Board (PCAOB).
3. Restriction on consulting services performed by
auditors.
4. Term limits on person leading the audit.
5. Harsh penalties for violators, including prison time
with severe fines.
6-7
Principles of Internal Control
C1
1.
Establish responsibilities.
2.
Maintain adequate records.
3.
Insure assets and bond key employees.
4.
Separate recordkeeping from custody
of assets.
5.
Divide responsibility for related transactions.
6.
Apply technological controls.
7.
Perform regular and independent reviews.
6-8
C1
Technology and Internal Control
Reduced
Processing
Errors
More
Extensive Testing
of Records
Limited
Evidence of
Processing
Crucial
Separation of
Duties
Increased
E-commerce
6-9
C1
Limitations of Internal Control
Human Error
Human Fraud
Negligence
Fatigue
Misjudgment
Confusion
Intent to
defeat internal
controls for
personal gain
6-10
C1
Limitations of Internal Control
The costs of internal controls
must not exceed their benefits.
Benefits
Costs
6-11
C1
Control of Cash
An effective system of internal control that
protects cash and cash equivalents should meet
three basic guidelines:
Handling cash is
separate from
recordkeeping of
cash.
Cash receipts are
promptly deposited
in a bank.
Cash
disbursements are
made by check.
6-12
C2
Cash, Cash Equivalents, and
Liquidity
Cash
Currency, coins, and amounts on deposit in
bank accounts, checking accounts, and
many savings accounts. Also includes items
such as customer checks, cashier checks,
certified checks, and money orders.
Cash Equivalents
Short-term, highly liquid investments that are:
1. Readily convertible to a known cash amount.
2. Close to maturity date and not sensitive to
interest rate changes.
6-13
C2
Cash, Cash Equivalents, and
Liquidity
Liquidity
How easily an asset can be converted into
cash to be used to pay for services or
obligations.
Inventory
Cash
6-14
C2
Cash Management Principles
When companies fail, one of the most
common causes is their inability to
manage cash. The goals of cash
management are twofold:
◼ Plan cash receipts to meet cash
payments when due.
◼ Keep the minimum level of cash
necessary to operate.
6-15
Control of Cash Receipts
P1
Over-the-Counter
Cash Receipts
◼
◼
Cash register with
locked-in record of
transactions.
Compare cash
register record with
cash reported.
Cash Receipts By Mail
◼
Two people open the
mail.
✓ Money to cashier’s
office.
✓ List to accounting
dept.
✓ Copy of list filed.
6-16
Control of Cash Disbursements
P1
◼
◼
◼
All expenditures should be made by check.
The only exception is for small payments
from petty cash.
Separate authorization for check signing
and recordkeeping duties.
Use a voucher system.
6-17
Voucher System of Control
P1
A voucher system establishes procedures
for:
⚫
Verifying, approving, and recording obligations
for eventual cash disbursements.
⚫
Issuing checks for payment of verified,
approved, and recorded obligations.
6-18
P1
Voucher System of Control
Sender
Cashier
Accounting
Receiving
Supplier (Vendor)
Purchasing
Requesting
Receiver
Check
Invoice Approval
Receiving Report
Invoice
Purchase Order
Purchase Requisition
Supplier (Vendor)
Cashier
Accounting, Requesting
& Purchasing
Accounting
Supplier, Requesting,
Receiving & Accounting
Purchasing and
Accounting
Voucher
6-19
P2
Petty Cash System of Control
Small payments required in most
companies for items such as postage,
courier fees, repairs, and supplies.
6-20
P2
Operating a Petty Cash Fund
Petty Cash
Company
Cashier
Petty
Cashier
May 1
Petty cash
Cash
400
400
Accountant
6-21
P2
Operating a Petty Cash Fund
Petty Cash
Petty
Cashier
6-22
P2
Operating a Petty Cash Fund
A petty cash fund
is used only for
business
expenses.
Petty
Cashier
39¢
Stamps
$45
Courier
$80
6-23
P2
Operating a Petty Cash Fund
Petty cash
receipts with
either no
signature or a
forged signature
usually indicate
misuse of petty
cash.
Receipts
Petty
Cashier
39¢
Stamps
$45
Courier
$80
6-24
P2
Operating a Petty Cash Fund
Receipts
$125
Company
Cashier
To reimburse
petty cash fund
May 31
Use a Cash
Over and Short
account if needed.
Petty
Cashier
Postage expense
Delivery expense
Cash
45
80
125
Accountant
6-25
P2
Petty Cash Example
Tension Co. maintains a petty cash fund of $400.
The following summary information was taken from
petty cash vouchers for July:
Travel Expenses
Customer Business Lunches
Express Mail Postage
Miscellaneous Office Supplies
$79.30
93.42
55.00
32.48
Let’s look at replenishing the fund if the balance on
July 31 was $137.80.
6-26
P2
Petty Cash Example
What amount of cash will be required
to replenish the petty cash fund?
a. $260.20
b. $262.20
c. $139.80
d. $137.80
6-27
Petty Cash Example
P2
What amount of cash will be
required to replenish the petty
cash fund?
a.
b.
c.
d.
$260.20
$262.20
$139.80
$137.80
Desired balance
Actual balance
Amount needed
$ 400.00
137.80
$ 262.20
Let’s prepare the journal entry to replenish the
petty cash fund.
6-28
P2
Petty Cash Example
Journal entry to replenish petty cash fund
Dr.
July 31 Travel Expense
79.30
Entertainment Expense
93.42
Postage Expense
55.00
Office Supplies Expense
32.48
Cash Over and Short
2.00
Cash
Cr.
262.20
6-29
P1
Banking Activities as Controls
Bank Accounts
Signature Cards
Deposit Tickets
Checks
Electronic
Funds
Transfer
Bank
Statements
6-30
Bank Reconciliation
P3
A bank reconciliation is prepared periodically to explain the
difference between cash reported on the bank statement and the
cash balance on company’s books.
Bank Statement
First National Bank
Nashville, TN 37459
May 31, 2011
*
Clothes Mart
Nashville, TN
Why are the
balances different?
Acct No 278609
Previous
Balance
Total Checks
1488.79
5/1
5/2
1,367.09
107
5/4
5/7
5/9
5/12
108
109
110
111
Total
Deposits
2,604.22
55.00
Current
Balance
2,725.92
Account: Cash
GENERAL LEDGER
Acct. No.
1,251.88
279.50
44.75
21.81
37.55
5/15
5/18
5/21
5/27
5/30
112
113
114
175.98
288.31
12.54
5/31
115
451.65
Date
Item
May 31 Balance
PR
Debit
Credit
102
Balance
DR (CR)
2,481.18
825.04
527.30
6-31
P3
Reconciling Items
Bank Statement Balance
⚫ Add:
Deposits in transit.
⚫ Deduct:
Outstanding
checks
⚫ Add or Deduct:
Bank errors.
•
•
•
•
•
Book Balance
Add: Collections
made by the bank.
Add: Interest earned
on checking account.
Deduct:
Nonsufficient funds
check (NSF).
Deduct: Bank
service charge.
Add or Deduct:
Book errors.
6-32
P3
Bank Reconciliation
Two sections:
1. Reconcile bank statement balance to
the adjusted bank balance.
2. Reconcile book balance to the adjusted
book balance.
The adjusted balances should be equal.
6-33
P3
Bank Reconciliation Example
Let’s prepare a July 31 bank reconciliation
statement for the Simmons Company.
◼
◼
The July 31 bank statement indicated a
balance of $9,610.
The cash general ledger account on that
date shows a balance of $7,430.
Additional information necessary for the
reconciliation is shown on the next screen.
6-34
P3
Bank Reconciliation Example
1.
Outstanding checks totaled $2,417.
2.
A $500 check mailed to the bank for deposit had not
reached the bank at the statement date.
3.
The bank returned a customer’s NSF check for $225
received as payment on account receivable.
4.
The bank statement showed $30 interest earned during
July.
5.
Check No. 781 for supplies expense cleared the bank for
$268 but was erroneously recorded in our books as $240.
6.
A $486 deposit by Acme Company was erroneously
credited to our account by the bank.
6-35
P3
Bank Reconciliation Example
Simmons Company
Bank Reconciliation
July 31, 2011
Bank Balance, July 31
Add: Deposit in Transit
Less: Bank Error
$
486
Outstanding Checks
2,417
Adjusted Balance, July 31
Book Balance, July 31
Add: Interest
Less: Recording Error
NSF Check
Adjusted Balance, July 31
$
(2,903)
$ 7,207
$
$
9,610
500
28
225
$
7,430
30
(253)
7,207
6-36
P3
Adjusting Entries from a
Bank Reconciliation
Only amounts shown on the book portion
of the reconciliation require an adjusting
entry.
Dr.
30
July 31 Cash
Interest revenue
July 31 Supplies expense
Accounts receivable
Cash
Cr.
30
28
225
253
6-37
P3
Adjusting Entries from a
Bank Reconciliation
After posting the reconciling entries the cash account
looks like this:
Account: Cash
GENERAL LEDGER
Acct. No.
Date
Item
July 31 Balance
31 Adjusting entry
31 Adjusting entry
PR
Debit
Credit
30
253
101
Balance
DR (CR)
7,430
7,460
7,207
Adjusted balance on July 31.
6-38
A1
Days’ Sales Uncollected
How much time is likely to pass before
we receive cash receipts from credit sales?
Days’
=
sales
uncollected
Accounts receivable
Net sales
× 365
6-39
End of Chapter 06
6-40
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 7
Reporting and Analyzing
Receivables
7-2
Conceptual Learning Objectives
C1: Describe accounts receivable and
how they occur and are recorded.
C2: Describe a note receivable,
computation of its maturity date
and the recording of its existence.
C3: Explain how receivables can be
converted to cash before maturity.
7-3
Analytical Learning Objectives
A1: Compute accounts receivable
turnover and use it to help assess
financial condition.
7-4
Procedural Learning Objectives
P1: Apply the direct write-off method to
account for accounts receivable.
P2: Apply the allowance method and estimate
uncollectibles based on sales and accounts
receivable.
P3: Record the honoring and dishonoring of a
note and adjustments for interest.
7-5
C1
Accounts Receivable
◼
◼
Amounts due from
customers for credit sales.
Credit sales require:
 Maintaining a separate
account receivable for
each customer.
 Accounting for bad
debts that result from
credit sales.
7-6
C1
Sales on Credit
On July 16, Barton, Co. sells $950 of
merchandise on credit to Webster, Co., and
$1,000 of merchandise on account to Matrix, Inc.
Jul. 16 Accounts Receivable – Webster
Sales
950
950
To record credit sales to Webster Co.
Accounts Receivable – Matrix
Sales
1,000
1,000
To record credit sales to M atrix, Inc.
7-7
C1
Sales on Credit
Accounts Receivable Ledger
Webster, Co.
Date
PR Debit Credit
Jul. 16
950
Balance
950
Matrix, Inc.
Date
PR Debit Credit
Jul. 16
1,000
Balance
1,000
Schedule of
Accounts Receivable
Webster, Co.
$ 950
Matrix, Inc.
1,000
Total
$ 1,950
General Ledger
Accounts Receivable
Date
PR Debit Credit Balance
Jul. 16
1,950
1,950
7-8
C1
Sales on Credit
On July 31, Barton, Co. collects $500 from Webster,
Co., and $800 from Matrix, Inc. on account.
Jul. 31 Cash
500
Accounts Receivable – Webster
500
To record cash collections on account
Cash
Accounts Receivable – Matrix
800
800
To record cash collections on account
7-9
C1
Sales on Credit
Accounts Receivable Ledger
Webster, Co.
Date
PR Debit Credit
Jul. 16
950
Jul. 31
500
Balance
950
450
Matrix, Inc.
Date
PR Debit Credit
Jul. 16
1,000
Jul. 31
800
Balance
1,000
200
Schedule of
Accounts Receivable
Webster, Co.
$ 450
Matrix, Inc.
200
Total
$ 650
General Ledger
Accounts Receivable
Date
PR Debit Credit Balance
Jul. 16
1,950
1,950
Jul. 31
1,300
650
7-10
C1
Credit Card Sales
Advantages of allowing customers to
use credit cards:
Customers’
credit is
evaluated by
the credit
card issuer.
Sales increase by
providing purchase
options to the
customer.
The risks of extending
credit are transferred to
the credit card issuer.
Cash collections
are quicker.
7-11
C1
Credit Card Sales
 With bank credit cards, the seller
deposits the credit card sales receipt
in the bank just like it deposits a
customer’s check.
 The bank increases the balance in the
company’s checking account.
 The company usually pays a fee of 1%
to 5% for the service.
7-12
C1
Credit Card Sales
On July 16, 2011, Barton, Co. has a bank credit
card sale of $500 to a customer. The bank
charges a processing fee of 2%. The cash is
received immediately.
Jul. 16 Cash
Credit Card Expense
Sales
490
10
500
To record credit card sales
and fees
7-13
C1
Credit Card Sales
On July 16, 2011, Barton, Co. has a bank credit card
sale of $500 to a customer. The bank charges a
processing fee of 2%. Barton remits the credit card
sale to the credit card company and waits for the
payment that is received on July 28.
Jul. 16 Accounts Receivable – Credit Card Co.
Credit Card Expense
Sales
DR
490
10
CR
500
To record credit card sales and fees.
Jul. 28 Cash
490
Accounts Receivable – Credit Card Co.
490
To record receipt from credit card company
7-14
C1
Installment Accounts Receivable
Amounts owed by customers from credit sales for
which payment is required in periodic amounts over
an extended time period. The customer is usually
charged interest.
7-15
P1/P2
Valuing Accounts Receivable
Some customers may not pay
their account. Uncollectible
amounts are referred to as bad
debts. There are two methods
of accounting for bad debts:
 Direct write-off method
 Allowance method
7-16
P1
Direct Write-Off Method
On August 4, Barton determines it
cannot collect $350 from Martin, Inc.,
a credit customer.
Aug. 4
Bad Debts Expense
Accounts Receivable – Martin
DR
350
CR
350
To write off uncollectible account
7-17
P1
Direct Write-Off Method
On September 9, Martin decides to pay
$200 that was previously written off.
Sep. 9
Accounts Receivable – Martin
Bad Debts Expense
DR
200
CR
200
To reinstate account previously written-off
Sep. 9
Cash
200
Accounts Receivable – Martin
200
To record payment on account
7-18
P1
Matching vs. Materiality
The matching
principle requires
expenses to be
reported in the same
accounting period as
the sales they help
produce.
The materiality
constraint states that
an amount can be
ignored if its effect
on the financial
statements is
unimportant to
users’ business
decisions.
7-19
P2
Allowance Method
At the end of each period, estimate total bad debts
expected to be realized from that period’s sales.
There are two advantages to the allowance method:
1. It records estimated bad debts expense in the
period when the related sales are recorded.
2. It reports accounts receivable on the balance
sheet at the estimated amount of cash to be
collected.
7-20
P2
Recording Bad Debts Expense
At the end of its first year of operations, Barton Co.
estimates that $3,000 of its accounts receivable will prove
uncollectible. The total accounts receivable balance at
December 31, 2011, is $278,000.
Dec. 31 Bad Debts Expense
Allowance for Doubtful Accounts
DR
3,000
CR
3,000
To record estimated bad debts
Contra-asset account
Bal.
Accounts Receivable
278,000
Allowance for Doubtful Accounts
Dec. 31
3,000
7-21
P2
Recording Bad Debts Expense
At the end of its first year of operations, Barton Co.
estimates that $3,000 of its accounts receivable will prove
uncollectible. The total accounts receivable balance at
December 31, 2011, is $278,000.
Barton, Co.
Partial Balance Sheet
December 31, 2011
Cash
Accounts receivable
Less: Allowance for doubtful accounts
$ 278,000
3,000
$ 275,000
7-22
P2
Estimating Bad Debts Expense
Two Methods
1. Percent of Sales Method; and
2. Accounts Receivable Methods
Percent of Accounts
Receivable Method
Aging of Accounts
Receivable Method.
7-23
P2
Percent of Sales Method
Bad debts expense is computed as follows:
Current Period Sales
× Bad Debt %
= Estimated Bad Debts Expense
Barton has credit sales of $1,400,000 in 2011.
Management estimates 0.5% of credit sales will
eventually prove uncollectible.
What is bad debts expense for 2011?
7-24
P2
Percent of Sales Method
$
×
= $
1,400,000
0.50%
7,000
Barton’s accountant
computes estimated
Bad Debts Expense of
$7,000.
Dec. 31 Bad Debts Expense
Allowance for Doubtful Accounts
DR
7,000
CR
7,000
To record estimated bad debts
7-25
P2
Percent of Accounts Receivable
Method

Compute the estimate of the allowance
for doubtful accounts.
Year-end Accounts Receivable × Bad Debt %

Bad debts expense is computed as:
Estimated Adj. Bal. in Allowance for Doubtful Accounts
– Unadj. Year-End Bal. in Allowance for Doubtful Accounts
= Estimated Bad Debts Expense
7-26
P2
Percent of Accounts Receivable
Barton has $100,000 in
accounts receivable and a $900
credit balance in Allowance for
Doubtful Accounts on
December 31, 2011. Past
experience suggests that 4% of
receivables are uncollectible.
What is Barton’s bad debts
expense for 2011?
7-27
P2
Percent of Accounts Receivable
Desired balance in Allowance for
Doubtful Accounts.
$ 100,000
×
4.00%
= $
4,000
Allowance for
Doubtful Accounts
900
Dec. 31 Bad Debts Expense
Allowance for Doubtful Accounts
3,100
4,000
DR
3,100
CR
3,100
To record estimated bad debts
7-28
P2
Aging of Accounts Receivable
Method
 Each receivable is grouped by
how long it is past its due date.
 Each age group is multiplied
by its estimated bad debts
percentage.
 Estimated bad debts for each
group are totaled.
7-29
P2
Aging of Accounts Receivable
Barton, Co.
Schedule of Accounts Receivable by Age
December 31, 2011
Accounts
Estimated
Receivable
Percent
Uncollectible
Days Past Due
Balance
Uncollectible
Amount


Not Yet Due
1 – 30 Days Past Due
31 – 60 Days Past Due
61 – 90 Days Past Due
Over 90 Days Past Due

$
64,500
18,500
10,000
3,900
3,100
$ 100,000
1% $
3%
7%
40%
60%
$
645
555
700
1,560
1,860
5,320
7-30
P2
Aging of Accounts Receivable
Barton’s unadjusted balance
in the allowance account is
$900.
Allowance for
Doubtful Accounts
900
4,420
5,320
We estimated the proper
balance to be $5,320.
DR
Dec. 31 Bad Debts Expense
4,420
Allowance for Doubtful Accounts
CR
4,420
To record estimated bad debts
7-31
P2
Writing Off a Bad Debt
With the allowance method, when an
account is determined to be uncollectible,
the debit goes to Allowance for Doubtful
Accounts.
Barton determines that Martin’s $300
account is uncollectible.
Dec. 31 Allowance for Doubtful Accounts
Accounts Receivable – Martin
DR
300
CR
300
To write-off an uncollectible account
7-32
P2
Recovery of a Bad Debt
Subsequent collections on accounts written
off require that the original write-off entry be
reversed before the cash collection is
recorded.
Feb. 8
Accounts Receivable – Martin
Allowance for Doubtful Accounts
DR
300
CR
300
To reinstate account previously written off
Feb. 8
Cash
300
Accounts Receivable – Martin
300
To record full payment on account
7-33
P2
Summary
% of Sales
% of Receivables
Aging of
Receivables
Emphasis on
Matching
Emphasis on
Realizable Value
Emphasis on
Realizable Value
Accts.
Rec.
Accts.
Rec.
Sales
Bad
Debts
Exp.
Income
Statement
Focus
All. for
Doubtful
Accts.
Balance
Sheet Focus
All. for
Doubtful
Accts.
Balance
Sheet Focus
7-34
C2
Notes Receivable
$1,000.00
Term
Payee
July 10, 2011
Ninety days
after date I promise to pay to
Principal
the order of Barton Company, Los Angeles, CA
One thousand and no/100 ——————————— Dollars
Payable at
First National Bank of Los Angeles, CA
Maker
Interest Rate
12% per annum
Value received with interest at
No.
42
Due Oct. 8, 2011
Julia Browne
Due Date
7-35
C2
Principal
of the
note
Interest Computation
×
Annual
interest
rate
Even for
maturities less
than one year,
the rate is
annualized.
Time
× expressed
in years
=
Interest
If the note is
expressed in
days, base a
year on 360
days.
7-36
C2
Computing Maturity and Interest
On March 1, 2011,
Matrix, Inc. purchased a
copier for $12,000 from
Office Supplies, Inc.
Matrix gave Office
Supplies a 9% note due
in 90 days in payment
for the copier.
What is the maturity
date of the note?
7-37
C2
Computing Maturity and Interest
Days in March
Minus the date of the note
Days remaining in March
Days in April
Days in May to maturity
Period of the note in days
31
1
30
30
30
90
The note is due and payable on May 30, 2011.
How much interest will Matrix pay to Office
Supplies, Inc. on this note?
7-38
C2
Computing Maturity and Interest
Principal
of the
note
×
Annual
interest
rate
$ 12,000
×
9%
Time
× expressed = Interest
in years
×
90/360
=
$
270
Total interest due
at May 30.
7-39
P3
Recognizing Notes Receivable
Here are the entries to record the note on
March 1, and the settlement on May 30, 2011.
Mar. 1
Notes Receivable
Sales
DR
12,000
CR
12,000
Sold goods in exchange for note
DR
12,270
May 30 Cash
Interest Revenue
Notes Receivable
CR
270
12,000
Collected note and interest due
7-40
P3
Recording a Dishonored Note
On May 30, 2011, Matrix informs us that the
company is unable to pay the note or interest.
Accounts Receivable – Matrix
Interest revenue
Notes Receivable
12,270
270
12,000
To charge accounts receivable for dishonored
note
7-41
P3
Recording End-of-Period Interest
Adjustments
On December 1, 2011, Matrix, Inc. purchased a
copier for $12,000 from Office Supplies, Inc. Matrix
issued a 9% note due in 90 days in payment for the
copier. What adjusting entry is required on
December 31, the end of the company’s accounting
period?
$12,000 × 9% × 30/360 = $90
Dec. 31 Interest Receivable
Interest Revenue
DR
90
CR
90
To accrue interest on note
7-42
P3
Recording End-of-Period Interest
Adjustments
Recording collection on note at maturity.
Days in December
Minus the date of the note
Day remaining in December
Days in January
Days in February
Days in March until maturity
Period of the note in days
Mar. 1
31
(1)
30
31
28
1
90
DR
12,270
Cash
Interest Receivable
Interest Revenue
Notes Receivable
CR
90
180
12,000
To record full payment of note
7-43
C3
Disposing of Receivables
Companies sometimes want to convert
receivables to cash before they are
due.
◼ They can sell or factor receivables.
◼ They may pledge receivables as
security for a loan.
◼
7-44
A1
Accounts Receivable Turnover
This ratio provides useful information for
evaluating how efficient management has
been in granting credit to produce revenue.
Accounts
receivable
turnover =
Net sales
Average accounts receivable, net
7-45
End of Chapter 7
7-46
Financial Accounting
John J. Wild
Sixth Edition
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 08
Reporting and Analyzing
Long-Term Assets
Conceptual Learning Objectives
C1: Explain the cost principle for
computing the cost of plant assets.
C2: Distinguish between revenue and
capital expenditures, and account for
them.
C3: Explain depreciation for partial years
and changes in estimates.
8-3
Analytical Learning Objectives
A1: Compute total asset turnover and
apply it to analyze a company’s use
of assets.
8-4
Procedural Learning Objectives
P1: Compute and record depreciation using the
straight-line, units-of-production, and decliningbalance methods.
P2: Account for asset disposal through discarding or
selling an asset.
P3: Account for natural resource assets and their
depletion.
P4: Account for intangible assets.
P5: Appendix 8A – Account for asset exchanges (see
text for details).
8-5
C1
Plant Assets
Tangible in Nature
Actively Used in Operations
Expected to Benefit Future Periods
Called Property, Plant & Equipment
8-6
C1
Plant Assets
Acquisition
1. Compute cost
Use
2. Allocate cost to periods
benefited
3. Account for subsequent
expenditures
Disposal
4. Record disposal
8-7
C1
Land and Buildings
Land is not a depreciable asset,
but land improvements are.
The cost of buildings include many costs;
the purchase price plus the following:
Cost of purchase or
construction
Title fees
Attorney fees
Brokerage
fees
Taxes
8-8
C1
Machinery and Equipment
Purchase
price
Taxes
Transportation
charges
Installing,
assembling, and
testing
Insurance while
in transit
8-9
C1
Lump-Sum Asset Purchase
The total cost of a combined
purchase of land and building
is separated on the basis of
their relative market values.
On January 1, Matrix, Inc. purchased land and
building for $200,000 cash. The appraised
values are building, $162,500, and land, $87,500.
How much of the $200,000 purchase price will be
charged to the building and land accounts?
8-10
C1
Lump-Sum Asset Purchase
Asset
Appraised
Value
% of
Value
b*
Land
Building
Total
a
$ 87,500
162,500
$ 250,000
Purchase
Price
Apportioned
Cost
c
b × c
35%
35% × $ 200,000 = $ 70,000
65%
65% ×
200,000 =
130,000
100%
100%
$ 200,000
* $87,500
$87,500÷÷$250,000
$250,000==35%
35%
$162,500 ÷ $250,000 = 65%
8-11
P1
Depreciation
Depreciation is the process of allocating
the cost of a plant asset to expense in the
accounting periods benefiting from its use.
Balance Sheet
Acquisition
Cost
(Unused)
Income Statement
Cost
Allocation
Expense
(Used)
8-12
Factors in Computing
Depreciation
P1
The calculation of depreciation requires
three amounts for each asset:
1.
Cost
2.
Salvage value
3.
Useful life
8-13
P1
Depreciation Methods
1.
Straight-line
2.
Units-of-production
3.
Declining-balance
8-14
P1
Straight-Line Method
Depreciation
=
expense for period
Depreciation
=
expense per year
Cost – Salvage value
Useful life
$50,000 – $5,000
= $9,000
5 years
Depreciation Expense
Accumulated Depreciation – Equipment
Dr.
9,000
Cr.
9,000
To record annual depreciation
8-15
P1
Straight-Line Method
Year
2011
2012
2013
2014
2015
Depreciation
Expense
(debit)
Accumulated
Depreciation
(credit)
Accumulated
Depreciation
$
$
$
$
9,000
9,000
9,000
9,000
9,000
45,000
$
9,000
9,000
9,000
9,000
9,000
45,000
9,000
18,000
27,000
36,000
45,000
Book
Value
$ 50,000
41,000
32,000
23,000
14,000
5,000
Salvage
Value
Depreciation
= (100% ÷ 5 years) = 20% per year
Rate
8-16
P1
Units-of-Production Method
Step 1:
Depreciation
per unit
=
Step 2:
Depreciation
expense
=
Cost – Salvage value
Total units of production
Number of
Depreciation
× units produced
per unit
in the period
8-17
P1
Units-of-Production Method
On December 31, 2011, equipment was
purchased for $50,000 cash. The
equipment is expected to produce 100,000
units during its useful life and has an
estimated salvage value of $5,000.
If 22,000 units were produced in 2011, what
is the amount of depreciation expense?
8-18
P1
Units-of-Production Method
Step 1:
Depreciation
=
per unit
$50,000 – $5,000
100,000 units
= $.45 per unit
Step 2:
Depreciation
= $.45 per unit × 22,000 units = $9,900
expense
8-19
P1
Units-of-Production Method
Year
Units
2011
2012
2013
2014
2015
22,000
28,000
32,000
18,000
100,000
Depreciation
Expense
Accumulated
Depreciation
$
$
$
9,900
12,600
14,400
8,100
45,000
9,900
22,500
22,500
36,900
45,000
Book
Value
$ 50,000
40,100
27,500
27,500
13,100
5,000
No depreciation expense if the equipment is idle
8-20
P1
Declining Balance Method
Depreciation
Expense
Early Years
High
Later Years
Low
Repair
Expense
Low
High
Early years’ total expense approximates
later years’ total expense.
8-21
P1
Double-Declining-Balance Method
Step 1:
Straight-line
= 100 % ÷ Useful life = 100% ÷ 5 = 20%
rate
Step 2:
Double-decliningbalance rate = 2 × Straight-line rate = 2 × 20% =
40%
Step 3:
Depreciation
=
expense
DoubleBeginning period
×
decliningbook value
balance rate
40% × $50,000 = $20,000 for 2011
8-22
P1
Double-Declining-Balance Method
2011 Depreciation:
40% × $50,000 = $20,000
2012
Depreciation:
40% × ($50,000 – $20,000) = $12,000
8-23
P1
Double-Declining-Balance Method
Year
2011
2012
2013
2014
2015
Depreciation
Expense
Accumulated
Depreciation
$
$
$
20,000
12,000
7,200
4,320
2,592
46,112
Book
Value
$ 50,000
20,000
30,000
32,000
18,000
39,200
10,800
43,520
6,480
46,112
3,888
Below salvage value
8-24
P1
Double-Declining-Balance Method
Year
2011
2012
2013
2014
2015
Depreciation
Expense
Accumulated
Depreciation
$
$
$
20,000
12,000
7,200
4,320
1,480
45,000
20,000
32,000
39,200
43,520
45,000
Book
Value
$ 50,000
30,000
18,000
10,800
6,480
5,000
We usually must force depreciation expense in the
last year so that book value equals salvage value.
8-25
Comparing Depreciation
Methods
P1
Annual Production
Depreciation
$8,000
$6,000
$4,000
$2,000
P2
$0
1
2
3
4
5
$16,000
$14,000
$12,000
$10,000
$8,000
$6,000
$4,000
$2,000
$0
1
2
Life in Years
3
4
5
Life in Years
$20,000
Annual DDB
Depreciation
Annual SL
Depreciation
$10,000
$15,000
$10,000
$5,000
$0
1
2
3
4
5
Life in Years
8-26
P1
Depreciation for Tax Reporting
Most corporations use the Modified
Accelerated Cost Recovery System
(MACRS) for tax purposes.
MACRS depreciation provides for rapid
write-off of an asset’s cost in order to
stimulate new investment.
8-27
C3
Partial-Year Depreciation
Calculate the straight-line depreciation on
December 31, 2011, for equipment purchased
on June 30, 2011. The equipment cost $75,000,
has a useful life of 10 years and an estimated
salvage value of $5,000.
Depreciation
Depreciation
=
=
=
($75,000 – $5,000) ÷ 10
$7,000 for all 2011
$7,000 × 6/12 = $3,500 for 6
months
8-28
C3
Change in Estimates for
Depreciation
On January 1, 2011, equipment was purchased
that cost $30,000, has a useful life of 10 years, and
no salvage value. During 2014, the useful life was
revised to eight years total (five years remaining).
Calculate depreciation expense for the year ended
December 31, 2011, using the straight-line method.
Book value at
date of change
–
Salvage value at
date of change
Remaining useful life at date of change
8-29
C3
Change in Estimates for
Depreciation
Asset cost
Accumulated depreciation, 12/31/2013
($3,000 per year × 3 years)
Remaining book value
Divide by remaining life
Revised annual depreciation
Dec. 31 Depreciation Expense
Accumulated Depreciation – Equipment
$ 30,000
9,000
$ 21,000
÷ 5
$ 4,200
Dr.
4,200
Cr.
4,200
To record depreciation for 2014
8-30
P1
Reporting Depreciation
Property, plant, and equipment:
Land and buildings
Machinery and equipment
Office furniture and equipment
Land improvements
Total
Less Accumulated depreciation
Net property, plant, and equipment
$ 150,000
200,000
175,000
50,000
$ 575,000
(122,000)
$ 453,000
8-31
C2
Additional Expenditures
Treatment
Financial Statement Effect
Current Current
Statement
Expense Income Taxes
Capital
Balance sheet
Expenditure account debited
Deferred Higher
Revenue
Income statement Currently
Expenditure account debited recognized Lower
Higher
Lower
If the amounts involved are not material, most
companies expense the item.
8-32
C2
Revenue and Capital
Expenditures
Type of
Capital or
Expenditure Revenue
Identifying Characteristics
Ordinary
Revenue 1. Maintains normal operating condition.
Repairs
2. Does not increase productivity.
3. Does not extend life beyond original
estimate.
Betterments
Capital 1. Major overhauls or partial
and
replacements.
Extraordinary
2. Extends life beyond original estimate.
Repairs
8-33
P2
Disposals of Plant Assets
Update depreciation
to the date of disposal
Journalize disposal by:
Recording cash
received (debit)
or paid (credit)
Removing accumulated
depreciation (debit)
Recording a
gain (credit)
or loss (debit)
Removing the
asset cost (credit)
8-34
P2
Discarding Plant Assets
Update
depreciation
If Cash > BV,
record
a gain (credit)
to the date of disposal.
If Cash < BV, record a loss (debit) If Cash =Journalize BV, no gain or loss disposal by: Recording cash received (debit) or paid (credit) Removing accumulated depreciation (debit) Recording a gain (credit) or loss (debit) Removing the asset cost (credit) 8-35 P2 Disposal of Assets On September 30, 2011, Evans Company sells a machine that originally cost $100,000 for $60,000 cash. The machine was placed in service on January 1, 2009. It was depreciated using the straight-line method with an estimated salvage value of $20,000 and a useful life of 10 years. Annual depreciation ($100,000 - $20,000) ÷ 10 Yrs. = $8,000 Depreciation to September 30, 2011:9/12 × $8,000 = $6,000 Dr. Sep. 30 Depreciation Expense 6,000 Accumulated Depreciation - Machine Cr. 6,000 To update depreciation to date of disposal 8-36 P2 Determine Book Value of Asset Cost $ 100,000 Accumulated depreciation: ( 3 yrs. × $8,000) + $6,000 = 30,000 Book value $ 70,000 8-37 P2 Determine Gain or Loss on Disposal If Cash > BV, record a gain (credit)
If Cash < BV, record a loss (debit) If Cash = BV, no gain or loss Cost Accumulated depreciation $ 100,000 30,000 Book value Cash received Loss on disposal 70,000 60,000 $ (10,000) 8-38 P2 Record the Disposal in the Journal Dr. Sep. 30 Cash 60,000 Accumulated Depreciation - Machine 30,000 Loss on Disposal of Asset 10,000 Machine Cr. 100,000 To record disposal of equipment 8-39 P3 Natural Resources: Cost Determination and Depletion Step 1: Depletion per unit = Cost - Salvage value Total units of capacity Step 2: Depletion expense = Depletion per unit Units extracted × and sold in period 8-40 P3 Depletion of Natural Resources Apex Mining acquired a tract of land containing ore deposits. Total costs of acquisition and development were $1,000,000 and Apex estimates the land contained 40,000 tons of ore. During the first year of operations Apex extracted and sold 13,000 tons of ore. 8-41 P3 Depletion Expense Step 1: Depletion per unit = $1,000,000 - $0 40,000 tons = $25 per ton Step 2: Depletion = $25 per ton expense × 13,000 units = $325,000 8-42 P4 Intangible Assets Noncurrent assets without physical substance Often provide exclusive rights or privileges Intangible Assets Useful life is often difficult to determine Usually acquired for operational use 8-43 P4 Cost Determination and Amortization Record at current cash equivalent cost, including purchase price, legal fees, and filing fees o o o o o o o Patents Copyrights Leaseholds Leasehold improvements Franchises & licenses Goodwill Trademarks & trade names 8-44 P4 Types of Intangibles Patents The exclusive right granted to its owner to manufacture and sell a patented item or use a process for 20 years. A patent is generally amortized, using the straight-line method, over its useful life, not to exceed 20 years. Matrix, Inc. purchased a patent for $10,000. The patent is expected to have a useful life of 10 years. Amortization Expense - Patents Accumulated Amortization - Patents Dr. 1,000 Cr. 1,000 To amortize patent costs 8-45 P4 Types of Intangibles Copyrights The exclusive right to publish and sell a musical, literary, or artistic work during the life of the creator plus 70 years. Leaseholds The rights the lessor grants to the lessee under the terms of a lease. Most leases have a determinable life. 8-46 P4 Types of Intangibles Leasehold Improvements A lessee may pay for alterations or improvements to the leased property such as partitions, painting, and storefronts. These costs are usually amortized over the term of the lease. Franchises and Licenses The right granted by a company or the government to deliver a product or service under specified conditions. Trademarks and Trade Names A symbol, name, phrase, or jingle identified with a company, product, or service. 8-47 P4 Goodwill Goodwill Occurs when one company buys another company Only purchased goodwill is an intangible asset Goodwill is not amortized. It is tested each year to determine if there has been any impairment in carrying value. 8-48 A1 Total Asset Turnover Total asset turnover = Net sales Average total assets Provides information about a company’s efficiency in using its assets 8-49 End of Chapter 08 8-50 Financial Accounting John J. Wild Sixth Edition McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 09 Reporting and Analyzing Current Liabilities Conceptual Learning Objectives C1: Describe current and long-term liabilities and their characteristics. C2: Identify and describe known current liabilities. C3: Explain how to account for contingent liabilities. 9-3 Analytical Learning Objectives A1: Compute the times interest earned ratio and use it to analyze liabilities. 9-4 Procedural Learning Objectives P1: Prepare entries to account for short-term notes payable. P2: Compute and record employee payroll deductions and liabilities. P3: Compute and record employer payroll expenses and liabilities. P4: Account for estimated liabilities, including warranties and bonuses. P5: Appendix 9A – Identify and describe the details of payroll reports, records, and procedures (see text for details). 9-5 C1 Defining Liabilities Because of a past event . . . Past The company has a present obligation Present . . . For future sacrifices Future 9-6 C1 Classifying Liabilities Current Liabilities Long-Term Liabilities Expected to be paid within one year or the company’s operating cycle, whichever is longer Expected not to be paid within one year or the company’s operating cycle, whichever is longer 9-7 C1 Uncertainty in Liabilities Uncertainty in whom to pay Uncertainty in when to pay Uncertainty in how much to pay 9-8 C2 Known Liabilities Accounts Payable Sales Taxes Payable Unearned Revenues Short-Term Notes Payable Payroll Liabilities Multi-Period Known Liabilities 9-9 Note Given to Extend Credit Period P1 On August 1, 2011, Matrix, Inc. asked Carter Co. to accept a 90-day, 12% note to replace its existing $5,000 account payable to Carter. Matrix would make the following entry: Aug 1 Accounts Payable - Carter Notes Payable - Carter DR 5,000 CR 5,000 To replace customer account with note 9-10 C2 Sales Taxes Payable On May 15, 2011, Max Hardware sold building materials for $7,500 that are subject to a 6% sales tax. DR 7,950 May 15 Cash Sales Sales Taxes Payable CR 7,500 450 To record cash sales and 6% sales tax. $7,500 × 6% = $450 9-11 C2 Unearned Revenues On May 1, 2011, A-1 Catering received $3,000 in advance for catering a wedding party to take place on July 12, 2011. May 1 DR 3,000 Cash Unearned Revenue - Catering CR 3,000 To record advance payment. Jul 12 Unearned Revenue - Catering Revenue - Catering DR 3,000 CR 3,000 To recognize revenue received in advance 9-12 P1 Note Given to Extend Credit Period On October 30, 2011, Matrix, Inc. pays the note plus interest to Carter. Oct 30 Notes payable - Carter Interest expense Cash 5,000 150 5,150 To record payment of note and interest Interest expense = $5,000 × 12% × (90 ÷ 360) = $150 9-13 P1 Note Given to Borrow from Bank PROMISSORY NOTE $20,000 Face Value Ninety days after date Sept. 1, 2011 Date promise to pay to the order of I American Bank Nashville, TN Twenty thousand and no/100 - - - - - - - - - - - - - - - - - Dollars plus interest at the annual rate of 6% . Jackson Smith 9-14 Face Value Equals Amount Borrowed P1 On September 1, 2011, Jackson Smith borrows $20,000 from American Bank. The note bears interest at 6% per year. Principal and interest are due in 90 days (November 30, 2011). Sep 1 Cash Notes payable DR 20,000 CR 20,000 To record note to American Bank 9-15 P1 Face Value Equals Amount Borrowed On November 30, 2011, Smith would make the following entry: Notes payable Interest expense Cash DR 20,000 300 CR 20,300 To record payment of note and interest $20,000 × 6% × (90 ÷ 360) = $300 9-16 End-of-Period Adjustment to Notes P1 Note Date End of Period Maturity Date An adjusting entry is required to record interest expense incurred to date. 9-17 End-of-Period Adjustment to Notes P1 Dec. 16, 2011 Note Date Dec. 31, 2011 End of Period Feb. 14, 2012 Maturity Date James Burrows borrowed $8,000 on Dec. 16, 2011, by signing a 12%, 60-day note payable. 9-18 P1 End-of-Period Adjustment to Notes On December 16, 2011, James Burrows would make the following entry: Dec 16 Cash 8,000 Notes payable 8,000 To record amount borrowed from bank On December 31, 2011, the adjustment is: Dec 31 Interest expense Interest payable DR 40 CR 40 To accrue interest on note $8,000 × 12% × (15 ÷ 360) = $40 9-19 P1 End-of-Period Adjustment to Notes On February 14, 2012, James Burrows would make the following entry. Feb 14 Notes payable Interest payable Interest expense Cash DR 8,000 40 120 CR 8,160 To record payment of note $8,000 × 12% × (45 ÷ 360) = $120 9-20 P2 Payroll Liabilities Employers incur expenses and liabilities from having employees. 9-21 P2 Employee Payroll Deductions Gross Pay FICA Taxes Medicare Taxes Federal Income Tax State and Local Income Taxes Voluntary Deductions Net Pay 9-22 P2 Employee FICA Taxes Federal Insurance Contributions Act (FICA) FICA Taxes — Soc. Sec. FICA Taxes — Medicare 2010: 6.2% of the first $106,800 earned in the year ( Max = $6,622). 2010: 1.45% of all wages earned in the year. Employers must pay withheld taxes to the Internal Revenue Service (IRS). 9-23 P2 Employee Income Tax Federal Income Tax State and Local Income Taxes Amounts withheld depend on the employee’s earnings, tax rates, and number of withholding allowances. Employers must pay the taxes withheld from employees’ gross pay to the appropriate government agency. 9-24 P2 Employee Voluntary Deductions Voluntary Deductions Amounts withheld depend on the employee’s request. Examples include union dues, savings accounts, pension contributions, insurance premiums, and charities. Employers owe voluntary amounts withheld from employees’ gross pay to the designated agency. 9-25 P2 Recording Employee Payroll Deductions The entry to record payroll expenses and deductions for an employee might look like this. DR 4,000 CR Jan. 31 Salaries Expense FICA - Social Security Tax Payable FICA - Medicare Tax Payable Employee Federal Income Tax Payable Employee Medical Insurance Payable Employee Union Dues Payable 248 58 420 48 100 Accrued Salaries Payable 3,126 To record accrued payroll for January $4,000  6.2% = $248 $4,000  1.45% = $58 9-26 P3 Employer Payroll Taxes FICA Taxes Medicare Taxes Federal and State Unemployment Taxes Employers pay amounts equal to that withheld from the employee’s gross pay. 9-27 P3 Federal and State Unemployment Taxes Federal Unemployment Tax (FUTA) State Unemployment Tax (SUTA) 2010: 6.2% on the first $7,000 of wages paid to each employee (A credit up to 5.4% is given for SUTA paid, therefore the net rate is .8%.) 2010: Basic rate of 5.4% on the first $7,000 of wages paid to each employee (Merit ratings may lower SUTA rates.) 9-28 P3 Recording Employer Payroll Taxes The entry to record the employer payroll taxes for January might look like this: FICA amounts are the same as that withheld from the employee’s gross pay. SUTA: $4,000  5.4% = $216 FUTA: $4,000  (6.2% - 5.4%) = $32 Jan. 31 Payroll Taxes expense FICA - Social Security Tax Payable FICA - Medicare Tax Payable State Unemployment Taxes Payable Federal Unemployement Taxes Payable DR 554 CR 248 58 216 32 To record employer payroll taxes for January 9-29 P3 Multi-Period Known Liabilities Often include unearned revenues and notes payable. Unearned revenues from magazine subscriptions often cover more than one accounting period. A portion of the earned revenue is recognized each period and the unearned revenue account is reduced. Notes payable often extend over more than one accounting period. A three-year note payable would be classified as a current liability for one year and a long-term liability for two years. 9-30 P4 Estimated Liabilities An estimated liability is a known obligation of an uncertain amount, but one that can be reasonably estimated. 9-31 P4 Health and Pension Benefits Employer expenses for pensions or medical, dental, life, and disability insurance Assume an employer agrees to pay an amount for medical insurance equal to $8,000, and contribute an additional 10% of the employees’ $120,000 gross salary to a retirement program. Jan. 31 Employee Benefits Expense Employee Medical Insurance Payable Employee Retirement Program Payable DR 20,000 CR 8,000 12,000 To record employee benefit costs 9-32 P4 Vacation Benefits Employer expenses for paid vacation by employees Assume an employee earns $62,400 per year and earns two weeks of paid vacation each year. $62,400 ÷ 52 weeks = $1,200 $62,400 ÷ 50 weeks = $1,248 Weekly vacation benefit $ 48 Jan. 5 Vacation Benefits Expense Vacation Benefits Payable 48 48 To record weekly vacation for one employee 9-33 P4 Bonus Plans Many bonuses paid to employees are based on reported net income. Assume the annual yearly bonus to the store manager is equal to 10% of the company’s annual net income minus the bonus. The store earned $100,000 net income this year. B B 1.10B B = 0.10 × ($100,000 - B) = $10,000 - 0.10B = $10,000 = $9,091 (rounded) 9-34 P4 Bonus Plans Many bonuses paid to employees are based on reported net income. Assume the annual yearly bonus to the store manager is equal to 10% of the company’s annual net income minus the bonus. The store earned $100,000 net income this year. Dec. 31 Employee Bonus Expense Bonus Payable DR 9,091 CR 9,091 To accrue annual bonus to manager 9-35 P4 Warranty Liabilities Seller’s obligation to replace or correct a product (or service) that fails to perform as expected within a specified period. To conform with the matching principle, the seller reports expected warranty expense in the period when revenue from the sale is reported. A dealer sells a car for $32,000, on December 1, 2011, with a warranty for parts and labor for 12 months, or 12,000 miles. The dealership experiences an average warranty cost of 3% of the selling price of each car. 9-36 P4 Warranty Liabilities A dealer sells a car for $32,000, on December 1, 2011, with a warranty for parts and labor for 12 months, or 12,000 miles. The dealership experiences an average warranty cost of 3% of the selling price of each car. Dec. 1 Warranty Expense Estimated Warranty Liability DR 960 CR 960 To accrue estimated warranty expense On February 15, 2012, parts of $200 and labor of $250 covered under warranty were incurred. Feb. 15 Estimated Warranty Liability Auto Parts Inventory Salaries Payable To record warranty costs DR 450 CR 200 250 9-37 C3 Contingent Liabilities Potential obligation that depends on a future event arising out of a past transaction or event. Amount . . . Probability of future sacrifice . . . Reasonably Probable Possible Remote Can be Estimated Record the contingent liability. Disclose the liability in the No notes to the action. financial stmts. Disclose the Disclose the Cannot be liability in the Estimated notes to the liability in the notes to the financial stmts. financial stmts. No action. 9-38 C3 Accounting for Contingent Liabilities 9-39 C3 Reasonably Possible Contingent Liabilities Potential Legal Claims – A potential claim is recorded if the amount can be reasonably estimated and payment for damages is probable. Debt Guarantees – The guarantor usually discloses the guarantee in its financial statement notes. If it is probable that the debtor will default, the guarantor should record and report the guarantee as a liability. 9-40 A1 Times Interest Earned Times interest = earned Income before interest and income taxes Interest expense If income before interest and taxes varies greatly from year to year, fixed interest charges can increase the risk that an owner will not earn a positive return and be unable to pay interest charges. 9-41 End of Chapter 09 9-42