Solutions to Chapter 1 1St Version

Chapter 1

Role of Accounting in Starting a Business

ANSWERS TO QUESTIONS

A sole proprietorship is a business owned by one individual. It is relatively inexpensive to form a sole proprietorship, but the owner is personally liable for all debts of the business.

A partnership is legally similar to a sole proprietorship, but has two or more owners of the business.

Unlike proprietorships and partnerships, a corporation is a separate entity both legally and from an accounting perspective. Although it is much more expensive to form a corporation than a partnership or sole proprietorship, two major advantages of a corporation are that (1) owners cannot be held responsible for debts that are greater than their investment in the company and (2) shareholders can sell their shares at any time if they wish to leave the business.

2.Accounting is an information system that collects and processes (analyzes, measures, and records) information about an organization and communicates that information to decision makers both inside and outside the organization.

3.Financial accounting involves preparation of the four basic financial statements and related disclosures for external decision makers. Managerial accounting involves the preparation of detailed plans and continually updated performance reports for internal decision makers.

Accountants employed by a single business or nonprofit organization are in private accounting. Accountantswho charge fees for services to a variety of businesses and nonprofit organizations are in public accounting.

4.Financial reports are used by both internal and external groups and individuals. The internal groups are comprised of the various managers of the entity. The external groups include the owners, investors, creditors, governmental agencies, other interested parties, and the public at large.

5.Assets = Liabilities + Owner’s Equity

Assets are the measurable economic resources owned by the business that are likely to provide future benefits to the firm. Liabilities are the measurable and probable obligations that require the business to pay goods or services to others in the future. Owner’s Equity is the difference between the assets the business owns and the liabilities that the business owes.

6.Revenues – Expenses = Net Income (or net loss)

Revenues are the amounts earned when goods or services are delivered to customers. Expenses are the dollar amount of resources used by an entity to generate revenues during the period. Net income and net loss are defined in the next question.

7.Net income is the positive difference between revenues earned during a period and the expenses that were incurred to generate the revenues during the period. Net loss is the result when expenses exceed revenues during the period.

8.Beginning Owner’s Equity + Additional Investments – Withdrawals + Net Income (or – net loss) = Ending Owner’s Equity

Beginning and Ending Owner’s Equity is the difference between the assets the business owns and the liabilities the business owes at the beginning and ending of the accounting period, respectively. Additional investments is the amount of additional money that the owner invested in the business during the period, while withdrawals represent money that the owner withdrew from the business. Net income and net loss were defined in the previous question.

9. +/- Cash from Operating Activities

+/- Cash from Investing Activities

+/- Cash from Financing Activities

Change in cash during the period

+ Cash at beginning of period

Cash at end of period

Cash from operating activities is the cash received and used in running the business to earn profit. Cash from investing activities is the cash received and used in buying and selling productive resources with long lives. Cash from financing activities is cash received and used in financing the business itself, such as through bank loans or additional investments/withdrawals by owners.

10.(a)The purpose of the balance sheet is to report the financial position of an entity at a point in time – information about the assets, obligations, and owners’ equity of the entity as of a specific date.

(b)The purpose of the income statement is to present information about the revenues, expenses, and net income (or loss) of the entity for a specified period of time.

(c)The statement of owner’s equity reports the changes in owner’s equity during the period from any additional amounts invested, earnings, and any amounts withdrawn.

(d) The purpose of the statement of cash flows is to present information about the flow of cash into the entity (sources), the flow of cash out of the entity (uses), and the net increase or decrease in cash during the period.

11.The heading of each of the four required financial statements should include the following:

(a) Name of the entity

(b) Name of the statement

(d) Unit of measure

12.The purpose of the notes to the financial statements is to provide information to help those who study the statements to understand how the amounts were measured and what additional relevant information may affect their decisions.

13.The Securities and Exchange Commission (SEC) is the U.S. government agency that supervises the work of the Financial Accounting Standards Board (FASB) and Public Company Accounting Oversight Board (PCAOB). The Financial Accounting Standards Board (FASB) is the private sector body given the primary responsibility for setting detailed rules of accounting which become generally accepted accounting principles.

14.Ethical dilemmas in accounting arise when managers and owners decide between reporting fraudulently or accurately in the face of personal greed and the desire to appear successful. Ethical dilemmas harm many: employees, the business’ reputation, the corporation’s stock price, lenders, and the public in general.

Authors' Recommended Solution Time

(Time in minutes)

Mini-exercises / Exercises / Problems / Skill Development Cases
No. / Time / No. / Time / No. / Time / No. / Time
1 / 3 / 1 / 12 / PA1-1 / 45 / 1 / 20
2 / 3 / 2 / 12 / PA1-2 / 45 / 2 / 20
3 / 5 / 3 / 12 / PA1-3 / 45 / 3 / *
4 / 3 / 4 / 20 / PA1-4 / 45 / 4 / 30
5 / 3 / 5 / 25 / PA1-5 / 45 / 5 / 20
6 / 3 / 6 / 20 / PA1-6 / 45 / 6 / 60
7 / 5 / 7 / 15 / PB1-1 / 45
8 / 5 / 8 / 25 / PB1-2 / 45
9 / 5 / 9 / 25 / PB1-3 / 45
10 / 3 / 10 / 30 / PB1-4 / 45
11 / 6 / 11 / 15 / PB1-5 / 45
12 / 3 / 12 / 20 / PB1-6 / 45
13 / 10 / 13 / 12
14 / 30
15 / 30
16 / 15
17 / 20

* Due to the nature of this project, it is very difficult to estimate the amount of time students will need to complete the assignment. As with any open-ended project, it is possible for students to devote a large amount of time to these assignments. While students often benefit from the extra effort, we find that some become frustrated by the perceived difficulty of the task. You can reduce student frustration and anxiety by making your expectations clear. For example, when our goal is to sharpen research skills, we devote class time discussing research strategies. When we want the students to focus on a real accounting issue, we offer suggestions about possible companies or industries.

MINI-EXERCISES

M1–1

Firm type

B / (1) Manufacturing business
C / (2) Merchandising business
A / (3) Service business

M1–2

B / (1)Sole proprietorship
A / (2)Partnership
C / (3)Corporation

M1–3

1.)The primary internal users are a company’s managers and owner/managers (sole proprietors and partners)who make business decisions affecting the operating, investing, and financing activities of the organization.

2.)The primary external users are bankers, suppliers, governments, and owners (stockholders in corporations) who are not directly involved in the business but make decisions such as whether to lend the firm money, whether to extend credit to the firm, how much to collect in taxes from the firm, and whether to invest additional money in the firm as well as evaluate how current investments are doing.

M1–4

L / (1)Accounts Payable
A / (2)Accounts Receivable
A / (3)Cash
E / (4)Cost of Goods Sold
A / (5)Buildings
E / (6)Interest Expense
A / (7)Inventories
E / (8)Selling and Administrative Expenses
R / (9)Sales Revenue
L / (10)Notes Payable

M1–5

A / (1)Inventories
L / (2)Accounts payable
R / (3)Sales revenue
A / (4)Property and equipment
L / (5)Notes payable
OE / (6)Owner’s capital
A / (7)Accounts receivable
A / (8)Cash
E / (9)Promotion expense
E / (10)Cost of goods sold

M1–6

Element

/ Financial Statement
B / (1) Expenses / A. Balance sheet
D / (2) Cash flows from investing activities / B. Income statement
A / (3) Assets / C. Statement of owner’s equity
C* / (4) Withdrawals / D. Statement of cash flows
B / (5) Revenues
D / (6) Cash flows from operating activities
A / (7) Liabilities
D / (8) Cash flows from financing activities

*Withdrawals paid in cash are also subtracted in the Financing section of the Statement of Cash Flows

M1–7

The Tea Room

Income Statement

For the year ended December 31, 2010

M1–8

M1–9

The Tea Room

Balance Sheet

December 31, 2010

Assets / $180,000
Total assets / $180,000
Liabilities / $ 30,000
Owner’s Equity / 150,000
Total liabilities and owner’s equity / $180,000

M1–10

Assets / = / Liabilities / + / Owner’s Equity
Example: Borrowed $30,000 from a bank. / Cash +30,000 / Notes
Payable +30,000
a. Received $10,000 contribution from owner, Alecia Simpson. / Cash +10,000 / A. Simpson, Capital +10,000
b. Purchased a $4,000 computer for use in the business on account. / Equipment +4,000 / Accounts
Payable +4,000
c. Provided $22,000 of service to customers for cash. / Cash +22,000 / Service
Revenue+22,000
d. Paid employees $15,000 cash. / Cash -15,000 / Salaries
Expense -15,000
e. Withdrew $1,200 cash from the profits of the business. / Cash -1,200 / A. Simpson, Drawing -1,200

M1–11

Abbreviation Full Designation

(1)
(2)
(3)
(4) / CPA
GAAP
FASB
SEC / Certified Public Accountant.
Generally Accepted Accounting Principles.
Financial Accounting Standards Board.
Securities and Exchange Commission.

M1–12

1.)This is an example of an ethical dilemma. The government will be harmed because an insufficient amount of tax revenue will be collected from the client, which will in turn harm the public as well.

2.)This is an example of an ethical dilemma. Both of you will be harmed if you are caught, but you will be harmed regardless of whether you are caught because without doing the homework for yourself you lose an opportunity to learn the material.

3.)This is an example of an ethical dilemma. The owner(s) of the store will be harmed because of lost revenue, and both you and your manager will likely lose your jobs if you are caught.

M1–13

Private / 1. Preparing financial statements for external users.
Public / 2. Consulting
Private / 3. Cost accounting.
Public / 4. Auditing by CPA.
Private / 5. Internal auditing.
Both / 6. Reviewing financial information for compliance with generally
accepted accounting principles.

EXERCISES

E1–1

Partnership (P)

Sole proprietorship (S)

Corporation (C)

Sole proprietorship (S)

E1–2

Case / Total Revenues / - / Total Expenses / = / Net Income or (Loss) / Total Assets / = / Total Liabilities / + / Owner’s Equity
A / $100,000 / - / $82,000 / = / $18,000 / $150,000 / = / $70,000 / + / $80,000
B / 92,000 / - / 80,000 / = / 12,000 / 112,000 / = / 52,000 / + / 60,000
C / 80,000 / - / 86,000 / = / (6,000) / 104,000 / = / 26,000 / + / 78,000
D / 50,000 / - / 37,000 / = / 13,000 / 99,000 / = / 22,000 / + / 77,000
E / 75,000 / - / 81,000 / = / (6,000) / 101,000 / = / 73,000 / + / 28,000

E1–3

SOE, B/S /

1. Total owners’ equity

I/S /

2. Sales Revenue

B/S /

3. Total assets

SCF /

4. Cash flows from operating activities

B/S /

5. Total liabilities

I/S, SOE /

6. Net income

SCF /

7. Cash flows from financing activities

E1–4

A / (1)Inventories / L / (6) Notes Payable
L / (2)Accounts Payable / OE / (7) Owners’ Capital
E / (3)Income Tax Expense / E / (8) Cost of Goods Sold
A / (4)Equipment / E / (9) Selling and Administrative Expense
A / (5)Accounts Receivable / R / (10)Sales Revenue

E1–5

L / (1)Accounts Payable / A / (7)Cash
A / (2)Accounts Receivable / A / (8)Machinery
L / (3)Wages Payable / E / (9)Promotion and Advertising Expenses
OE / (4)Owners’ Capital / R / (10)Sales Revenue
E / (5)Income Tax Expense / L / (11)Notes Payable to Banks
A / (6)Inventory / E / (12)Selling and Administrative Expenses

E1–6

Req. 1

Clay Company
Income Statement
For the Month Ended January 31, 2010
Revenue:
Service Revenue / $130,000
Expenses:
Wages Expense / 15,000
Other Expenses / 80,000
Net income / $ 35,000
Clay Company
Statement of Owner's Equity
For the Month Ended January 31, 2010
J. Clay, Capital, January 1, 2010 / $ 0
Add: Additional investments by owner / 26,000
Net income / 35,000
Less: J. Clay, Drawing / (0)
J. Clay, Capital, January 31, 2010 / $ 61,000
Clay Company
Balance Sheet
At January 31, 2010
Assets
Cash / $ 30,000
Accounts Receivable / 15,000
Supplies / 42,000
Total Assets / $ 87,000
Liabilities
Accounts Payable / $ 26,000
Total liabilities / 26,000
Owner's Equity
J. Clay, Capital / 61,000
Total liabilities and owner's equity / $ 87,000

Req. 2

Clay Company should be able to pay its liabilities because its cash balance is $30,000 and its liabilities are only $26,000.
E1–7

Lucas Rock Company
Income Statement
For the Year Ended December 31, 2011
(in thousands)
Revenue / $ 10,500
Expenses / 9,200
Net income / $ 1,300

Lucas Rock Company
Statement of Owner's Equity
For the Year Ended December 31, 2011
(in thousands)
L. Rock, Capital, January 1, 2011 / $ 3,500
Add: Additional investments by
owner / 150
Net income / 1,300
Less: L. Rock, Drawings / (500)
L. Rock, Capital, December 31, 2011 / $ 4,450

Lucas Rock Company
Balance Sheet
At December 31, 2011
(in thousands)
Assets / $ 18,200
Total Assets / $ 18,200
Liabilities and Owner’s Equity
Total liabilities / $ 13,750
L. Rock, Capital / 4,450
Total liabilities and owner's equity / $ 18,200

E1–7 (continued)

Lucas Rock Company
Statement of Cash Flows
For the Year Ended December 31, 2011
(in thousands)
Cash flows from operating activities / $ 1,600
Cash flows from investing activities / (1,000)
Cash flows from financing activities / (900)
Change in cash / (300)
Cash at January 1, 2011 / 1,000
Cash at December 31, 2011 / $ 700

E1–8

Req. 1

FedEx
Income Statement
For the Year Ended May 31, 2007
(in millions)
Revenue:
DeliveryRevenue / $22,527
Expenses:
Salaries Expense / 8,051
Fuel Expense / 2,946
Rent Expense / 1,598
Maintenance and Repairs Expense / 1,440
Other Expenses / 7,241
Total expenses / 21,276
Net income / $ 1,251

Req. 2

FedEx’s largest expense is Salaries Expense.

E1–9

Req. 1

Dave & Buster's Inc.
Balance Sheet
At February 4, 2007
(in millions)
Assets
Cash / $ 10
Supplies / 13
Property and Equipment / 317
Other Assets / 167
Total Assets / $ 507
Liabilities
Accounts Payable / $ 19
Notes Payable / 254
WagesPayable / 46
Other Liabilities / 91
Total liabilities / 410
Owners’ Equity
Owners’Capital / 97
Total liabilities and owner's equity / $ 507

Req. 2

Dave & Buster’s largest asset is its property and equipment.

Req. 3

Most of the financing for assets come from creditors($410 millionin liabilities vs. $97 million in owners’ equity)

E1–10

Req. 1