Solutions Manual For Principle of Accounting and Finance by Peter Carey

Chapter 1
Accounting in Action
ANSWERS TO QUESTIONS
1.
Yes, this is correct. Virtually every organisation and person in our society
uses accounting information. Businesses, investors, creditors, government
agencies, and not-for-profit organisations must use accounting information to
operate effectively. We can group these users into 2 types: internal and
external usersInternal users who include managers require
specific
information about the day to day operations of the organization whilst
external users who include shareholders, banks, creditors, regulators require
less detailed financial information which focuses on their specific needs.
2.
Accounting is the process of identifying, recording, and communicating the

economic events of an entity to interested users of the information. The first
step of the accounting process is therefore to identify events that are: (a)
considered evidence of economic activity and (b) relevant to a particular
business entity. Once identified and measured, the events are recorded to
provide a permanent history of the financial activities of the entity. Recording
consists of keeping a chronological diary of these measured events in an
orderly and systematic manner. The information is communicated through
the preparation and distribution of accounting reports, the most common of
which are called financial reports. A vital element in the communication
process is the accountants ability and responsibility to analyse and interpret
the reported information.
3.
(a)
(b)
4.
(a)
(b)
Internal users are those who manage the business and therefore are
officers and other decision makers.
To assist management, accounting provides internal reports. Examples
include financial comparisons of operating alternatives, projections of
income from new sales campaigns, and forecasts of cash needs for the
next year.
Investors (owners) use accounting information to make decisions to buy,
hold or sell shares.
Creditors use accounting information to evaluate the risks of granting
credit or lending money.
5.
Bookkeeping usually involves only the recording of economic events and

therefore is just one part of the entire accounting process. It involves score
keeping. Accounting, on the other hand, involves the entire accounting
process, including identifying, measuring, recording, and communicating and
therefore focuses on attention directing and problem solving activities.
6.
Jack Jones Travel Agency should report the land at $85 000 on its 31
December 2007 balance sheet. An important concept that accountants follow
is the cost principle. The cost principle states that assets should be recorded
at their historical cost. Cost has an important advantage over other
valuations: it is reliable and faithfully represents what the entity paid for the
land. Cost can be objectively measured and can be verified. (Developments
Principles of Accounting and Finance
2-1
Accuracy checked
in accounting standards now allow us an alternative to cost to show the lands

value at fair value presumably ($93 000)).This alternative measurement
system presumably provides more relevant information for users for
investment decision making.
7.
The monetary unit assumption requires that only transaction data capable of
being expressed in terms of money should be included in the accounting
records. An important part of the monetary unit assumption is the added
assumption that the unit of measurement remains sufficiently constant over
time. The assumption of a stable monetary unit has been challenged because
of the significant decline in the purchasing power of the dollar.
8.
The economic entity assumption requires that the activities of the entity be
kept separate and distinct from the activities of its owners and all other
economic entities. The implication of this assumption include drawings being
treated as a deduction from the owners entitlements rather than a cost
incurred in earning income. Owners equity is shown in the balance sheet
separately from outside claims (liabilities).
9.
The three basic forms of business organisations are: (1) proprietorship, (2)
partnership, and (3) company.
10.
One of the advantages Teresa Bono would enjoy is that ownership of a

company is represented by transferable shares. This would allow Teresa to
raise money easily by selling a part of her ownership in the company. Also,
because ownership can be transferred without dissolving the company, the
company enjoys an unlimited life. Another advantage is that because holders
of the shares (shareholders) enjoy limited liability, they are not personally
liable for the debts of the company.
11.
The basic accounting equation is Assets = Liabilities + Owners Equity.
12.
(a)
(b)
Assets are resources controlled by an entity. Liabilities are claims

against assets. Put more simply, liabilities are existing debts and
obligations. Owners equity is the owners claim on total assets.
Owners equity is affected by owners investments, drawings, income
and expenses (Net profit or loss).
13.
The liabilities are: (b) Accounts payable and (g) Salaries payable.
14.
Yes, an entity can enter into a transaction in which only the left side (Asset
Side) of the basic accounting equation is affected. An example would be a
transaction where an increase in one asset is offset by a decrease in another
asset. An example is if equipment is purchased, an increase in the Equipment
account which is offset by a decrease in the Cash.
15.
Business transactions are the economic events of the entity recorded by

accountants because they affect the basic equation.
(a)
(b)
(c)
The death of the owner of the company is not a business transaction as it

does not affect the basic equation.
Supplies purchased on account is a business transaction as it affects the
basic equation.
An employee being fired is not a business transaction as it does not affect
the basic equation.
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Accuracy checked
(d)
16.
A withdrawal of cash from the business is a business transaction as it

affects the basic equation.
Corporate governance is the system in which entities are directed or controlled,

managed and administered. Corporate governance helps ensure that the goals
and hence the decision made by management are aligned with those of the
shareholders.
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Accuracy checked
17.
The principles of corporate governance still apply to small business. Those

principles, monitoring and assessing risk, optimizing performance, creating
value and providing accountability still apply to small businesses but the risk of
companies objectives not equating to owners is less likely in small business
There is no separation of ownership from control in these organizations and the
goals and hence decisions made by management should be aligned with the
owners.
18.
ASXCGC principles and recommendations capitulate best business practice.

While these principles do not have a legal backing, much of their contents
are covered by current legislations. Eg. Insider trading, mandatory audit
committee. The top 500 companies are required to follow these principles,
and if they opt not to, they must provide reasons for non-compliance.
19.
Corporate social responsibility reporting can lead to increased capital

investment by ethical investors who see such companies as a worthwhile
investment due to their social and environment responsibility as well as
providing them with competitive returns. Such companies may be seen to
attract increased revenues from ethical customers who buy from these
companies on the basis of their awareness of their social responsibilities.
Difficulties of social responsibility reporting include lack of benchmarks,
difficulties in quantifying non financial information and costs involved with
the gathering of such data.
20.
The three components of triple bottom line reporting are:

(i)
(ii)
(iii)
(i)
(ii)
(iii)
Social bottom line

Environment bottom line
Economic bottom line
Social bottom line includes how the entity deals with issues such as
employee working conditions, safety and security and the entities
support and contribution to community services
Environment bottom line looks at how an entity is products or
operations impact on the environment
Economic bottom line refers to the entities profitability and business
strategy as reflected in the financial reports.
21.
Information on environmental and social matters is considered important to

users for assessing whether an organization is being socially and
environmentally responsible. This information can influence users when
making an important decision such as whether to invest, lend, supply or buy
products from this organization.
22.
(a)
(b)
23.
Generally accepted accounting principles (GAAP) are a set of

standards and rules, having substantial authoritative support, that are
recognised as a general guide for financial reporting.
The bodies that provide authoritative support for GAAP are the
Australian Accounting Standards Board (AASB) and the Australian and
Securities Investments Commission (ASIC).
The framework consists of the following:

(1)
Objectives of financial reporting.
2-4
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(2)
(3)
(4)
24.
(a)
(b)
Qualitative characteristics of accounting information.

Elements of financial statements.
Concepts of capital and capital maintenance.
According to the framework, the objectives of financial reporting are to
provide information that: (1) is useful to those making economic
decisions, (2) to show the results of the stewardship of management
or the accountability of management for the resources entrusted to it.
The qualitative characteristics are: (1) relevance, (2) faithful
representation,
(3)
comparability,
(4)
understandability,
(5)
verifiability, and (6) timeliness.
25.
Income should generally be recognised in the accounting period in which it is

earned (not received). The sales basis involves an exchange transaction
between the seller and buyer and the sales price provides an objective
measure of the amount of sales income realised.
26.
Income from layby sales is recognised when the goods are delivered. However,
if experience indicates that most such sales are consummated, sales revenue
can be recognised when a significant deposit is received provided the goods are
on hand, identified and ready for delivery to the buyer.
27.
Initially, the subscription received in advance should be recognized as a liability

(unearned revenue).
If the items involved are of similar value in each time
period (such as a magazine), subscription is recognised on a straight line basis
over the period in which the items are dispatched. If the items are not of similar
value in each time period, subscription is recognised on the basis of the sales
value of the item delivered relative to the total estimated sales value of all
items covered by the subscription.
28.
The two constraints are balancing the benefits and costs of accounting
information and materiality. Balancing the benefits and costs involves using
judgment as to whether the benefits derived from information exceed the cost
of providing it. Some information may be beneficial however the cost of
providing the information would outweigh the benefits and hence the
information may not be required to be provided. Similarly only items that are
considered to be material will be disclosed in the financial statements. An item
is considered to be material if its omission, misstatement or nondisclosure
would likely affect users decisions. In considering whether an item is material
both the nature and/or the amount must be considered. In determining $
values AASB 1031 gives guidelines as:
<5% of an approx base is immaterial
5-10% is a value judgment
>10% is material
29.
Accounting standards are not uniform throughout the world although

considerable progress has been made since the mid/late 1990s in developing
international financial reporting standards that have been accepted by
various countries. For example, Australia and the European Union adopted
IFRS in 2005. Many Asian countries are progressing their move towards IFRS.
The US has committed to converge its standards with IFRS.
30.
Comparability is an enhancing qualitative characteristic of financial

information. With the globalization of reporting entities it is important that
the users of these entities reports can make important decisions based on
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the assumption that consistent and comparable accounting principles are

used throughout the world. This will provide participants in international
capital markets with better quality information on which to base investment
and credit decisions. This is desirable because, all other things being equal,
the more soundly based those decisions, the more likely it will be that funds
are directed to those entities who can use them most productively and that
capital will be appropriately processed for a given level of risk. Due to
globalization of capital markets, the standards should be comparable.
31.
There has been quite a bit of research done in relation to this question, however,
there is no definitive answer. Students may like to consider the following points:
32.
Impact of ones values and upbringing

Impact of religion on ethics
Impact of importance of family
Ones principles and morals
Impact of various codes of conduct
Legal and professional consequences of acting ethically/unethically
Impact of personal reputation and community standing.
For information to be recorded, it must first meet the definition and recognition
criteria associated with the appropriate element in the balance sheet. Is
Intellectual property an Asset to Monash University?
Definition Criteria
Future economic benefits
Yes/No
Yes
Why
Can be sold, enhances
reputation leading to
increase funding and attract
more students.
If Monash has an exclusive
use or control over the
material.
It has been fully developed
Controlled by the entity
Yes
Past transaction
Yes
Recognition Criteria
Probable future economic
benefit
Yes/No
Yes
Why
It is more likely to be sold or
enhance reputation
Can be measured reliably
Yes/No
Yes: If like material has been

sold or purchased
No: If there is no active
market
SOLUTIONS TO BRIEF EXERCISES

BRIEF EXERCISE 1-1
(a)
(b)
(c)
$90 000 $50 000 = $40 000 (Owners Equity).

$45 000 + $70 000 = $115 000 (Assets).
$94 000 $65 000 = $29 000 (Liabilities).
BRIEF EXERCISE 1-2

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Accuracy checked
(a)
(b)
(c)
$100 000 + $232 000 = $332 000 (Total assets).

$190 000 $80 000 = $110 000 (Total liabilities).
$600 000 0.5($600 000) = $300 000 (Owners equity).
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Accuracy checked
BRIEF EXERCISE 1-3

(a)
(b)
(c)
($870 000 + $150 000) ($500 000 $80 000) = $600 000 (Owners equity).
($500 000 + $100 000) + ($870 000 $500 000 $70 000) = $900 000 (Assets).
($870 000 $80 000) ($870 000 $500 000 + $120 000) = $300 000
(Liabilities).
BRIEF EXERCISE 1-4

A
L
A
(a)
(b)
(c)
Accounts receivable
Salaries payable
Equipment
A
OE
L
(d)
(e)
(f)
Office supplies
Owners investment
Notes payable
BRIEF EXERCISE 1-5

(a)
(b)
True
True
BRIEF EXERCISE 1-6

(a)
(b)
(c)
Yes
No
Yes
BRIEF EXERCISE 1-7

(a)
(b)
(c)
Yes
No
Yes
BRIEF EXERCISE 1-8

(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
Predictive
Confirmatory
Substance over form
Accuracy
Understandability
Timeliness
Materiality
Cost versus benefit
BRIEF EXERCISE 1-9

(a)
(b)
(c)
Faithful representation
Comparability
Relevant
BRIEF EXERCISE 1-10

(a)
(b)
(c)
1
2
3
2-8
Accuracy checked
(d) 4
BRIEF EXERCISE 1-11
(a)
For information to be recorded, it must first meet the definition and

recognition criteria associated with the appropriate element in the balance
sheet. Should the money spent on developing a new software be recorded
as an Asset to Microsoft?
Definition Criteria
Future economic benefits
Yes/N
o
Yes
Controlled by the entity
Yes
Past transaction
Yes
benefit
(b)
Yes/N
o
Yes
Yes
Why
Past experience suggests this expenditure has led
to commercial sales, unlike some research and
development expenditure which may not lead to
commercial outcomes.
Assuming Microsoft has got the patent and
exclusive right to the use of this program.
Money has been spent on its development
Why
It is more likely to generate benefits based on the
past experience on development expenditure on
previous Windows programs eg. XP and Vista.
Yes: based on the amount that Microsoft has
spent
For information to be recorded, it must first meet the definition and recognition
criteria associated with the appropriate element in the balance sheet. Would an
organisation report an employees sick leave entitlement?
Definition Criteria
Present obligation
Yes/N
o
Yes
Past event
Yes
Outflow of resources
embodying economic
benefits
Yes

benefit
Yes/N
o
Yes
Yes
Why
Once an employee is contracted the organisation
is legally bound to provide 10 days sick leave per
annum
The employee and the organisation have signed a
written work place agreement
The employee will be paid a salary (cash) to
compensate for days lost due to sickness
Why
It is more likely rather than less likely that an
employee will be sick during the course of the
year
Yes: presumably past data can be sourced to
provide an accurate estimate of the amount
likely, on average ,to be paid to an employee who
claims sick leave
2-9
Accuracy checked
BRIEF EXERCISE 1-12

I)
2)
Increase Cash
Increase Insurance revenue*
Increase Commission Exp **
Increase Commission Payable (L)
$460
$ 460
$46???
$46???
Meets element definition

*
**
Insurance revenue is increased as it represents an increase in an economic benefit

in the form of an increase in an asset (cash) resulting in an increase in equity
other than those relating to contributions from equity participants
Commission expense is increased as it represents an incurrence of a liability
(commission payable) resulting in a decrease in equity ,other than those relating
to distributions to equity participants
Meets recognition criteria

(i)
Measurable The contract will stipulate the insurance to be received and the
commission to be paid
(ii)
Probable Once contract is signed revenue is guaranteed but commission to

be paid may or may not be probable depending upon likelihood of client
renewing their insurance ????
Past data including industry averages could be gathered to provide a likely
commission payable and expense amount to be included in the B/S and P/L
BYP 1-1
(a)
A framework is similar to a constitution in that it is a coherent system of

interrelated objectives and fundamentals that can serve as the basis for
resolving accounting and reporting problems.
(b)
FINANCIAL REPORTING PROBLEM
The conceptual framework covers the general theory of accounting

and is used as the basis for developing specific accounting rules and
regulations.
It is a set of inter-related concepts which define the NATURE, SUBJECT
and BROAD CONTENT of accounting.
ie . a set of broad principles underlying accounting theory.
It comprises SAC1,SAC2 and the Framework. The Framework consists
of Qualitative characteristics of accounting information and the
Elements of financial statements both definition and recognition
criteria.
Prior to a well-developed framework, accounting principles were developed on

a problem-by-problem basis. Thus, rule-making bodies developed and issued
accounting rules and methods to solve specific problems. Critics charged that
the problem-by-problem approach led to inconsistent rules and practices over
time.
Business more complex today.
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May be differences in opinion about how new transactions should be

measured, recorded and disclosed.
Eg Interpretation 13 Customer Loyalty Programs

Interpretation 132 Intangible assets Web Site Costs
Interpretation 1055 Accounting for Road Earthworks
Provides a logical and consistent framework and a clear and agreed

understanding of the nature, purpose and methods of financial
accounting.
The objectives of financial reporting are to provide information that: (1) is
useful to those making economic decisions; and (2) shows the results of
stewardship of management or the accountability of the management for
the resources entrusted to it.
(c)
(d)
Para 26 Objective of GPFRs is to provide information to users for

making and evaluating decisions about the allocation of scarce
resources
Para 27 When these objectives are met also means that management
and governing bodies discharge their accountability to users of the
reports
Generally accepted accounting principles are principles that have substantial

authoritative support. Authoritative support comes from the accounting
regulators and enforcers in countries. For example, in Australia, the AASB
issues accounting rules and the ASIC enforces the rules.
Accounting principles must change to reflect changes in the business
environment and changes in the needs of users of accounting information.
(e)
The qualitative characteristics of accounting are relevance, reliability,

comparability and understandability. Relevance means that the accounting
information must be capable of making a difference in a decision. Reliability
is the quality of information that gives assurance that it is free of error and
bias; it can be depended on. Comparability results when different companies
use the same accounting principles and companies use the same accounting
principles over time. Understandability presumes that users have a reasonable
knowledge of business and economic activities and study the information. As
such, complex financial information should not be excluded.
(f)
The basic assumptions used in accounting are the economic entity assumption,
the monetary unit assumption, the time period assumption, accrual accounting
and the going concern assumption.
(g)
The two major constraints are materiality and the costs/benefit trade-off of
accounting information.
In considering whether an item is material both the nature and/or the amount
must be considered. In determining $ values AASB 1031 gives guidelines as:
<5% of an approx base is immaterial
5-10% is a value judgment
>10% is material
When regulating accounting information it is necessary to consider the costs and
benefits of the regulation. The benefits derived from providing information
should exceed the costs of providing such and this is a judgmental process.
BYP 1-2
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(a)
This answer is based on the information on the website dated 30 Jun 2009.
(b)
Billabong reports on its commitment, social, environment and ethical

responsibilities on its website. It has adopted the Social Accountability 8000
(SA8000) to help it manage workplace conduction throughout its global
supply chain. It also reports on its carbon footprint (CO 2 emission).
(c)
Billabong International Limiteds total assets at 30 June 2008 were $1625.4

million and at 30 June 2007 were $1390.6 million.
(d)
Billabong International Limited had $128 million of cash at 30 June 2008.
(e)
Billabong International Limited had trade and other payable totaling $194
million on 30 June 2008 and $152 million on 30 June 2007.
(f)
Billabong International Limited reports net sales for the last two years as
follows:
2008 $1,347.6 million
2007 $1,222.9 million
(g)
Information obtained from Note 5 of the annual report shows that from 2007
to 2008, Billabongs Profit increased by $9 million: from $167 million to $
176 million.
Please note: these figures are taken from the 2008 Annual Report as an
example. Students are requested to use the most recent report available on
the Billabong International Ltd website.
BYP 1-3
(in millions)
1.
2.
3.
4.
(a)
Total assets
Receivables
Sales of goods
Profit before tax
Billabong International Ltd

$1,625.50
$302.70
$1,347.60
$245.60
Globe International Ltd

$78.50
$21.30
$120.70
($20.90)
Billabong International Ltds total assets were greater than Globe

International Ltds assets, and Billabongs sales were 11 times that of Globe
International Ltds. In addition, Billabongs accounts receivables were
substantially greater than Globe Internationals and represent 22% of its
sales. It would appear that both Globe Internationals accounts receivable
and Billabongs may appear to be too high.
Please note: these figures are taken from the 2008 Annual Report as an
example. Students are requested to use the most recent report available on
the Billabong International Ltd website.
Billabong International Ltd recorded a profit for its most recent year,
whereas Globe International Ltd had a loss year.
BYP 1-4
2-12
Accuracy checked
Nestl follows the International Financial Reporting Standards (IFRS) issued by the
International Accounting Standards Board. Kraft Foods is a US company and follows
the standards issued by the Financial Accounting Standards Board. To the extent
that these standards differ, then comparison may be difficult. Cadbury is an
Australian company and prepares its financial reports in accordance with standards
issued by the Australian Accounting Standards Board. As Australia adopted
International Accounting Standards on 1 January 2005, Australian accounting
standards are equivalent to IFRS.
Nestls financial reports are prepared under the historical cost convention. The
cost principle also underlies US accounting standards. Thus, this would assist
comparison.
2-13
Accuracy checked
The primary concern here relates to the monetary unit assumption. In the US,
financial reports are prepared in terms of US dollars. Nestl prepares its reports in
terms of Swiss francs and Cadbury prepares in terms of the Australian Dollar. While
conversion from francs to dollars is possible, it will not necessarily capture the full
economic situation.
BYP 1-5
(1)
The field is normally divided into three broad areas: audit accounting, tax
and financial accounting, and management accounting.
(2)
The skills required in these areas are:

People skills, sales skills, communication skills, analytical skills, ability to
synthesis, creative ability, initiative, computer skills, and work hours.
(3)
The skills required in these areas differ as follows:
People skills
Sales skills
Communication
skills
Analytical skills
Ability to
synthesise
Creative ability
Initiative
Computer skills
Work hours
(4)
Audit
accounting
Tax and
Financial
Management
Accounting
Medium
Medium
Medium
Medium
Medium
Low
Medium
High
Medium
Very Hgih
High
High
Medium
Low
Medium
High
40-70/week
Low
Medium
Medium
High
40-70/week
High
Medium
Medium
Very High
40-50/week
Some key job functions in accounting:

Auditing: Work in audit involves checking accounting ledgers and financial
statements within entities. This work is becoming increasingly computerized
and can rely on sophisticated random sampling methods. This work allows
you to really understand how entities operate. Its great background!
Financial Accounting and Taxation: Financial accountants prepare financial
reports based on general ledgers and participate in important financial
decisions involving mergers and acquisitions, planning, and long-term
financial projections. This work can be varied over time. One day you may be
running spreadsheets. The next day you may be visiting a customer or
supplier to set up a new account and discuss business. This work requires a
good understanding of both accounting and finance.
Tax accountants prepare corporate and personal income tax statements and
formulate tax strategies involving issues such as financial choice, how to
best treat a merger or acquisition, deferral of taxes, when to expense items
and the like. This work requires a thorough understanding of economics and
2-14
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the relevant tax legislation. Increasingly, large entities are looking for
persons with both an accounting and legal background in tax.
Management Accounting: Management accountants work in companies and
participate in decisions about capital budgeting and line of business
analysis. Major functions include cost analysis, analysis of new contracts,
and participation in efforts to control expenses efficiently. This work often
involves the analysis of the structure of organizations. Is responsibility to
spend money in a company at the right level of our organization? Are goals
and objectives to control costs being communicated effectively? Historically,
many management accountants have been derided as bean counters. This
mentality has undergone major changes as management accountants now
often work side by side with marketing and finance to develop new business.
Note: accounting and finance employees normally earn $82,809-$250,000.
BYP 1-6
(a)The estimated of the $4900 loss was based on the difference between the
$20,000 invested in the tennis clinic and the bank balance of the $15,100 at
30 June. This is not a valid basis for determining profit because it only shows
the change in cash between two points in time.
(b)The statement of financial position at 30 June is as follows:
ACE COACHING CLINIC
Statement of Financial Position
as at 30 June 2010
Assets
$15,1
00
6000
800
$21,9
00
Cash
Club rooms
Equipment
Total assets
Liabilities and Owner's Equity
Liabilities
Accounts payables ($150+$100)
Owner's Equity
Capital
$250
21650
$21,9
00
Total liabilities and owner's equity
(c)Actual profit for June can be determined by adding owners drawings to the
change in owners capital during the month as shown below:
Owner's capital, 30 June, per Statement of
Financial Position
Owner's capital, 1 June
Increase in owner's capital
Add: Drawings
$21, 650
20,000
1,650
800
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Accuracy checked
Profit:
$2,450
Alternatively, profit can be found by determining revenue earned (described

in (d) below) and subtracting expenses.
(d)Revenue earned can be determined by adding expenses incurred during the
month to profit. June expenses were Rent, $1000; Wages, $400; advertising,
$750; and Utilities, $100 for a total of $2250. Revenue earned, therefore,
was $4700 ($2250+$2450). Alternatively, since all revenue is received in
cash, revenue earned can be computed from an analysis of the changes in
cash as follows:
(e)
Beginning cash balance
Less: Cash payments
Club rooms
Tenis racquets
Rent
Advertising
Wages
Drawings
Cash balance before revenue
Cash balance, 30 June
Revenue earned
$20,000
$6,000
$800
$1,000
$600
$400
$800
$9,600
$10,400
$15,100
$4,700
BYP 1-7
To:
From:
Esther Grime
Student
I have received the statement of financial position of Elite Training as at 30 June

2010. A number of items in this statement of financial position are not properly
reported. They are:
1.
2.
3.
4.
5.
Equipment should be shown as an asset and reported below Supplies on the

Statement of financial position.
Accounts receivable should be shown as an asset and reported between
Cash and Supplies on the Statement of financial position.
Accounts payable should be shown as a liability, not an asset. The notes
payable is also a liability, and should be reported in the liability section.
Liabilities and owners equity should be shown on the statement of financial
position of Nancy Twong, Capital and Nancy Twong, Drawings are not
liabilities.
Nancy Twong, Capital and Nancy Twong, Drawings are part of owners equity.
The Drawings account is not reported on the statement of financial position
but is subtracted from Nancy Twong, Capital to arrive at owners equity at
the end of the period.
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Accuracy checked
A correct Statement of financial position is as follows:

ELITE TRAINING
Statement of Financial Position
as at 30 June 2010
Assets
$9,00
0
6000
2000
22500
$39,5
00
Cash
Accounts receivable
Supplies
Equipment
Total assets
Liabilities and Owner's Equity
Liabilities
Notes payables
Accounts payables
Total liabilities
Owner's equity
Nancy Twong, Capital ($23000-2000)
Total liabilities and owner's equity
$10,5
00
8000
18500
21000
$39,5
00
BYP 1-8
(a)
The students should identify all of the stakeholders in the case; that is, all
the parties that are affected, either beneficially or negatively, by the action
or decision described in the case. The list of stakeholders in this case are:
(b)
Geoff Hughes, interviewee.

Both firms
Great Southern University.
The students should identify the ethical issues, dilemmas, or other

considerations pertinent to the situation described in the case. In this case
the ethical issues areas:
Is it proper that Geoff charged both firms for the total travel costs
rather than split the actual amoung of $282 between the two firms?
2-17
Accuracy checked
(c)
Is collecting $564 as reimbursement for total costs of $282 ethical

behavior?
Did Geoff deceive both firms or neither firms?
Each student must answer the question for him/herself. Would you want to
start your first job having deceived your employer before your first day of
work? Would you be embarrassed if either firm found out that you doublecharged? Would the university be embarrassed if your act was uncovered?
Would you be proud to tell your lecturer that you collected your expenses
twice?
2-18
Accuracy checked
BYP 1-9
(a)
Currently carbon emissions disclosures may be voluntary or regulated. This

type of information can be disclosed as part of the annual report, in standalone sustainability reports or in databases as in Carbon Disclosure Project
(http://www.cdproject.net ).
(b)
Other benefits proposed by the authors include:
(c)
Public reporting and verification of emissions will expose organizations

to the pressure of being held accountable to their stakeholders.
May reduce legislative interventions
If well established, reporting and assurance mechanism exist, the
companies are better able to meet their obligations.
This information is from the total population of 2005 annual reports

Level of Disclosure
1. Full disclosure
2. Partial disclosure
3. Initiatives
4. Discussion
5. Mention
No disclosure
(1)
No of companies
7
17
38
6
50
1346
Including emission levels in the financial report section of the annual

report has the advantage that these disclosures would then be subject
to the same level of rigorous assurance as other aspects of the
financial reports. Therefore, auditors are able to comment on such
disclosures if they are included in the annual report section of the
annual report. Hence, auditors can comment on any misleading,
inaccurate or unclear information.
2-19
Accuracy checked
Chapter 2
Cash and accrual accounting and the statement of
cash flows
1.
The law firm should recognise the income in April under accrual accounting. The
income recognition principle states that income should be recognised in the
accounting period in which it is earned.
2.
Information presented on an accrual basis is more useful than on a cash basis

because it reveals relationships that are likely to be important in predicting
future results. To illustrate, under accrual accounting, income is recognised
when earned. Trends in income are thus more meaningful.
3.
Expenses of $4500,should be deducted from the income in April. Under the

matching principle efforts (expenses) should be matched with accomplishments
(income).
4.
A number of factors could have caused an increase in cash despite the net loss.
These are: (1) high cash revenues relative to low cash expenses; (2) sales of
property, plant and equipment; (3) sales of investments; and (4) issue of debt or
shares.
5.
The basic accounting equation is Assets = Liabilities + Owners Equity.
6.
(a)
7.
Yes, an entity can enter into a transaction in which only the left side of the
accounting equation is affected. An example would be a transaction where an
increase in one asset is offset by a decrease in another asset. An increase in
the Equipment account which is offset by a decrease in the Cash account is a
specific example.
8.
(a)
(b)
(c)
(d)
9.
A T-account has the following parts: (a) the title, (b) the left or debit side, and
(c) the right or credit side.
10.
Disagree. The terms debit and credit mean left and right respectively.
11.
John is incorrect. The double-entry system merely records the dual effect of a
transaction on the accounting equation. A transaction is not recorded twice; it is
recorded once, with a dual effect.
Assets are resources controlled by an entity. Liabilities are claims

against assets. Put more simply, liabilities are existing debts and
obligations. Owners equity is the ownership claim on total assets.
(b)
Owners equity is affected by owners investments, drawings, income
and expenses.
Decrease assets and decrease owners equity.

Increase assets and decrease assets.
Increase assets and increase owners equity.
Decrease assets and decrease liabilities.
2-20
Accuracy checked
12.
Kathy is incorrect. A debit balance only means that debit amounts exceed credit
amounts in an account. Conversely, a credit balance only means that credit
amounts are greater than debit amounts in an account. Thus, a debit or credit
balance is neither favorable nor unfavorable.
2-21
Accuracy checked
13.
(a) Asset accounts are increased by debits and decreased by credits.

(b) Liability accounts are decreased by debits and increased by credits.
(c) Income and owners capital are increased by credits and decreased by
debits. Expenses and owners drawings are increased by debits and
decreased by credits.
14.
(a) Accounts Receivable debit balance.

(b) Cash debit balance.
(c) Owners Drawings debit balance.
(d) Accounts Payable credit balance.
(e) Service Revenue credit balance.
(f) Salaries Expense debit balance.
(g) Owners Capital credit balance.
15.
(a)
(b)
(c)
(d)
(e)
16.
(a)
Debit Supplies and credit Accounts Payable.
(b) Debit Cash and credit Notes Payable.
(c) Debit Salaries Expense and credit Cash.
17.
(1)
Cash both debit and credit entries.
(2) Accounts Receivable both debit and credit entries.
(3) Owners Drawings debit entries only.
(4) Accounts Payable both debit and credit entries.
(5) Salaries Expense debits entries only.
(6) Service Revenue credit entries only.
18.
The basic steps in the recording process are:
Accounts Receivable asset debit balance.

Accounts Payable liability credit balance
Equipment asset debit balance.
Owners Drawings owners equity debit balance.
Supplies asset debit balance.
(1) Identify the transaction from source documents, such as receipts, cheque
butts etc.
(2) Analyse each transaction for its effect on the accounts.
(3) Enter the transaction information in a journal (book of original entry).
(4) Transfer the journal information to the appropriate accounts in the ledger
(book of accounts).
19.
The advantages of using the journal in the recording process are:

(1) It discloses in one place the complete effects of a transaction.
(2) It provides a chronological record of all transactions.
(3) It helps to prevent or locate errors because the debit and credit amounts for
each entry can be readily compared.
20.
(a)
(b)
The debit should be entered first.

The credit should be indented.
21.
When three or more accounts are required in one journal entry, the entry is
referred to as a compound entry. An example of a compound entry is the
purchase of equipment, part of which is paid for with cash and the remainder is
on account.
2-22
Accuracy checked
22.
(a)
No, debits and credits should not be recorded directly in the ledger.
(b) The advantages of using the journal are:
1.
2.
3.
It discloses in one place the complete effects of a transaction.

It provides a chronological record of all transactions.
It helps to prevent or locate errors because the debit and credit
amounts for each entry can be readily compared.
23.
The advantage to the last step in the posting process is to indicate that the item
has been posted.
24.
(a)
(b)
(c)
(d)
25.
Cash....................................................................
Albert Darman, Capital.....................................
(Invested cash in the business)
7000
Prepaid Insurance................................................
Cash..................................................................
(Paid one-year insurance policy)
800
Supplies...............................................................
Accounts Payable..............................................
(Purchased supplies on account)
1,000
Cash....................................................................
Service Revenue...............................................
(Received cash for services rendered)
7500
7000
800
1,000
7500
(a)
The entire group of accounts maintained by an entity, including all the

asset, liability, and owners equity accounts, is referred to collectively as
the ledger.
(b)
The chart of accounts is important, particularly for an entity that has a

large number of accounts, because it helps organise the accounts and
identify their location in the ledger. The numbering system used to
identify the accounts usually starts with the balance sheet accounts and
follows with the income statement accounts.
26.
A trial balance is a list of accounts and their balances at a given time. The
primary purpose of a trial balance is to prove the mathematical equality of
debits and credits after all journalised transactions have been posted. A trial
balance also facilitates the discovery and correction of errors in journalising and
posting. In addition, it is useful in preparing financial statements.
27.
No, Joe is not correct. The proper sequence is as follows:

(b) Business transaction occurs.
(c) Information is entered in the journal.
(a) Debits and credits are posted to the ledger.
(e)
Trial balance is prepared.
(d)
Financial statements are prepared.
28.
(a)
(b)
The trial balance would balance.

The trial balance would not balance.
2-23
Accuracy checked

BRIEF EXERCISE 2-1
(a)
(b)
(c)
$90,000, $50,000,= $40,000,(Owners Equity).

$45,000,+ $70,000,= $115,000,(Assets).
$94,000, $65,000,= $29,000,(Liabilities).
BRIEF EXERCISE 2-2

(a)
(b)
(c)
$100,000,+ $232,000,= $332,000,(Total assets).

$190,000, $80,000,= $110,000,(Total liabilities).
$600,000,,0.5($600,000) = $300,000,(Owners equity).
BRIEF EXERCISE 2-3

(a)
(b)
(c)
($870,000,+ $150,000) ($500,000, $80,000) = $600,000,(Owners equity).

($500,000,+ $100,000) + ($870,000, $500,000, $70,000) = $900,000,(Assets).
($870,000, $80,000) ($870,000, $500,000,+ $120,000) = $300,000,
(Liabilities).
BRIEF EXERCISE 2-4

Assets
Liabilities
Owners Equity
+
+
+
NE
NE
NE
+
BRIEF EXERCISE 2-5

(a)
Debit
(b)
Credit
Effect
Accounts Payable
Advertising Expense
Service Revenue
Accounts Receivable
B. C. King, Capital
B. C. King, Drawings
Decrease
Increase
Decrease
Increase
Decrease
Increase
Effect
Increase
Decrease
Increase
Decrease
Increase
Decrease
(c)
Normal
Balan
ce
Credit
Debit
Credit
Debit
Credit
Debit
BRIEF EXERCISE 2-6

June 1
2
3
12
Account Debited
Cash
Equipment
Rent Expense
Accounts Receivable
Account Credited
Kevin Quach, Capital
Accounts Payable
Cash
Service Revenue
2-24
Accuracy checked
BRIEF EXERCISE 2-7

June
1Cash
............................................................4000
Kevin Quach, Capital...........................................
4000
2Equipment...................................................................
Accounts Payable.................................................
900
3Rent Expense / Prepaid Rent........................................

Cash ....................................................................
800
800
12Accounts Receivable..................................................
Service Revenue..................................................
300
900
300
BRIEF EXERCISE 2-8

The basic steps in the recording process are:
1.
Identify the transaction from source documents, such as receipts.
2.
Analyse each transaction. In this step, business documents are examined to

determine the effects of the transaction on the accounts.
3.
Enter each transaction in a journal. This step is called journalising and it results
in making a chronological record of the transactions.
4.
Transfer journal information to ledger accounts. This step is called posting.

Posting makes it possible to accumulate the effects of journalised transactions
on individual accounts.
BRIEF EXERCISE 2-9

(a)
Aug.
Effect on Accounting Equation
Debit-Credit Analysis
The asset Cash is increased;

the owners equity account J.A.
Tan, Capital is increased.
Debits increase assets:

debit Cash $5000.
Credits increase owners equity:
credit J.A. Tan, Capital $5000.
The asset Prepaid Insurance is

increased; the asset Cash is
decreased.

debit Prepaid Insurance $1800.
Credits decrease assets:
credit Cash $1800.
1
6
The asset Cash is increased;

the Income Service Revenue is
increased.

debit Cash $800.
Credits increase Income:
credit Service Revenue $800.
2
7
The expense Salaries Expense

is increased; the asset Cash is
decreased.
Debits increase expenses:

debit Salaries Expense $1,000.
Credits decrease assets:
credit Cash $1,000.
BRIEF EXERCISE 2-10

2-25
Accuracy checked
Aug.
Cash ....................................................................
J. A. Tan, Capital...................................................
5000
Prepaid Insurance.................................................
Cash....................................................................
1800
1800
16
Cash ....................................................................
Service Revenue..................................................
800
Salaries Expense..................................................
Cash....................................................................
1,000
1,000
27
5000
800
BRIEF EXERCISE 2-11

Cash
12/5 A/c Rec
2400,
15/5 Service Rev3000,
Ending bal. 5400,
Accounts Receivable
5/5 Service 6000,
Revenue
Ending bal. 3600,
Service Revenue
5/5
A/c Rec6000
15/5 Cash 3000
Ending bal. 9000
12/5 cash
2400
BRIEF EXERCISE 2-12

Cash
Date
Explanation
May 12 A/c Receivable
15 Service Revenue
Accounts Receivable
Date
Explanation
May 5 Service Revenue
12 Cash
Service Revenue
Date
Explanation
May 5 A/c Receivable
15 Cash
Debit
2400
3000
Credit
Balance
2400
5400
Debit
6000
Credit
2400
Balance
6000
3600
Credit
6000
3000
Balance
6000
9000
Debit
2-26
Accuracy checked
BRIEF EXERCISE 2-13

P. J. COTTON
Trial Balance
as at 30,June 2010
Debit
Cash........................................................................................
Accounts Receivable................................................................
Equipment...............................................................................
Accounts Payable....................................................................
P. J. Cotton, Capital..................................................................
P. J. Cotton, Drawings...............................................................
Service Revenue......................................................................
Salaries Expense.....................................................................
Rent Expense...........................................................................
Credit
$ 6 800
3,000
17,000
$ 9,000
20,000
1 200
6,000
6,000
1,000
$35,000
$35,000
BRIEF EXERCISE 2-14

CHEN COMPANY
Trial Balance
as at 31 December 2010
Cash........................................................................................
Prepaid Insurance....................................................................
Accounts Payable....................................................................
Unearned Income....................................................................
P. Chen, Capital........................................................................
P. Chen, Drawings....................................................................
Service Revenue......................................................................
Salaries Expense.....................................................................
Rent Expense...........................................................................
Debit
$16 800
3 500
Credit
$ 3,000
4 200
13,000
4 500
25,600
18 600
2 400
$45 800
2-27
Accuracy checked
$45 800
SOLUTIONS TO EXERCISES
EXERCISE 2-1
1.
2.
3.
4.
5.
6.
7.
8.
9.
Increase in assets and increase in owners equity.

Decrease in assets and decrease in owners equity.
Increase in assets and increase in liabilities.
Decrease in assets and decrease in owners equity.
Increase in assets and decrease in assets.
Increase in liabilities and decrease in owners equity.
Increase in assets and decrease in assets.
EXERCISE 2-2
1.
2.
3.
4.
(c)
(d)
(a)
(b)
5.
6.
7.
8.
(d)
(b)
(e)
(f)
EXERCISE 2-3
(a)
1. Owner invested $15,000,cash in the firm.

2. Purchased office equipment for $5000, paying $2000,in cash and the
balance of $3000,on account.
3. Paid $750,cash for supplies.
4. Earned $6300,in income, receiving $2600,cash and $3700,on account.
5. Paid $1500,cash on accounts payable.
6. Owner withdrew $2000,cash for personal use.
7. Paid $650,cash for rent.
8. Collected $450,cash from customers on account.
9. Paid salaries of $3900.
10. Incurred $500,of utilities expense on account.
(b)
Investment...........................................................................................
Service revenue.......................................................................
Drawings..................................................................................
Rent expense...........................................................................
Salaries expense......................................................................
Utilities expense......................................................................
Increase in capital....................................................................
$15,000,
6 300,
(2,000)
(650)
(3 900)
(500)
$14 250,
(c)
Service revenue...................................................................................
Rent expense.......................................................................................
Salaries expense..................................................................................
Utilities expense..................................................................................
Net profit..............................................................................................
$6 300,
(650)
(3 900)
(500)
$1 250,
2-28
Accuracy checked
EXERCISE 2-4
Account Debited
Trans
actio
n
Jan. 2
(a)
Basic
Type
(b)
Specific
account
Asset
Cash
Asset
Motor
Account Credited
(d)
Norma
(a)
l
Basic
Balanc
Type
e
Debit
Owners
Equity
(b)
Specific
account
Effect
H. Burns,
Capital
Increas
e
Increase
Debit
Asset
Cash
Decreas
e
Debit
(c)
Effect
Increase
Ve
hic
les
(c)
(d)
Norma
l
Balanc
e
Credit
Asset
Supplies
Increase
Debit
Liability
Accounts
Payable
Increas
e
Credit
Asset
Accounts
Receivabl
e
Increase
Debit
Owners
Equity
Service
Revenue
Increas
e
Credit
Owners
Equity
Advertisi
ng
Expense
Increase
Debit
Asset
Cash
Decreas
e
Debit
Asset
Cash
Increase
Debit
Asset
Accounts
Receivabl
e
Decreas
e
Debit
Liability
Accounts
Payable
Decreas
e
Credit
Asset
Cash
Decreas
e
Debit
Owners
Equity
H. Burns,
Drawings
Increase
Debit
Asset
Cash
Decreas
e
Debit
2-29
Accuracy checked
EXERCISE 2-5
General Journal
J1
Date
Jan. 2
3
9
11
16
20
23
28
Account Titles and Explanation

Cash
H. Burns, Capital
Motor Vehicles
Cash
Supplies
Accounts Payable
Accounts Receivable
Service Revenue
Advertising Expense
Cash
Cash
Accounts Receivable
Accounts Payable
Cash
H. Burns, Drawings
Cash
Ref.
Debit
15,000
Credit
15,000
4,000
4,000
500
500
1,800
1,800
200
200
700
700
300
300
2,000
2,000
EXERCISE 2-6
Oct.
Debits increase assets: debit Cash $20,000.

Credits increase owners equity: credit Lynn Sinclair, Capital $20,000.
No transaction.
Debits increase assets: debit Office Furniture $1900.

Credits increase liabilities: credit Accounts Payable $1900.
Debits increase assets: debit Accounts Receivable $3200.

Credits increase income: credit Service Revenue $3200.
27
Debits decrease liabilities: debit Accounts Payable $700.

Credits decrease assets: credit Cash $700.
30
Debits increase expenses: debit Salaries Expense $2000.

Credits decrease assets: credit Cash $2000.
2-30
Accuracy checked
EXERCISE 2-7
General Journal
Date
Oct. 1
2
3
6
27
30
Accounts Titles and Explanation Ref.

Cash
Lynn Sinclair, Capital
No entry.
Office Furniture
Accounts Payable
Accounts Receivable
Service Revenue
Accounts Payable
Cash
Salaries Expense
Cash
Debits
20,000
Credit
20,000
1,900
1,900
3,200
3,200
700
700
2,000
2,000
EXERCISE 2-8
(a)
Cash
Aug. 1 Capital3000, Aug. 12
Office
1,000
10Revenue
Equip
2400,
31A/c
Rec
900,
Bal. 5300,
Accounts Receivable
Aug. 25Revenue
1600,
Bal. 700,
Office Equipment
Aug. 12
Cash
1,000
Payable
Bal.
4000
Aug. 31
Cash
900
Notes Payable
Aug. 12
Office
4000
Equip
Shirley Tan, Capital
Aug. 1 Cash 3000
Service Revenue
Aug. 10
Cash
2400
25
A/c
1600
Rec
2-31
Accuracy checked
(b)
SHIRLEY TAN, INVESTMENT BROKER

Trial Balance
as at 31 August 2010
Cash ............................................................................
Accounts Receivable........................................................
Office Equipment.............................................................
Notes Payable..................................................................
Shirley Tan, Capital..........................................................
Service Revenue...............................................................
............................................................................
Debit
$5,300
700
5,000
$11,000
2-32
Accuracy checked
Credit
$4,000
3,000
4,000
$11,000
EXERCISE 2-9
(a)
Oct.
1
Cash .............................................................
Maxim, Capital.....................................................
(Owners investment of cash in business)
5,000
5,000
10
Cash
.............................................................
Service Revenue..................................................
(Received cash for services provided)
650
650
10
Cash
.............................................................
Notes Payable......................................................
(Obtained loan from bank)
3,000
3,000
20
Cash
.............................................................
Accounts Receivable............................................
(Received cash in payment of account)
500
500
20
Accounts Receivable............................................
Service Revenue..................................................
(Billed clients for services provided)
(b)
940
940
MAXIM CONSULTING
Trial Balance
as at 31 October 2010
Cash ............................................................................
Supplies...........................................................................
Furniture..........................................................................
Notes Payable..................................................................
Accounts Payable.............................................................
Maxim, Capital................................................................
Maxim, Drawings............................................................
Service Revenue..............................................................
Store Wages Expense......................................................
Rent Expense..................................................................
............................................................................
Debit
$ 8 200
1 240
Credit
400
2,000
$ 3,000
500
7,000
300
2 390
500
250
$12 890
2-33
Accuracy checked
_____
$12 890
EXERCISE 2-10
(a)
General Journal
J1
Date
Sept. 1
5
2
5
3
0
Accounts
Titles
Explanation
Cash
Ian Campbell, Capital
and Ref.
Debit
101
301
10,00
0
Equipment
Cash
Accounts Payable
157
101
201
12,00
0
Accounts Payable
Cash
201
101
3,000
Ian Campbell, Drawings

Cash
306
101
500
Credit
10,000
6,000
6,000
3,000
500
(b)
Cash
Date
Sept.
Sept.
Sept.
Sept.
1
5
25
30
No. 101
Explanation
Capital
Equipment
A/c Payable
Drawings
Equipment
Date
Explanation
Sept. 5
Cash / A/c Payable
Debit
10,000
Balance
10,000
4,000
1,000
500
6,000
3,000
500
No. 157
Debit
12,000
Accounts Payable
Date
Explanation
Sept. 5
Equipment
25
Cash
Debit
Credit
Debit
Ian Campbell, Drawings

Date
Explanation
Sept. 30
Cash
Debit
500
Balance
12,000
Credit
6000
3000
Ian Campbell, Capital

Date
Explanation
Sept. 1
Cash
Credit
Credit
10,000
Credit
No. 201
Balance
6000
3000
No. 301
Balance
10,000
No. 306
Balance
500
2-34
Accuracy checked
EXERCISE 2-11
Error
1.
2.
3.
4.
5.
6.
(a)
In Balance
No
Yes
Yes
No
Yes
No
(b)
Difference
$400
300
36
(c)
Larger Column
Debit
Credit
Credit
EXERCISE 2-12
SPEEDY DELIVERY SERVICE
Trial Balance
as at 31 July 2010
Cash ($90,907 Debit total without Cash $69 340)...............
Prepaid Insurance....................................................................
Delivery Equipment..................................................................
Notes Payable..........................................................................
$26,450
Accounts Payable.....................................................................
Salaries Payable.......................................................................
815
I. M. Speedy, Capital................................................................
I. M. Speedy, Drawings.............................................................
Service Revenue......................................................................
Salaries Expense......................................................................
Petrol Expense.........................................................................
Repair Expense........................................................................
Insurance Expense...................................................................
............................................................................
Debit
$21 567
10,642
1,968
49,360
Credit
8,396
44,636
700
10,610
4,428
758
961
523
$90,907
$90,907
EXERCISE 2-13
Report to colleague
A trial balance is a list of accounts and their balances at a given point in time. It is
usually prepared at the end of an accounting period. The accounts are listed in the
order in which they appear in the ledger. Debit balances appear in the left column,
with credit balances appearing in the right column.
The purpose of a trial balance is to check that the debits equal the credits after
posting from the journal to the ledger. The trial balance is useful in preparing the
financial statements such as the income statement and the balance sheet. It is not
prepared as an alternative to the financial statements.
Blossom Park Lawn Mowing Services has made a net profit for the period ending
30,September 2010,of $3895. This has been calculated by deducting the balances of
the expense accounts of wages, garden supplies, advertising and interest expense
from the service revenue balance.
2-35
Accuracy checked
2-36
Accuracy checked
EXERCISE 2-14
Trial balance totals with errors.................................................
Impact of errors:
(a)
............................................................................
(b) No impact to total as both are expense accounts
(c)
............................................................................
(d)
............................................................................
(e)
............................................................................
Correct trial balance totals.......................................................
Debit
$87,850
Credit
$95 150
5,150
(5,150)
(1,800)
(1,200)
4 60
$94 600
4 600,
$94 600
EXERCISE 2-15
ETERNAL DANCE STUDIO
Trial Balance
as at 30,June 2010
Cash
............................................................................
Accounts Receivable (410,+ 90)..............................................
Equipment and props (5000,+ 2000).......................................
Land
............................................................................
Accounts Payable (3000,+ 2000).............................................
Loan, National Bank ................................................................
Jenny Lee, Capital (24 300,+ 700)...........................................
Jenny Lee, Drawings (800,+ 700).............................................
Dancing Fees (12 400, 400)....................................................
Wages expense........................................................................
Advertising expense.................................................................
Electricity and gas expense (5200, 2700)..............................
Interest expense .....................................................................
............................................................................
Debit
$ 4,000
500
7,000
30,000
Credit
$ 5,000
10,000
25,000
1,500
12,000
3,500
2,000
2 500
1,000
$52,000
2-37
Accuracy checked
$52,000
2-38
Accuracy checked
SOLUTIONS TO PROBLEMS
PROBLEM 2-1
(a)
MATRIX TRAVEL AGENCY

Accounts
Receivable
Cash
Supplies
Office
Equipment
Accounts
Payable
+
$1
0,
00
0
+
10
,0
00
+ 400
+9 60
0
+2 50
0
+7 10
0
+000,00
0
+7 10
0
+ 600
+6 50
0
+
1,
00
+$6 500
+6 500
+0,000
+6 500
+0,000
+6 500
+0,000
+6 500
+5,000
+$1 500
+$600
+600
+0000
+600
+0000
+600
+0000
+600
+0000
+600
+0000
+$600
+$2 500
+2 500
+00,000
+2 500
+00,000
+2 500
+00,000
+2 500
+00,000
+2 500
+00,000
+2 500
+00,000
2 500
+00,000
+$2 500
+$300
+300
+0000
+300
+0000
+300
+0000
+300
+300
+0
+0000
+0000
+$0
Ly Aing,
Capital
+$10,000Investment
+10,000
+ 400 Rent Expense
+9 600
+000,000
+9 600 Adv. Expense
+ 300
+9 300
+000,000
Serv.
+9 300
Revenu
+7 500
e
+16 800
+ 200 Drawings
+16 600
+000,000
+16 600 Salaries Exp.
+2 200
+14 400
+000,000
+$14 400
0
+7 50
0
+ 200
+7 30
0
+ 300
+
7,
00
0
+2 20
0
+4 80
0
+
5,
00
0
+$
9
80
0
(b)
Ending capital......................................................................................
Add: Drawings....................................................................................
................................................................................................
Deduct: Investments...........................................................................
Net profit..............................................................................................
$14,400
200
14,600
10,000
$ 4,600
OR
Service revenue...............................................................
Expenses
Salaries .......................................................................
Rent
.......................................................................
Advertising.....................................................................
2,900
Net profit .......................................................................
$7,500
$2,200
400
300
$4,600
PROBLEM 2-2
(a)
COLLEEN PHAM, MEDICAL PRACTITIONER
Cash
Accounts
Receivabl
e
+
Supplie
s
+
Office
Equipme
nt
=
Notes
Payabl
e
+
Account
s
Payable +
Collee
n
Pham,
Capital
$4,000
+1,400
5,400
2,700
2,700
+3,000
5,700
400
5,300
4,250
1,050
550
,500
+2,000
2,500
00,000
$2,500
$1,500
1,400
,100
00,000
,100
+4,500
4,600
00,000
4,600
$500
0000
500
0000
500
0000
500
0000
500
$5,000
00,000
5,000
00,000
5,000
00,000
5,000
+1,000
6,000
$4,200
00,000
4,200
2 700
1,500
00,000
1,500
+600
2,100
00,000
4,600
00,000
4,600
00,000
4,600
00,000
$4,600
0000
500
0000
500
0000
500
0000
$500
00,000
6,000
00,000
6,000
00,000
6,000
00,000
$6,000
00,000
2,100
00,000
2,100
00,000
2,100
+250
$2,350
+
$
2
,
0
0
0
+
2
,
0
0
0
+00,0
0
0
+
$
2
,
0
0
0
$6
8
0
0
000,00
0
6
8
0
0
000,00
0
6
8
0
0
+
7
,
5
0
0
1
4
,
3
0
0
000,00
0
1
4
,
3
Service Revenue
Salaries Expense
Rent Expense
Advertising
Expense
Drawings
Utilities Expense
PROBLEM 2-3
BASILE CONSULTING
Assets
Date Cash
May
1
2
3
5
9
12
15
17
20
23
26
29
30
Accounts
Office
+ Receivabl + Supplies + Equip.
e
Owners
Liabilities
Equity
Notes
Account L. Basile,
= Payabl + s
+Capital
e
Payable
($8,000
(800)
($8,000) Investment
(800) Rent Expense
$500
(50)
(3,000)
(700)
($ 500)
($3,300)
(3,000)
(500)
(2,000)
(5,000)
Advertising Expense
Service Revenue
Drawings
Service Revenue
Salaries Expense
(500)
(2,000)
000(150) (00,000)
($12 800)+ ($1,300)
(50)
(3,000)
(700)
(3,300)
(3,000)
0000
+ $500
$5,000
$2,400
(2,400)
00,000
00,000
(00,000) ( (150) Utilities Expense
+ $2,400 = $5,000 + ($2,400) +($9,600)
PROBLEM 2-4
J1
Date
Mar.

Cash
Ref.
Debit
60,000
Credit
1
Bill Tran, Capital
(Owners investment of cash in
business)
3
10
18
60,000
Land
Buildings
Equipment
Cash
(Purchased Lees Golf Land)
23,000
9,000
6,000
Advertising Expense
Cash
(Paid for advertising)
1,600
Prepaid Insurance
Cash
(Paid for one-year insurance policy)
1,480
Equipment
Accounts Payable
(Purchased equipment on account)
2,600
Cash
38,000
1,600
1,480
2,600
800
Golf Revenue
(Received cash for services
provided)
19
800
Cash
Unearned Income
(Received cash for coupon books
1,500
Bill Tran, Drawings

Cash
(Withdrew cash for personal use)
1,000
1,500
sold)
25
30
30
31
Salaries Expense
Cash
(Paid salaries)
Accounts Payable
Cash
(Paid creditor on account)
Cash
Golf Revenue
provided)
1,000
600
600
2,600
2,600
500
500
PROBLEM 2.5
(a)
Date
Apr. 1

Cash
Judy Dench, Capital
Ref.
101
301
J1
DebitCredit
25,000
25,00
0
(Owners investment of cash in

business)
1
No entry not a transaction.
Rent Expense
Cash
(Paid monthly office rent)
729
101
800
Supplies
Accounts Payable
(Purchased supplies on account
from
Halo Company)
126
201
1,500
Accounts Receivable
Service Revenue
(Billed clients for services provided)
112
400
900
Cash
101
205
500
101
400
1,500
Salaries Expense
Cash
(Paid monthly salary)
726
101
1,500
Accounts Payable
Cash
(Paid Halo Company on account)
201
101
600
10
11
Unearned Income
(Received cash for future service)
20
Cash
Service Revenue
provided)
30
30
800
1,500
900
500
1,500
1,500
600
PROBLEM 2-5 (continued)

(b)
Cash
Date
Apr. 1
2
11
20
30
30
Explanation
Ref.
Judy Dench - Capital
J1
Rent Expense
Unearned Income
Service Revenue
Salaries Expense
Accounts Payable
J1
J1
J1
J1
J1
Debit
25,00
0
Credit
800
500
1,500
1,500
600
No. 101
Balance
25,000
24,200
24,700
26,200
24,700
24,100
Accounts Receivable
Date
Explanation
Apr. 10
Service Revenue
Ref.
J1
Debit
900
Credit
No. 112
Balance
900
Supplies
Date
Apr. 3
Ref.
J1
Debit
1,500
Credit
No. 126
Balance
1,500
Ref.
J1
J1
Debit
Credit
1,500
No. 201
Balance
1,500
900
Explanation
Accounts Payable
Accounts Payable
Date
Explanation
Apr. 3
Supplies
30
Cash
Unearned Income
Date
Explanation
Apr. 11
Cash
Judy Dench, Capital
Date
Explanation
Apr. 1
Cash
Ref.
J1
Ref.
J1
600
Debit
Debit
Credit
500
No. 205
Balance
500
Credit
25,000
No. 301
Balance
25,000
No. 400
Balance
900
2,400
Service Revenue
Date
Explanation
Apr. 10
Accounts Receivable
20
Cash
Ref.
J1
J1
Debit
Credit
900
1,500
Salaries Expense
Date
Explanation
Apr. 30
Cash
Ref.
J1
Debit
1,500
Credit
No. 726
Balance
1,500
Rent Expense
Date
Explanation
Apr. 2
Cash
Ref.
J1
Debit
800
Credit
No. 729
Balance
800

(c)
JUDY DENCH, ARCHITECT
Trial Balance
as at 30,April 2010
Cash ............................................................................
Supplies...........................................................................
Unearned Income............................................................
Judy Dench, Capital.........................................................
Service Revenue..............................................................
Salaries Expense.............................................................
Rent Expense...................................................................
............................................................................
Debit
$24,100
900
Credit
1,500
800
$28,800
1,500
900
500
25,000
2,400
$28,800
PROBLEM 2-6
(a)
Trans.
1.

Cash
Dennis Tropp, Capital
Debit
120,000
120,00
0
2.
No entry.
3.
Prepaid Rent
Rent Expense
Cash
33,000
3,000
Furniture & Equipment

Cash
Accounts Payable
70,000
Prepaid Insurance
Insurance Expense
Cash
2,750
250
Office Supplies
Cash
1,000
Office Supplies
Accounts Payable
3,000
Cash
Accounts Receivable
Transport Revenue
10,000
20,000
4.
5.
6.
7.
8.
9.
10.
Accounts Payable
Cash
Cash
36,000
20,000
50,000
3,000
1,000
3,000
30,000
800
800
5,000
Accounts Receivable
11.
12.
Credit
Utility Expense
Accounts Payable
Salaries Expense
Cash
5,000
400
400
4,000
4,000

Cash
(1)
(8)
Accounts Payable
(4) Furn/Equip 50,000
(7) Office Supp 3,000
800
(11) Utility Exp
400
Capital120,000
(3) Rent
Rev
10,000
36,000
(4) Furn/Equip20,000
(5) Insurance 3,000
(6) Office Supp1,000
(9) A/c Pay
(10) A/c Rec
(9) Cash
52,600
Dennis Tropp, Capital
(1) Cash
120,000
120,000
800
5,000
(12) Salaries 4,000
Transport Revenue
(8) Cash /
A/c Pay
70,200
(8)
Accounts Receivable
Rev
20,000
(10) Cash
15,000
Office Supplies
1,000
3,000
4,000
(6)
(7)
Cash
A/c Pay
(5)
Cash
Prepaid Insurance
2,750
2,750
Cash
Prepaid Rent
33,000
33,000
(3)
(4)
Furniture & Equipment

Cash / 70,000
A/c Pay
70,000
30,000
30,000
5,000
(12) Cash
(3)
Cash
Salaries Expense
4,000
4,000
Rent Expense
3,000
3,000
Utility Expense
(11) A/c Pay
400
400
(5)
Cash
Insurance Expense
250
250

(c)
TROPP TRANSPORT SERVICES
Trial Balance
as at 31 May 2010
Cash ..........................................................................
Accounts Receivable......................................................
Office Supplies...............................................................
Prepaid Insurance..........................................................
Prepaid Rent..................................................................
Furniture & Equipment..................................................
Accounts Payable...........................................................
Dennis Tropp, Capital.....................................................
Transport Revenue.........................................................
Salaries Expense...........................................................
Rent Expense.................................................................
Utility Expense...............................................................
Insurance Expense........................................................
..........................................................................
Debit
$ 70,200
15,000
4,000
2,750
33,000
70,000
Credit
$ 52,600
120,000
30,000
4,000
3,000
400
250
$202 600
______
$202 600
3-51
Accuracy checked
PROBLEM 2-7
RON WOOLLEY CO.
Trial Balance
as at 30,June 2010
Cash ($3840,+ $180)..............................................................
Accounts Receivable ($3231 $180).......................................
Supplies ($800, $340)............................................................
Equipment ($3000,+ $340).....................................................
Accounts Payable ($2666 $309 $390)................................
Unearned Income....................................................................
R. Woolley, Capital...................................................................
R. Woolley, Drawings ($800,+ $500).......................................
Service Revenue ($2380,+ $801)............................................
Salaries Expense ($3400,+ $367 $500)................................
Office Expense.........................................................................
_____
............................................................................
Debit
$ 4,020
3,051
460
3,340
Credit
$ 1,967
2,200
9,000
1,300
3,181
3,267
910
$16 348
3-52
Accuracy checked
$16 348
PROBLEM 2-8
(a) & (c)
Cash
Date
Mar. 1
2
9
10
12
20
20
31
31
31
Explanation
Balance
Film Rental Expense
Admission Revenue
Accounts Payable
Advertising Expense
Admission Revenue
Film Rental Expense
Salaries Expense
Concession Revenue
Admission Revenue
Debit
J1
J1
J1
J1
J1
J1
J1
J1
J1
No. 101
Balance
16,000
13,000
19,500
10,500
9,700
16,900
13,900
9,100
9,500
21,500
Credit
3,000
6,500
9,000
800
7,200
3,000
4,800
400
12,00
0
Accounts Receivable
Date
Explanation
Mar. 31
Concession Revenue
Debit
400
Credit
No. 112
Balance
400
Land
Date
Mar. 1
Explanation
Balance
Debit
Credit
No. 140
Balance
42,000
Buildings
Date
Mar. 1
Explanation
Balance
Debit
Credit
No. 145
Balance
18,000
Debit
Credit
Debit
Credit
Equipment
Date
Explanation
Mar. 1
Balance
Accounts Payable
Date
Explanation
Mar. 1
Balance
2
Film Rental Expense
10
Cash
No. 157
J1
J1
A. Russo, Capital
Date
Explanation
Mar. 1
Balance
Admission
Date
Mar. 9
20
31
Revenue
Explanation
Cash
Cash
Cash
6,000
9,000
Debit
Credit
Debit
Credit
6,500
7,200
12,000
J1
J1
Balance
16,000
No. 201
Balance
12,000
18,000
9,000
No. 301
Balance
80,000
No. 405
Balance
6,500
13,700
25,700
Concession Revenue
Date
Explanation
No. 406
Ref.
Mar. 31
Cash / A/c Receivable
J1
Advertising Expense
No. 610
Debit
Credit
800
Balance
800
3-53
Accuracy checked
Date
Explanation
Ref.
Mar. 12
Cash
J1
Film Rental Expense
Debit
800
Explanation
Ref.
Debit
Mar. 2
20
Cash / A/c Payable

Cash
J1
J1
9,000
3,000
Explanation
Ref.
Debit
Mar. 31
Cash
J1
4,800
(b)
Date
Mar. 2
Film Rental Expense

Accounts Payable
Cash
(Rented films for cash and on
account)
No entry.
Cash
Admission Revenue
10

provided)
Accounts Payable ($6000,+ $3000)
Cash
11
12
800
Credit
Balance
9,000
12,000
No. 726
Date
3
9
Balance
No. 632
Date
Salaries Expense
Credit
(Paid creditors on account)

No entry.
Advertising Expense
Cash
Credit
Balance
4,800
Re
f.
63
2
20
1
10
1
Debit
10
1
40
5
6,500
20
1
10
1
9,000
61
0
10
1
800
10
1
40
5
7,200
63
2
10
1
3,000
J1
Credit
9,000
6,000
3,000
6,500
9,000
800
(Paid advertising expense)

20
Cash
Admission Revenue
20

provided)
Film Rental Expense
Cash
7,200
3,000
(Paid film rental)
3-54
Accuracy checked
31
Salaries Expense
Cash
72
6
10
1
4,800
10
1
11
2
40
6
400
10
1
40
5
12,000
4,800
(Paid salaries expense)

31
Cash
Accounts Receivable
Concession Revenue
31
(10% $8000)
(Received cash and balance on
account for concession revenue)
Cash
Admission Revenue
400
800
12,000

provided)
3-55
Accuracy checked

(d)
RUSSO THEATRE
Trial Balance
as at 31 March 2010
Debit
$ 21,500
400
42,000
18,000
16,000
Cash
Accounts Receivable
Land
Buildings
Equipment
Accounts Payable
A. Russo, Capital
Admission Revenue
Concession Revenue
Advertising Expense
Film Rental Expense
Salaries Expense
Credit
800
12,000
4,800
$115,500
9,000
80,000
25,700
800
______
$115,500
PROBLEM 2-9
(a) + (c)
Cash
Date
April
1
2
10
14
15
16
22
30
No. 101
Explanation
26
30
Debit
Credit
Balance
Insurance
Salaries Expense
Electrical Services
Revenue
Drawings
Office Equipment
Accounts Payable
Accounts Receivable
Accounts Receivable No. 130

Date
Explanation
April
1
2
Ref
.
17,000
J1
J1
J1
J1
J1
J1
J1
Ref
.
3,600
1,400
13,400
12,000
14,300
500
3,500
250
13,800
10,300
10,050
13,650
Credit
Balance
2,300
3,600
Debit
Balance
Electrical Services
Revenue
Electrical Services
Revenue
Cash
Electrical Supplies
Date
Explanation
April
Balance
1
Office Equipment
Date
Explanation
Balance
4,400
J1
3,600
8,000
J1
2,000
10,000
J1
Ref.
Ref.
3,600
Debit
Debit
Credit
Credit
6,400
No. 141
Balance
4,400
No. 145
Balance
3-56
Accuracy checked
April
16
Cash
Prepaid Insurance
Date
Explanation
April
Cash
2
Utility Trucks
Date
Explanation
April
Balance
1
Accounts Payable
Date
Explanation
April
Balance
1
5
Advertising Expense
22
Cash
D. Trump, Capital
Date
Explanation
April
Balance
1
D. Trump, Drawings
Date
Explanation
April
Cash
15
Electrical Services Revenue
Date
Explanation
April
Accounts Receivable
2
14
Cash
26
Accounts Receivable
Insurance Expense
Date
Explanation
April
Cash
2
J1
3 500
Ref.
J1
Debit
3 300
3,500
Credit
No. 150
Balance
3,300
Ref.
Debit
Credit
No. 151
Balance
15,000
Ref.
J1
Debit
Credit
No. 201
Balance
10,000
J1
J1
250
10,250
10,000
250
Ref.
Debit
Credit
No. 301
Balance
30,800
Ref.
J1
Debit
500
Credit
No. 302
Balance
500
Ref.
J1
Debit
Credit
3 600
No. 400
Balance
3,600
2 300
2,000
5,900
7,900
Credit
No. 512
Balance
300
J1
J1
Ref.
J1
Debit
300
Advertising Expense
Date
Explanation
April
Accounts Payable
5
Ref.
J1
Debit
250
Credit
No. 522
Balance
250
Salaries Expense
Date
Explanation
April
Cash
10
Ref.
J1
Debit
1,400
Credit
No. 542
Balance
1,400
3-57
Accuracy checked
(b)
General Journal
Date Account Titles and Explanation
2007
April 1 Accounts Receivable
(Provision of electrical services
on account, A. Light)
Ref.
Debit
130
400
3,600
April 2 Insurance Expense

Prepaid Insurance
Cash
(Paid insurance for 12 months)
512
150
101
300
3,300
April 5 Advertising expense

Accounts Payable
(Advertising on account)
522
201
250
April 10 Salaries Expense

Cash
(Paid salaries)
542
101
1,400
April 14 Cash
3,600
3,600
250
1,400
101
400
April 15 D. Trump, Drawings

Cash
302
101
500
April 16 Office equipment

Cash
(Purchased computer for cash)
145
101
3,500
April 22 Accounts Payable

Cash
(Paid amount owed to creditor)
201
101
250
April 26 Accounts Receivable

130
400
(Provision of electrical services on account)
2,000
April 30 Cash
Accounts receivable
(Received cash from debtor)
3,600
101
130
1
Credit
2,300
2,300
500
3,500
250
2,000
3,600
3-58
Accuracy checked

(d)
GREENBROOK ELECTRICAL SERVICES

Trial Balance
as at 30 April 2010
Cash.................................................................................
Accounts receivable.........................................................
Electrical Supplies............................................................
Office equipment.............................................................
Prepaid Insurance............................................................
Utility Truck......................................................................
D. Trump, Capital.............................................................
D. Trump, Drawings..........................................................
Electrical Services Revenue.............................................
Insurance expense...........................................................
Advertising expense.........................................................
Salaries expense..............................................................
.........................................................................................
(e)
Debit
$13,650
6,400
4,400
3,500
3,300
15,000
Credit
$10,000
30,800
500
7,900
300
250
1,400
$48 700
$48 700
Insurance expense for the month is $300. (3600/12 months = 300 per month)
3-59
Accuracy checked
PROBLEM 2-10
(a) + (d)
General Journal
Date
2010
August 1
11
12
17
18
19
28
31
J1
Ref.
Cash101
P. Lim, Capital
(Contributed $20,000 to the business
bank account)
Office Supplies
Cash
(Purchased office equipment)
20,000
35,000
35,000
20,500
210
140
101
20,500
400
400
Cash101
4,000
Dental Services Revenue
400
4,000
Wages expense
Cash
(Paid wages)
512
101
600
Accounts Receivable
(Provided services on account)
120
400
2,300
P. Lim, Drawings
Cash
302
101
300
Advertising expense
Cash
(Paid for local advertising)
522
101
325
Accounts Payable
Cash
(Paid Dental Supplies)
201
101
1,200
Cash101
Dental Services revenue
(Received cash for services)
31
600
2,300
300
325
1,200
1,200
400
Interest expense
532
Cash
101
(Paid interest)
General Journal (continued)
Credit
20,000
301
Dental Equipment
130
Accounts Payable
201
(Purchase of dental equipment on account)
Cash101
Loan
(Borrowed cash from the bank)
Debit
1,200
70
70
J1
3-60
Accuracy checked
Date
Ref.
Debit
Sept. 2
Dental Equipment
Cash
(Purchase of dental equipment for cash)
130
101
650
Electricity Expense
Cash
(Paid electricity)
542
101
230
Telephone expense
Cash
(Paid telephone)
552
101
240
Cash
101
400
7,000
Wages expense
Cash
(Paid wages)
512
101
600
Accounts Receivable
(Provided services on account)
120
400
1,300
P. Lim, Drawings
Cash
302
101
500
Accounts Payable
Cash
(Paid Dental Supplies)
201
101
1,200
Cash
(Received cash for services performed)
101
400
1,500
Dental Equipment
Cash
(Purchased additional dental
equipment and supplies)
130
101
350
Cash
(Received cash for services performed)
101
400
2,300
13
14
20
21
22
24
25
30
Credit
650
230
240
7,000
600
1,300
500
1,200
1,500
350
2,300
3-61
Accuracy checked

(b) + (e)
Cash
Date
August 1
4
6
11
12
18
19
28
31
31
Sept.
2
4
6
13
14
21
22
24
25
30
Explanation
P Lim Capital
Loan
Office Supplies
Wages Expense
P Lim Drawings
Advertising Expense
Accounts Payable
Interest Expense
Ref.
J1
J1
J1
J1
J1
J1
J1
J1
J1
J1
Dental Equipment
Electricity Expense
Telephone Expense
Wages Expense
P Lim Drawings
Accounts Payable
Dental Equipment
J1
J1
J1
J1
J1
J1
J1
J1
J1
J1
Debit
20,000
20,500
Credit
400
4,000
600
300
325
1,200
1,200
70
650
230
240
7,000
600
500
1,200
1,500
350
2,300
Accounts Receivable
Date
Explanation
August 17
Sept. 20
Ref.
J1
J1
Debit
2,300
1,300
Credit
Dental Equipment
Date
Explanation
Aug. 2
Accounts Payable
Sept. 2
Cash
25
Cash
Ref.
J1
J1
J1
Debit
35,000
650
350
Credit
Office Supplies
Date
Explanation
August 6
Cash
Ref.
J1
Debit
400
Credit
Ref.
J1
Debit
Credit
35,000
J1
J1
1,200
1,200
Accounts Payable
Date
Explanation
August
Dental Equipment
2
28
Cash
Sept. 22
Cash
No. 101
Balance
$20,000
40,500
40,100
44,100
43,500
43,200
42,875
41,675
42,875
42,805
42,155
41,925
41,685
48,685
48,085
47,585
46,385
47,885
47,535
49,835
No. 120
Balance
2,300
3,600
No. 130
Balance
35,000
35,650
36,000
No. 140
Balance
400
No. 201
Balance
35,000
33,800
32,600

3-62
Accuracy checked
Loan
Date
August 4
Explanation
Cash
Ref.
J1
Debit
Credit
20,500
No. 210
Balance
20,500
No. 301
Balance
20,000
P. Lim, Capital
Date
Explanation
August 1
Cash
Ref.
J1
Debit
Credit
20,000
P. Lim, Drawings
Date
Explanation
August 18
Cash
Sept. 21
Cash
Ref.
J1
J1
Debit
300
500
Credit

Date
Explanation
Aug. 11
Cash
17
Accounts Receivable
31
Cash
Sept. 13
Cash
20
Accounts Receivable
24
Cash
30
Cash
Ref.
J1
J1
J1
J1
J1
J1
J1
Debit
Credit
4 000
2,300
1,200
7,000
1,300
1,500
2,300
Wages Expense
Date
Explanation
August
Cash
12
Sept. 14
Cash
Ref.
J1
J1
Debit
600
Credit
No. 302
Balance
300
800
No. 400
Balance
4 000
6 300
7,500
14,500
15,800
17,300
19,600
No.,512
Balance
600
600
1,200
Advertising Expense
Date
Explanation
August 19
Cash
Ref.
J1
Debit
325
Credit
No.,522
Balance
325
Interest Expense
Date
Explanation
Aug. 31
Cash
Ref.
J1
Debit
70
Credit
No.,532
Balance
70
Credit
No.,542
Balance
230
Credit
No.,552
Balance
240
Electricity Expense
Date
Explanation
Sept. 4
Telephone Expense
Date
Explanation
Sept. 6
Cash
Ref.
J1
Ref.
J1
Debit
230
Debit
240
3-63
Accuracy checked

(c)
P. LIM DENTAL CLINIC

Trial Balance
as at 31 August 2010
Cash.................................................................................
Dental Equipment............................................................
Office Supplies.................................................................
Loan.................................................................................
P. Lim, Capital..................................................................
P.Lim, Drawings................................................................
Dental Services Revenue.................................................
Wages expense................................................................
Interest expense..............................................................
.........................................................................................
(f)
Credit
$33,800
20,500
20,000
300
7,500
600
325
70
$81,800
$81,800
P. LIM DENTAL CLINIC

Trial Balance
as at 30 September 2010
Cash.................................................................................
Dental Equipment............................................................
Office Supplies.................................................................
Loan.................................................................................
P. Lim, Capital..................................................................
P.Lim, Drawings................................................................
Dental Services Revenue.................................................
Wages expense................................................................
Interest expense..............................................................
Electricity expense...........................................................
Telephone expense..........................................................
.........................................................................................
BYP 2-1
Debit
$49,835
3,600
36,000
400
Credit
$32,600
20,500
20,000
800
19,600
1,200
325
70
230
240
$92,700
$92,700
FINANCIAL REPORTING PROBLEM - HNH
(a)
(1)
Increase
Side
Right
(1)
Decrease
Side
Left
(2)
Normal
Balance
Credit
Trade and Other Receivables
Left
Right
Debit
Property, Plant and Equipment
Left
Right
Debit
Right
Left
Credit
Interest and Finance Charges
Left
Right
Debit
Inventories
Left
Right
Debit
Account
Trade and Other Payables
Current Tax Liabilities
(b)
Debit
$42,805
2,300
35,000
400
(1)
Cash is increased.
3-64
Accuracy checked
(c)
(2)
(3)
Cash is decreased.
Cash is decreased or Accounts Payable is increased.
(1)
(2)
Cash is decreased.
Cash is decreased or Notes or Mortgage Payable is increased.
BYP 2-2
(a)
May
GROUP DECISION CASE

1
Correct.
Cash
Lesson Revenue
250
Cash
Unearned Boarding Revenue
500
Office Equipment
Cash
800
Hubert Wu, Drawings

Cash
400
Cash
Riding Revenue
184
7
14
15
20
30
Correct
31
Hay and Feed Supplies

Accounts Payable
250
500
800
400
184
1,500
1,500
(b)
The errors in the entries of 14 and 20 May would prevent the trial balance from
balancing.
(c)
Net profit as reported..........................................................

Add:
15/5, Salaries expense (Hubert Wu, Drawings).......
31/5, Hay and feed expense (still on hand).............
................................................................................
Less: 7/5, Boarding revenue unearned.............................
Correct net profit.................................................................
(d)
Cash as reported.................................................................
Add:
20/5, Transposition error.........................................
31/5, Purchase on account......................................
................................................................................
$4,500
$ 400
1,500
1,900
6,400
500
$5,900
$12,475
$
36
1,500
3-65
Accuracy checked
1,536
$14,011
BYP 2-3
Date:
To:
From:
COMMUNICATION ACTIVITY
25 May 2010
Accounting Lecturer
Student
In the first transaction, bills totalling $5,000 were sent to customers for services
rendered. Therefore, the asset Accounts Receivable is increased $5,000 and the
income Service Revenue is increased $5,000. Debits increase assets and credits
increase income, so the journal entry is:
Accounts Receivable....................................................................
Service Revenue..................................................................
(Bill customers for services provided)
5,000
5,000
The $5,000 amount is then posted to the debit side of the general ledger account
Accounts Receivable and to the credit side of the general ledger account Service
Revenue.
In the second transaction, $2,000 was paid in salaries to employees. Therefore, the
expense Salaries Expense is increased $2,000 and the asset Cash is decreased
$2,000. Debits increase expenses and credits decrease assets, so the journal entry is:
Salaries Expense..........................................................................
Cash....................................................................................
(Salaries paid)
2,000
2,000
The $2,000 amount is then posted to the debit side of the general ledger account
Salaries Expense and to the credit side of the general ledger account Cash.
BYP 2-4
(a)
ETHICS CASE
The stakeholders in this situation are:

Sarah Rivkin, assistant chief accountant.
Users of the companys financial statements.
The Hokey Company.
(b)
By adding $1,000 to the Equipment account, that account total is intentionally

misstated. By not locating the error causing the imbalance, some other account
may also be misstated by $1,000. If the amount of $1,000 is determined to be
immaterial, and the intent is not to commit fraud (cover up an embezzlement or
other misappropriation of assets), Sarahs action might not be considered
unethical in the preparation of interim financial statements. However, if Sarah is
violating a company accounting policy by her action, then she is acting
unethically.
(c)
Sarahs alternatives are:

1.
Miss the deadline but find the error causing the imbalance.
2. Tell her supervisor of the imbalance and suffer the consequences.
3. Do as she did and locate the error later, making the adjustment in the next
quarter.
3-66
Accuracy checked
3-67
Accuracy checked
Chapter 3
The Recording Process
1.
(a)
Disagree. The steps in the accounting cycle are the same for both a retail
organisation and a service business. The only difference is the additional
recording required to deal with the inventory.
(b)
The measurement of profit is conceptually the same. In both types of

businesses, net profit (or loss) results from the deducting expenses for
the period from income for the period. For a retailer, sales revenue less
cost of sales equals gross profit. Once other expenses are deducted, the
net profit can be determined.
2.
The normal operating cycle for a retail business is likely to be longer than in a
service business because inventory must first be purchased and sold, and then
the receivables must be collected.
3.
(a)
The components of income and expenses differ as follows:

Income
Expenses
(b)
Sales
Revenue
4.
Retailer
Sales
Cost of Goods Sold and
Operating
Service
Fees, Rents, etc.
Operating (only)
The revenue measurement process is as follows:

Less
Cost of
Goods Equals
Sold
Gross
Profit
Less
Operating
Equals
Expenses
Net
Profit
The initial entry would have been Dr Accounts Receivable, Cr Sales Revenue for
$700. When $100 of goods are returned for credit, the entry would be Dr Sales
Returns, Cr Accounts Receivable. The balance owing from the customer is $600,
therefore:
July 19 Cash............................................................................... 600
Accounts Receivable ($700 $100)...............................
600
5.
All transactions that involve a movement of inventory either in or out of the

business affect the inventory ledger account under the perpetual system. These
include all purchases and purchase returns (goods returned to the supplier), all
sales and sales returns (goods returned to the business by the customer) and
any stock losses or write-downs.
6.
When a sale takes place under the perpetual inventory method, two journal
entries are required. The first records the sale of inventory at selling price to the
customer and records the revenue earned:
Dr Accounts Receivable or Cash
Cr Sales Revenue
3-68
Accuracy checked
The second entry records the sale at cost price, and adjusts the inventory
account to reflect that stock has been sold:
Dr Cost of Sales
Cr Inventory
7.
If a customer buys goods from a retailer on credit, and then returns some, the
retailer is unlikely to offer a cash refund. This is because the customer may still
have a balance outstanding to the retailer from the goods purchased. It is more
logical to allow a reduction in the amount still outstanding as a Credit to
Accounts Receivable.
8.
A retailer determines gross profit for a period by comparing total sales revenue
to cost of sales. The income statement would also take into account sales
returns. For example:
Sales
Less sales returns
Net sales
Less Cost of sales
Gross Profit
9.
100,000
(5,000)
95,000
(52,000)
43,000
If a price is quoted as GST inclusive, it means the GST component has already
been added to the price. You must divide the total by 11 to find the GST
component. For example, sales of $2,200 (GST inclusive) / 11 = $200. This
means the sale was for $2,000 and a further $200 was added as GST.

BRIEF EXERCISE 3-1
Giovanni Company
Inventory.................................................................................
Accounts Payable............................................................
Gordon Company
Sales...............................................................................
Cost of Goods Sold...................................................................
Inventory.........................................................................
780
780
780
780
560
560
BRIEF EXERCISE 3-2

(a)
(b)
(c)
Sales...............................................................................
Cost of Goods Sold...................................................................
Inventory.........................................................................
800,000
Sales Returns and Allowances.................................................

Accounts Receivable.......................................................
Inventory Write-down..............................................................
Cost of Goods Sold..........................................................
120,000
Cash ........................................................................................
Accounts Receivable ($800,000 $120,000)..................
680,000
800,000
620,000
620,000
120,000
90,000
90,000
680,000
3-69
Accuracy checked
BRIEF EXERCISE 3-3

(a)
(b)
(c)
Inventory.................................................................................
Accounts Payable............................................................
800,000
Accounts Payable.....................................................................
Inventory.........................................................................
120,000
Accounts Payable ($800,000 $120,000)................................

Cash................................................................................
680,000
800,000
120,000
680,400
BRIEF EXERCISE 3-4

The GST paid on each icecream purchased is $0.15 ($1.65 11). The shopkeeper sold
16 icecreams and so can claim a credit from the taxation authority for $2.40 (16
0.15).
BRIEF EXERCISE 3-5
This journal entry records the payment of the GST to the taxation authority. Sellers
Limited has collected $100 GST on sales during the reporting period, and the amount
of GST paid on purchases is $90; the remaining balance of $10 is the amount of cash
paid to the tax authority.
BRIEF EXERCISE 3-6
3 August
5 August
Dr Inventory
2,080
Cr Accounts Payable
(Recording purchase of inventory from supplier)
Dr Accounts Payable
Cr Inventory
(return of goods to supplier)
2,080
360
360
BRIEF EXERCISE 3-7

Dr Cash at Bank
Cr Sales Revenue
(recording cash sale)
295
Dr Cost of Sales
Cr Inventory
(recording cost price of sale)
150
295
150
3-70
Accuracy checked
EXERCISE 3-1
(1)
(2)
April 5
April 6
(3)
April 7
(4)
April 8
(5)
April 15
Inventory
Accounts Payable
Freight in
Cash
Equipment
Accounts Payable
Accounts Payable
Inventory
Accounts Payable
($20,000 $4000)
Cash
20,000
20,000
900
900
26,000
26,000
4,000
4,000
16,000
16,000
EXERCISE 3-2
Sept. 6
Inventory (80 $18)

Cash
1,440
1,440
10
Accounts Payable (2 $18)
Inventory
12
Accounts Receivable (26 $31)
Sales
806
Cost of Goods Sold (26 $18)
Inventory
Sept. 14
Sales Returns and Allowances
Accounts Receivable
Inventory
Cost of Goods Sold
20
Accounts Receivable (30 $31)
Sales
930
Cost of Goods Sold (30 $18)
Inventory
36
36
806
468
468
31
31
18
18
930
540
540
EXERCISE 3-3
Roberts Ltd
Dec.
Dec.
Dec.
Accounts Receivable
Sales
480,000
Cost of Goods Sold
Inventory
8
Accounts Receivable
Inventory
Cost of Goods Sold
13
Cash at bank
Accounts Receivable
480,000
350,000
350,000
65,000
65,000
49,000
49,000
415,000
415,000
5-71
Accuracy checked
EXERCISE 3-4
Gas Ltd
June
10
June
12
June
30
Inventory
Accounts Payable
Accounts Payable
Inventory
Accounts Payable
Cash at Bank
12,000
12,000
600
600
11,400
11,400
Isa Ltd
June
June
June
10
Accounts Receivable
Sales
12,000
Cost of Goods Sold
Inventory
12
Accounts Receivable
Inventory write down
Cost of Goods Sold
30
Cash at bank
Accounts Receivable
12,000
8,100
8,100
600
600
410
410
11,400
11,400
EXERCISE 3-5
Bill Roxam Ltd
Apr.
Apr.
Apr.
Apr.
Apr.
15
Inventory
Accounts Payable
Wages Expense
Cash at bank
Equipment
Accounts Payable
Accounts Payable
Inventory
Accounts Payable
Cash at Bank
19,800
19,800
15,200
15,200
28,600
28,600
2,100
2,100
17,700
17,700
EXERCISE 3-6
(a)
April
Cash at Bank
Sales Revenue
GST Collected
April
Accounts Receivable
Sales Revenue
GST Collected
April
Insurance Expense
GST Paid
Cash at bank
April
Supplies
GST Paid
Cash at bank
22,000
20,000
2,000
60,500
55,000
5,500
11,000
1,100
12,100
47,000
4,700
51,700
5-72
Accuracy checked
(b)
GST Paid
Date
April
Explanation
Cash at bank
Cash at bank
GST Collected
Date
Explanation
April
Cash at bank
Accounts Receivable
Ref.
Debit
1,100
4,700
Credit
Ref.
Debit
Credit
2,000
5,500
No.
Balance
1,100 Dr
5,800 Dr
No.
Balance
2,000 Cr
7,500 Cr
The net amount owing by Penbroke Retailers is $1,700.

EXERCISE 3.7
(a)
June
June
June
(b)
GST Paid
Date
June
Rent Expense
GST Paid
Cash at bank
Advertising Expense
GST Paid
Cash at bank
Cash at Bank
Sales Revenue
GST Collected
Explanation
Cash at bank
Cash at bank
GST Collected
Date
Explanation
June
Cash at bank
40,000
4,000
44,000
12,000
1,200
13,200
70,400
64,000
6,400
Ref.
Debit
4 000
1,200
Credit
Ref.
Debit
Credit
6 400
No.
Balance
4 000 Dr
5 200 Dr
No.
Balance
6 400 Cr
The net amount owing by Watsonia Ltd is $1,200.
5-73
Accuracy checked
PROBLEM 3-1
(a)
General Journal
Date
May 1
2
5
9
10
11
12
15
17
24
25
27
29
31

Inventory
Accounts Payable
Accounts Receivable
Sales
Cost of Goods Sold
Inventory
Accounts Payable
Inventory
Cash
Accounts Receivable
Accounts Payable ($6000 $600)
Cash
Supplies
Cash
Inventory
Cash
Cash
Inventory
Inventory
Accounts Payable
Cash
Sales
Cost of Goods Sold
Inventory
Inventory
Accounts Payable
Accounts Payable
Cash
Cash
Inventory Write-down
Cost of Goods Sold
Accounts Receivable
Sales
Cost of Goods Sold
Inventory
Ref.
120
201
112
401
505
120
201
120
101
112
201
101
126
101
120
101
101
120
120
201
101
401
505
120
120
201
201
101
412
101
515
505
112
401
505
120
Debit
6,000
Credit
6,000
5,000
5,000
3,100
3,100
600
600
5,000
5,000
5,400
5,400
900
900
2,700
2,700
230
230
1,900
1,900
6,200
6,200
4,600
4,600
1,000
1,000
1,900
1,900
100
100
20
20
1 600
1 600
1,120
1,120
5-74
Accuracy checked
(b)
Cash
Date
May 1
9
10
11
12
15
24
27
29
Explanation
Balance
Accounts Receivable
Accounts Payable
Supplies
Inventory
Inventory
Sales
Accounts Payable
Sales Returns
Accounts Receivable
Date
Explanation
Sales
May 2
Cash
9
Sales
31
Inventory
Date
May 1
2
5
12
15
17
24
25
31
Supplies
Date
May 11
Explanation
Accounts Payable
Cost of Goods Sold
Accounts Payable
Cash
Cash
Accounts Payable
Cost of Goods Sold
Accounts Payable
Cost of Goods Sold
Ref.
J1
J1
J1
J1
J1
J1
J1
J1
J1
Ref.
J1
J1
J1
Ref.
J1
J1
J1
J1
J1
J1
J1
J1
J1
Debit
Credit
5,000
5,400
900
2,700
230
6,200
Debit
5,000
1,900
100
Credit
5,000
1,600
Debit
6,000
2,700
1,900
1,000
Credit
3,100
600
230
4,600
1,120
Explanation
Cash
Ref.
J1
Debit
900
Credit
Accounts Payable
Date
Explanation
Inventory
May 1
Inventory
5
Cash
10
Inventory
17
Inventory
25
Cash
27
Ref.
J1
J1
J1
J1
J1
J1
Debit
Credit
6 000
600
5 400
1,900
1,900
1,000
No. 101
Balance
5,000 Dr
10,000
Dr
4,600 Dr
3,700 Dr
1,000 Dr
1,230 Dr
7,430 Dr
5,530 Dr
5,430 Dr
No. 112
Balance
5,000
0
1,600
No. 120
Balance
6,000 Dr
2,900 Dr
2,300 Dr
5,000 Dr
4,770 Dr
6,670 Dr
2,070 Dr
3,070 Dr
1,950 Dr
No. 126
Balance
900 Dr
No. 201
Balance
6,000 Cr
5,400 Cr
0
1,900 Cr
2,900 Cr
1,000 Cr
5-75
Accuracy checked
B. Copple, Capital
Date
Explanation
Balance
May 1
Ref.
Debit
Credit
Sales
Date
May 2
24
31
Explanation
Accounts Receivable
Cash
Accounts Receivable
Ref.
J1
J1
J1
Debit
Credit
5,000
6,200
1 600

Date
Explanation
May 29
Cash
Ref.
J1
Debit
100
Credit
Cost of Goods Sold

Date
Explanation
Inventory
May 2
Inventory
24
29
Inventory
31
Ref.
J1
J1
J1
J1
Debit
3,100
4,600
Credit
Date
Explanation
Cost of Goods Sold
May 29
Ref.
J1
Debit
20
20
1,120
Credit
No. 301
Balance
5,000 Cr
No. 401
Balance
5,000 Cr
11,200 Cr
12 800 Cr
No. 412
Balance
100 Dr
No. 505
Balance
3,100 Dr
7,700 Dr
7,680 Dr
8,800 Dr
No. 515
Balance
20 Dr
COPPLE HARDWARE STORE

Trial Balance
as at 31 May 2010
Cash
Accounts Receivable
Inventory
Supplies
Accounts Payable
B. Bloggs, Capital
Sales
Cost of Goods Sold
Debit
$5,430
1,600
1,950
900
Credit
$1,000
5,000
12,800
100
8,800
20
18,800
$18,800
5-76
Accuracy checked
PROBLEM 3-2
(Assumes a 5% discount offered by Ellis Company)
General Journal
(a)
Date
Apr. 5
7
9
10
12
14
17
20
21
27
30
(b)
Cash
Date
Apr.
1
7
14
21
30

Inventory
Accounts Payable
Freight-in
Cash
Accounts Payable
Inventory
Accounts Receivable
Sales
Cost of Goods Sold
Inventory
Inventory
Accounts Payable
Accounts Payable ($1,800 $100)
Discount Received ($1,700 5%)
Cash
Accounts Payable
Inventory
Accounts Receivable
Sales
Cost of Goods Sold
Inventory
Accounts Payable ($660 $60)
Cash
Accounts Receivable
Cash
Accounts Receivable
Explanation
Balance
Freight in
Accounts Payable
Accounts Payable
Accounts Receivable
Accounts Receivable
Date
Explanation
Apr. 10
Sales
20
Sales
27
Sales Returns
30
Cash
Ref.
J1
J1
J1
J1
Ref.
J1
J1
J1
J1
Ref.
120
201
510
101
201
120
112
401
505
120
120
201
201
515
101
201
120
112
401
505
120
201
101
412
112
101
112
Debit
Debit
1,800
1,800
80
80
100
100
1,200
1,200
810
810
660
660
1,700
85
1 615
60
60
700
700
490
490
600
600
40
40
1,000
1,000
Credit
80
1 615
600
1,000
Debit
1,200
700
Credit
Credit
40
1,000
No. 101
Balance
2,500 Dr
2,420 Dr
805 Dr
205 Dr
1,205 Dr
No. 112
Balance
1,200 Dr
1,900 Dr
1,860 Dr
860 Dr
5-77
Accuracy checked
Inventory
Date
Apr.
1
5
9
10
12
17
20
Explanation
Balance
Accounts Payable
Accounts Payable
Cost of Goods Sold
Accounts Payable
Accounts Payable
Cost of Goods Sold
Accounts Payable
Date
Explanation
Inventory
Apr.
5
Inventory
9
Inventory
12
Cash / Discount
14
Inventory
17
Cash
21
Ref.
J1
J1
J1
J1
J1
J1
Ref.
J1
J1
J1
J1
J1
J1
Debit
Credit
1,800
660
100
810
60
490
Debit
Credit
1,800
100
660
1,700
60
600
B. Bloggs, Capital
Date
Explanation
Apr.
1
Balance
Ref.
Debit
Credit
Sales
Date
Apr. 10
20
Ref.
J1
J1
Debit
Credit
1,200
700
Explanation
Accounts Receivable
Accounts Receivable

Date
Explanation
Apr. 27
Accounts Receivable
Cost of Goods Sold
Date
Explanation
Apr. 10
Inventory
20
Inventory
Freight-in
Date
Apr.
7
Explanation
Cash
Discount Received
Date
Explanation
Apr. 14
Accounts Receivable
Ref.
J1
Ref.
J1
J1
Debit
40
Credit
Debit
810
490
Credit
Ref.
J1
Debit
80
Credit
Ref.
J1
J1
Debit
Credit
85
No. 120
Balance
3,500 Dr
5,300 Dr
5,200 Dr
4,390 Dr
5,050 Dr
4,990 Dr
4,500 Dr
No. 201
Balance
1,800 Cr
1,700 Cr
2,360 Cr
660 Cr
600 Cr
0
No. 301
Balance
6 000 Cr
No. 401
Balance
1,200 Cr
1,900 Cr
No. 412
Balance
40 Dr
No. 505
Balance
810 Dr
1,300 Dr
No. 510
Balance
80 Dr
No. 515
Balance
85 Cr
5-78
Accuracy checked
(c)
BILLS PRO SHOP

Trial Balance
as at 30 April 2010
Cash
Accounts Receivable
Inventory
B. Bloggs, Capital
Sales
Cost of Goods Sold
Freight-in
Discount Received
Debit
$1,205
860
4,500
Credit
$6,000
1,900
40
1,300
80
85
$7,985
$7,985
PROBLEM 3-3
(assuming Perpetual inventory method)
KIDS AND KITES LTD
(a)
70,700
Dr. Cash/Accounts Receivable
Cr. GST Collected ($70 700/11)
Cr. Sales
(To record sales revenue and GST collected)
1,273
Dr. Sales Returns and Allowances
Dr. GST Collected ($1400/11)
Cr. Cash/Accounts Receivable
127
1,400
Dr. Inventory
Dr. GST Paid ($28 560/11)
Cr. Cash/Accounts Payable
(To record inventory purchase and GST paid)
Dr. Cash/Accounts Payable
Cr. GST Paid ($3360/11)
Cr. Inventory
(To record purchase return and GST recovered)
Dr. GST Collected
Cr. GST Paid
Cr. Cash
(To record payment of GST to tax authority)
(b)
(assuming Perpetual inventory method)
Dr. Cash/Accounts Receivable
Cr. GST Collected ($28 560/11)
Cr. Sales
(To record sales revenue and GST collected)
Dr. Inventory
Dr. GST Paid ($70 700/11)
Cr. Cash/Accounts Payable
(To record inventory purchase and GST paid)
Dr. Cash
Dr. GST Collected
Cr. GST Paid
(To record refund of GST from tax authority)
6,427
64,273
25 964
2,596
28,560
3,360
305
3,055
6,300
2,291
4,009
28,560
2,596
25,964
64,273
6,427
70,700
3,831
2,596
6,427
5-79
Accuracy checked
BYP 3-1FINANCIAL REPORTING PROBLEM COLES GROUP

The 2003 and 2004 figures were used here as an example. Students answers will vary,
depending on the reports accessed.
(a)
2004
(1) Percentage change in sales
($32 266. 8 - 27 016.6) / 27 106.6 =
(2)
(b)
Percentage increase in net profit

($616.5 429.5) / 429.5 =
43.5 per cent increase
Gross profit ratio

Gross Profit / Net Sales
2003 $7398 / 27 016.6
2004 $8207.3 / 32 266.8
(c)
19.4 per cent increase
=
=
27.4 per cent

25.4 per cent
Percentage of Net Profit to Sales

2003 ($429.5 / 27 016.6) =
2004 ($616.5 / 32 266.8) =
1.59%
1.91 %
The percentage of net profit to sales increased from 2003 to 2004 (1.59% to
1.91%). The gross profit ratio decreased during this time which would suggest
that the improvements have come from better control of expenses.
BYP 3-2
(a)
Harvey Norman Holdings Ltd
1.
2.
3.
4.
(b)
COMPARATIVE ANALYSIS PROBLEM - HNH
Inventories:
Property, Plant and
Equipment:
Payables:
Interest and Finance charges:
David Jones Ltd
debit
debit
1.
2.
Receivables:
Cash Assets:
debit
debit
credit
debit
3.
4.
Cost of Goods Sold:

debit
Sales (Revenue from sale of credit
goods):
The following other accounts are ordinarily involved:

(1)
(2)
(3)
(7)
(8)
(9)
Increase in Accounts Receivable: Service Revenue or Sales is increased

(credited).
Decrease in Wages Payable: Cash is decreased (credited).
Increase in Property, Plant and Equipment: Notes Payable is increased
(credited) or Cash is decreased (credited).
Increase Finance charges: Cash is decreased (credited).
Revenue from Sale of Goods is increased:
Interest-bearing Loans is increased:
5-80
Accuracy checked
BYP 3-3COMPARATIVE ANALYSIS PROBLEM COLES/WOOLW

The 2003 and 2004 figures were used here as an example. Students answers will vary,
depending on the reports accessed.
(a)
(1)
Gross profit
(2)
Gross profit ratio

($8207.3 / 32 266.8)
($6954.4 / 27 933.9)
Net Profit
Per cent change in net profit
($32 266.8 27 016.6) / 27 016.6
($27 933.9 26 321.4) / 26 321.4
(3)
(4)
(b)
Coles Myer
Ltd
($ million)
Woolworths
Limited
($ million)
$8207.3
6
25.4%
$6958.4
$6165
19.4%
increase
24.9%
$731.1
6.1% increase
Coles Myer has a higher gross profit and a higher gross profit ratio than
Woolworths Limited. Coles Myer also increased its profit from 2003 to 2004 by a
greater percentage than Woolworths which may suggest a better control on
expenses for that time period.
BYP 3-4
INTERPRETING FINANCIAL STATEMENTS

A Global Focus
(a)
Rebel Sports Ltd

(Australian dollars)
Gross profit ratio
(Gross Profit/Net
Sales)
(276 855 175 777) /

276 855
= 36.5%
Reebok International Ltd

(US dollars)
(3 485 316 2 147 111) /
3 485 316
= 38.4%
Both companies have a similar gross profit ratio, Reebok is only marginally better able
to control cost of goods sold.
(b)
Expense to
sales ratio
(Expenses/sales)
98 327 / 276 855

= 35.5%
1,112 236 / 3 485 316

= 31.9%
Whilst both companies have similar expenses to sales ratios, Reeboks is slightly
better.
(c)
Ratios improve our ability to compare these two companies that report financial
information using different currencies. However, there may be other factors
that can still reduce our ability to compare them. There may be differences in
the way the two companies might classify certain expense items. Also, different
accounting standards in the two countries might result in dramatically different
results under the same circumstances. Also, differences in laws, such as the
insolvency act, can affect the results. For example, if Australian insolvency laws
favour shareholders more than US insolvency laws, then it would be prudent for
an Australian company to rely more on debt financing than a US company. Also
5-81
Accuracy checked
the data for comparison is just one year. It would be more useful to compare
the trend over a number of years.
BYP 3-5 and 3-6
EXPLORING THE WEB
The answer is dependent upon the company selected by the student.
Chapter 4
Adjusting the accounts
ASSIGNMENT CLASSIFICATION TABLE

Brief
Exercise
s
Exercise
s
Problems
Set A
Learning Objectives
Question
s
*1.
Explain the time

period assumption.
1, 2
*2.
Explain the accrual

basis of accounting.
3, 4, 5
*3.
Explain why adjusting

entries are needed.
1, 6, 7
*4.
Identify the major

types of adjusting
entries.
8, 9, 10,
18
2, 8
2, 7
*5.
Prepare adjusting
entries for
prepayments.
8, 9, 10,
11, 12, 13,
18, 19, 20
3, 4, 5, 6
2, 3, 4, 5,
6, 7, 8, 9,
11
1A, 2A,
3A,
4A, 5A,
6A, 7A
*6.
Prepare adjusting
entries for accruals.
8, 14, 15,
16, 17, 18,
19, 20
2, 3, 4, 5,
6, 7, 8, 9,
11
1A, 2A,
3A,
4A, 5A,
6A, 7A
*7.
Describe the nature

and purpose of an
adjusted trial balance.
21
3, 4, 5, 6,
7, 8, 9, 10
1A, 2A,
3A,
5A, 6A, 7A
*8.
Prepare adjusting
entries for the
alternative treatment
of prepayments.
22
11
6A
1, 6
*Note:All asterisked Questions, Exercises and Problems relate to material contained

in the appendix to the chapter.
5-82
Accuracy checked
ASSIGNMENT CHARACTERISTICS TABLE

Proble
m
Numbe
r
Description
Difficult
y
Level
Time
Allotted
(min.)
Prepare adjusting entries, post to ledger accounts,

and prepare an adjusted trial balance.
Simple
40-50
Prepare adjusting entries, post, and prepare an

adjusted trial balance and financial reports.
Simple
50-60
Prepare adjusting entries and financial reports.
Moderate
40-50
Prepare adjusting entries.
Moderate
30-40
Journalise transactions and follow through

accounting
cycle to preparation of financial reports.
Moderate
60-70
Prepare adjusting entries, an adjusted trial balance,

and financial reports.
Moderate
40-50
Prepare adjusting entries and financial statements

using appendix
Moderate
40-50
5-83
Accuracy checked
BLOOMS TAXONOMY TABLE

Correlation Chart between Blooms Taxonomy, Learning Objectives and Endof-Chapter Exercises and Problems
Learning Objective
*1.
*2.
*3.
*4.
*5.
Explain the time period

assumption.
Explain the accrual basis of
accounting.
Explain why adjusting entries
are needed.
Identify the major types of
adjusting entries.
Prepare adjusting entries for
prepayments.
Knowledge Comprehension Applicatio

n
Q4-1
Q4-2
Q4-3
Q4-4
Q4-1
Q4-6
Q4-8
Q4-9
Q4-8
Q4-9
Q4-10
Q4-11
Q4-12
Q4-13
Q4-19
Q4-20
Q4-5
Q4-7
BE4-1
Q4-10
*6.

accruals.
Q4-8
Q4-14
Q4-15
Q4-19
Q4-20
Q4-17
*7.
Describe the nature and

purpose of an adjusted trial
balance.
Q4-21
BE4-9
BE4-10
E4-10
*8.

the alternative treatment of
prepayments.
Broadening Your Perspective
Q4-22
Communication
Analysis
Synthesis
E4-6
Q4-18
BE4-2
Q4-18
BE4-3
BE4-4
BE4-5
BE4-6
E4-2
E4-3
E4-4
E4-5
Q4-16
Q4-18
BE4-7
E4-2
E4-3
E4-4
E4-5
E4-6
E4-3
E4-4
E4-5
E4-6
E4-7
E4-8
BE4-11
Evaluation
E4-1
BE4-8
E4-2
E4-6
E4-7
E4-8
E4-9
E4.10
P4-1A
P4-2A
P4-3A
E4-7
P4-4A E4-11
P4-5A
P4-6A
P4-7A
E4-7 P4-5A E4-11

E4-8 P4-6A
E4-9 P4-7A
P4-1A
P4-2A
P4-3A
P4-4A
E4-9 P4-6A
P4-1A P4-7A
P4-2A
P4-4A
P4-5A
P4-6A
Financial Reporting
Group Decision Ethics Case
Comparative Analysis
Case
Interpreting
Exploring the Web
Interpreting
Financial
Financial
report
report
Sustainability
Financial
case
reporting
Financial
quality case
reporting
quality case
5-84
Accuracy checked
1.
2.
(a)
Under the time period assumption, an accountant is required to

determine the relevance of each business transaction to specific
accounting periods.
(b)
An accounting time period of one year in length is referred to as a fiscal

year. A fiscal year that extends from 1 January to 31 December is referred
to as a calendar year. A fiscal year that extends from July to June is
referred to as a financial year. Accounting periods of less than one year
are called interim periods.
The two generally accepted accounting principles that relate to adjusting the
accounts are:
The revenue recognition principle, which states that revenue should be

recognised in the accounting period in which the economic benefits have
been received.
The expense recognition principle, which states that expenses should be
recognised in the accounting period in which they are incurred.
3.
The law firm should recognise the revenue in April. The revenue recognition
principle states that revenue should be recognised in the accounting period in
which it is earned.
4.
Information presented on an accrual basis is more useful than on a cash basis

because it reveals relationships that are likely to be important in predicting
future results. To illustrate, under accrual accounting, revenue is recognised
when earned. Trends in revenue are thus more meaningful.
5.
Expenses of $6000 should be recorded in March. The expense recognition

principle states that expenses are recognized in the accounting period in which
they are incurred.
6.
No, adjusting entries are required by the revenue recognition and expense
recognition principles.
7.
A trial balance may not contain up-to-date information for financial reports
because:
(1)
(2)
(3)
Some events are not journalised daily because it is unnecessary and

inexpedient to do so.
The expiration of some costs occurs with the passage of time rather than
as a result of recurring daily transactions.
Some items may be unrecorded because the transaction data are not
known.
8.
The two categories of adjusting entries are prepayments and accruals.

Prepayments consist of prepaid expenses and unearned revenue. Accruals
consist of accrued revenue and accrued expenses.
9.
In the adjusting entry for a prepaid expense, an expense is debited and an asset
is credited.
5-85
Accuracy checked
10.
No. Depreciation is the process of allocating the cost of an asset to expense

over its useful life in a rational and systematic manner. Depreciation results in
the presentation of the carrying amount of the asset, not its market value.
11.
Depreciation expense is an expense account whose normal balance is a debit.

This account shows the cost that has expired during the current accounting
period. Accumulated depreciation is a contra asset account whose normal
balance is a credit. The balance in this account is the depreciation that has been
recognised from the date of acquisition to the balance sheet date.
5-86
Accuracy checked
12.
13.
Equipment
Less: Accumulated Depreciation
12,000
$20,000
$8 000
In the adjusting entry for an unearned revenue, a liability is debited and an

revenue is credited.
Answers to questions (continued)

14.
Asset and revenue. An asset would be debited and an revenue would be

credited.
15.
An expense is debited and a liability is credited.
16.
Net profit was understated $300 because prior to adjustment, revenue is

understated by $900 and expenses are understated by $600. The
difference
in
this
case
is
$300
($900 $600).
17.
The entry is:

Jan. 9
Salaries Payable (Accrued Salaries)
Salaries Expense
Cash
18.
3,000
6,000
9,000
(a) Accrued revenue.

expenses.
(b) Unearned revenue.
(c) Accrued expenses.
(d) Accrued expenses or prepaid
19.
(a) Salaries Payable.

(b) Accumulated Depreciation.
(c) Interest Expense.
(d) Supplies Expense.

(e) Service Revenue.
(f) Service Revenue.
20.
Disagree. An adjusting entry affects only one balance sheet account and one
revenue statement account.
21.
Financial reports can be prepared from an adjusted trial balance because the
balances of all accounts have been adjusted to show the effects of all financial
events that have occurred during the accounting period.
*22.
For Supplies Expense (prepaid expense): expenses are overstated and assets
are understated. The adjusting entry is:
(e) Prepaid expenses.

(f) Accrued revenue or unearned revenue.
Assets (Supplies)
Expenses (Supplies Expense)
XX
XX
For Rent Revenue (unearned revenue): revenue is overstated and liabilities are
understated. The adjusting entry is:
Revenue (Rent Revenue)
Liabilities (Unearned Rent Revenue)
XX
XX
5-87
Accuracy checked

BRIEF EXERCISE 4-1
(a)
Prepaid Insurance to recognise insurance expired during the period.
(b)
Depreciation Expense to account for the depreciation that has occurred on the
asset during the period.
(c)
Unearned Revenue to record revenue earned for services provided.
(d)
Interest Payable to recognise interest accrued but unpaid on interest payable.
BRIEF EXERCISE 4-2

(a)
Item
Type of Adjustment
(b)
Accounts before Adjustment
1.
Prepaid Expense
Assets Overstated
Expenses Understated
2.
Accrued Revenue
Assets Understated
Revenues Understated
3.
Accrued Expense
Liabilities Understated
4.
Unearned Revenue
Liabilities Overstated
Revenues Understated
BRIEF EXERCISE 4-3

Dec. 31
Advertising Supplies Expense

Advertising Supplies ($6700 $1700)
Advertising Supplies
6700 31/12
31/12 Bal.
1700
5,000
5,000
Advertising Supplies Expense

31/12
5,000
5,000
BRIEF EXERCISE 4-4

Dec. 31
Depreciation Expense Equipment

Accumulated Depreciation
Equipment
Depr. Expense Equipment

31/12
6000
6000
Accum. Depreciation Equipment
31/12
6000
Balance Sheet:
Equipment
Less: Accumulated Depreciation
BRIEF EXERCISE 4-5
6000
$30,000
6 000
5-88
Accuracy checked
$24 000
July
Dec. 31
Prepaid Insurance
Cash
Insurance Expense ($12,000 3) 1/2
Prepaid Insurance
Prepaid Insurance
1/7
12,000 31/12
31/12 Bal. 10,000
2,000
12,000
12,000
2,000
2,000
Insurance Expense
2,000
31/12
BRIEF EXERCISE 4-6

July
Cash
12,000
Unearned Insurance Revenue
Dec. 31
12,000

Insurance Revenue

31/12
2,000 1/7
12,000
31/12 Bal. 10,000
2,000
2,000
Insurance Revenue
31/12
2,000
BRIEF EXERCISE 4-7

1.
Dec. 31
Interest Expense
Interest Payable
400
Accounts Receivable
Service Revenue
1,250
Salaries Expense
Salaries Payable
BRIEF EXERCISE 4-8
900
2.
31
3.
400
1,250
31
Account
Accounts Receivable
Prepaid Insurance
Accum. Depr. Equipment
Interest Payable
Unearned Service Revenue
900
(a)
Type of Adjustment
Accrued Revenue
Prepaid Expenses
Prepaid Expenses
Accrued Expenses
Unearned Revenue
(b)
Related Account
Service Revenue
Insurance Expense
Depreciation Expense
Interest Expense
Service Revenue
*BRIEF EXERCISE 4-9

(a)
(b)
Apr.
30
30
Supplies
Supplies Expense
1,000
Service Revenue
2,000
1,000
2,000
5-89
Accuracy checked
EXERCISE 4-1
(a)
Accrual-basis accounting records the events that change an entitys financial

reports in the periods in which the events occur rather than in the periods in
which the entity receives or pays cash. Information presented on an accrual basis
is useful because it reveals relationships that are likely to be important in
predicting future results. Conversely, under cash-basis accounting, revenue is
recorded only when cash is received, and an expense is recognised only when
cash is paid. As a result, the cash basis of accounting often leads to misleading
financial reports.
(b)
Politicians might desire a cash-basis accounting system over an accrual-basis

system because if an accrual-accounting system is used, it could mean that
billions in government liabilities presently unrecorded would have to be reported
in the federal budget immediately. The recognition of these additional liabilities
would make the deficit even worse. This is not what politicians would like to see
and be held responsible for.
(c)
Proponents of accrual reporting, argue that whole of government financial

statements can provide a useful overview of a governments financial
performance, its assets and liabilities and cash flows. This provides useful
information upon which informed decisions can be made on the achievement of
the governments overall objectives and in respect of choices that a government
has made in the allocation of resources according to its various priorities and
commitments (i.e. its accountability). Accrual accounting permits users to assess
trends of financial performance and position. It provides more comprehensive
information as to the revenue generated by government entities and the full
costs of governments services and activities.
EXERCISE 4-2
Item
(a)
Type of Adjustment
(b)
Accounts before Adjustment
1.
Accrued Revenue
Assets Understated
Revenue Understated
2.
Prepaid Expenses
Assets Overstated
3.
Accrued Expenses
4.
Unearned Revenue
Liabilities Overstated
Revenue Understated
5.
Accrued Expenses
6.
Prepaid Expenses
Assets Overstated
5-90
Accuracy checked
EXERCISE 4-3
1. Mar.31
Depreciation Expense ($300 3)

Accumulated Depreciation Equipment
900
900
2.
31
3.
31
4.
31
5.
31
Unearned Rent
Rent Revenue ($9900 1/3)
Interest Expense
Interest Payable
Supplies Expense
Supplies ($2800 $900)
Insurance Expense ($200 3)
Prepaid Insurance
3,300
3,300
500
500
1,900
1,900
600
600
EXERCISE 4-4
1.
Jan. 31
2.
31
3.
31
31
4.
5.
31
31
Accounts Receivable
1,560
Service Revenue
Utilities Expense
800
Utilities Payable
400
Accumulated Depreciation Dental Equipment
Interest Expense
500
Interest Payable
Insurance Expense ($24 000 12)
2,000
Prepaid Insurance
Supplies Expense ($1600 $800)
800
Supplies
1,560
800
400
500
2,000
800
EXERCISE 4-5
1.
Oct. 31
2.
31
3.
31
4.
31
5.
31
6.
Oct. 31
7.
31
Stationary Supplies Expense

100
Stationary Supplies
($500 $400)
Insurance Expense
200
Prepaid Insurance
100
Accumulated Depreciation Office Equipment
Unearned Revenue
1,200
Service Revenue
Accounts Receivable
650
Service Revenue
Interest Expense
120
Interest Payable
Salaries Expense
1,400
Salaries Payable
5-91
Accuracy checked
100
200
100
1,200
650
120
1,400
EXERCISE 4-6
(a)
Answer
Supplies balance = $1150
Computation
Supplies expense
Add: Supplies (1/31)
Less: Supplies purchased
$ 950
850
(650)
Supplies (1/1)
(b)
(c)
$1,150
Total premium = $4800
Total premium = Monthly premium 12;

$400 12 = $4800
Purchase date = 1 Aug. 2006
Purchase date: On 31 Jan. there is 6 months

coverage remaining ($400 6). Thus, the
purchase date was 6 months earlier on 1 Aug.
2006.
Salaries payable = $2,000
Cash paid
Salaries payable (31/1/07)
$3,000
800
3,800
1,800
$2,000
Less: Salaries expense

Salaries payable (31/12/06)
(d)
Unearned Revenue = $1150
Service revenue
Unearned Revenue (31/1/07)
$2,000
750
2,750
1,600
$1,150
Cash received in January

Unearned Revenue (31/12/06)
EXERCISE 4-7
(a)
July
10
14
15
20
(b)
July
31
31
31
31
Supplies
Cash
Cash
Service Revenue
Salaries Expense
Cash
Cash
Unearned Revenue
200
Supplies Expense
Supplies
Accounts Receivable
Service Revenue
Salaries Expense
Salaries Payable
Unearned Revenue
Service Revenue
800
200
2,000
2,000
1,200
1,200
750
750
800
500
500
1,200
1,200
900
900
5-92
Accuracy checked
EXERCISE 4-8
June
30
30
30
30
Accounts Receivable
Service Revenue
600
600
Office Supplies Expense

Office Supplies
1,600
Insurance Expense
Prepaid Insurance
1,500
1,300
Salaries Expense
Salaries Payable
1,100
1,600
1,500
1,300
30
30
1,100
Unearned Rent
Rent Revenue
900
900
EXERCISE 4-9
(a)
1.
Cash
9,000
Fees Receivable
2.
3.
Unearned Fees
Fees Revenues
20,000
(a)
35,000
(b)
4.
5.
9,000
20,000
Cash
Unearned Fees
Unearned Fees
($35,000 $17 000)
Fees Revenue
35,000
18,000
18,000
Fees Receivable
Fees Revenue
($153 000 $20,000 $18 000)
115,000
Cash
103,000
115,000
Fees Receivable
($115,000 $12,000)
(b)
103,000
Cash received with respect to fees = $9000 + $103 000 + $35,000

Cash received with respect to fees = $147 000
5-93
Accuracy checked
EXERCISE 4-10
(a)
(1)
Jun. 30
(2)
Jun. 30
(3)
Jun. 30
(4)
Jun. 30
(5)
Jun. 30
(6)
Jun. 30
Salaries Expenses
Salaries Payable
8,500
Depreciation Office Furniture

Accumulated Depreciation Office Furniture
8,000
8,500
Accounts Receivable
Service Revenue
8,000
1,700
1,700
Utilities Expenses
Utilities Payable
1,500
1,500
Prepaid Subscription
Subscription Expense
900
900
Cash
5,000
5,000
Unearned Revenue
(7)
(b)
No economic transaction to record
Total adjustments recorded total a reduction in profit of $15400. Thus the net
profit that would be reported under an accrual based system is $25,0000 less
$15400 = $234600.
*EXERCISE 4-11
(a)
Jan. 2
10
15
2,400
Supplies Expense
Cash
1,700
2,400
1,700
Cash
Service Revenue
6,100
6,100
Insurance Expense
2400
2/1
Cash
6100 2/1
10/1
15/1
(b)
Insurance Expense
Cash
Jan.
10/1
Service Revenue
15/1
2400
1700
31
Prepaid Insurance ($200 11 months)

Insurance Expense
31
Supplies
Supplies Expense
31
Supplies Expense
1700
6100
2,200
2,200
800
800
Service Revenue
Unearned Revenue
4,600
4,600
5-94
Accuracy checked
Insurance Expense
Supplies Expense
Service Revenue
2/1
2400 31/1
2200 10/1
1700 31/1
800 31/1
4600 15/1
6100
Bal.
200
Bal.
900
Bal.
1500
31/1
(c)
Prepaid Insurance
2200
31/1
Supplies
800
Unearned Revenue
31/1
4600
Insurance expense
Supplies expense
Service revenue
Prepaid insurance
Supplies
Unearned revenue
$ 200
900
1,500
2,200
800
4,600
PROBLEM 4-1
(a)
Date
2010
May 31
31
31
31
31
31
31
J4
Credit
Ref.
Debit
Supplies Expense
Supplies
560
130
1,00
0
Travel Expense
Travel Payable
550
210
400
Insurance Expense
Prepaid Insurance
($2400 24 months)
540
120
200

Service Revenue
($3000 $1,000)
230
400
4,00
0
4,000
Salaries Expense
Salaries Payable
[(3/5 $500) 2 employees]
510
220
1,20
0
1,200
Accumulated Depreciation Office
Furniture
($12,000 60 months)
530
400
Accounts Receivable
Service Revenue
110
400
1,000
400
200
136
400
2,00
0
5-95
Accuracy checked
2,000
(b)
Cash
Date
2010
May 31
Explanation
Balance
Accounts Receivable
Date
Explanation
2010
May 31
Balance
31
Adjusting
Prepaid Insurance
Date
Explanation
2010
May 31
Balance
31
Adjusting
Supplies
Date
2010
May 31
31
Explanation
Balance
Adjusting
Office Furniture
Date
Explanation
2010
May 31
Balance
Ref.
Debit
Travel Payable
Date
Explanation
2010
May 31
Adjusting
Salaries Payable
Date
Explanation
2010
May 31
Adjusting
No. 101
Balance
15,40
0
Debit
J4
2,000
8,000
10,000
Debit
No. 120
Balance
Ref.
J4
Ref.
Credit
4,800
4,600
200
Debit
J4
Ref.
Credit
No. 110
Balance
Ref.
Credit
Debit
Credit
3,000
2,000
No. 135
Balance
24,000
Ref.
No. 130
Balance
1,000
Accumulated Depreciation Office Furniture

No. 136
Date
Explanation
Ref.
Debit
2010
May 31
Adjusting
J4
Accounts Payable
Date
Explanation
2010
May 31
Balance
Credit
Debit
Credit
Balance
400
400
Credit
No. 200
Balance
7,000
Ref.
Debit
J4
Ref.
J4
Credit
No. 210
Balance
400
Debit
400
Credit
No. 220
Balance
1,200
1,200
5-96
Accuracy checked

Date
Explanation
2010
May 31
Balance
31
Adjusting
M. Griffin, Capital
Date
Explanation
2010
May 31
Balance
Service Revenue
Date
Explanation
2010
May 31
Balance
31
Adjusting
31
Adjusting
Salaries Expense
Date
Explanation
2010
May 31
Balance
31
Adjusting
Rent Expense
Date
Explanation
2010
May 31
Balance
Date
Explanation
2010
May 31
Adjusting
Insurance Expense
Date
Explanation
2010
May 31
Adjusting
Travel Expense
Date
Explanation
2010
May 31
Adjusting
Supplies Expense
Date
Explanation
2010
May 31
Adjusting
Ref.
Debit
J4
4 000
Ref.
Debit
Credit
No. 230
Balance
6 000
2,000
Credit
No. 300
Balance
38,200
Ref.
Debit
J4
J4
Ref.
J4
Ref.
Debit
Credit
No. 400
Balance
4 000
2,000
12,000
16,000
18,000
Credit
No. 510
Balance
3,000
3,600
1,200
Debit
Credit
No. 520
Balance
2,000
Ref.
Debit
J4
400
Ref.
Debit
J4
200
Ref.
Debit
J4
400
Ref.
Debit
J4
1,000
Credit
No. 530
Balance
400
Credit
No. 540
Balance
200
Credit
No. 550
Balance
400
Credit
No. 560
Balance
1,000
5-97
Accuracy checked

(c)
VEKTEK CONSULTING
Adjusted Trial Balance
as at 31 May 2010
Cash
Accounts Receivable
Prepaid Insurance
Supplies
Office Furniture
Accumulated Depreciation Office Furniture................
Accounts Payable
Travel Payable
Salaries Payable
L. Griffin, Capital
Service Revenue
Salaries Expense
Rent Expense
Insurance Expense
Travel Expense
Supplies Expense
Debit
$
15,400
10,000
4600
2,000
24000
7,200
2,000
400
200
400
1,000
$67,200
Credit
$
400
7000
400
1,200
2,000
38,200
18,000
______
0$67,20
0
PROBLEM 4-2
(a)
Date
May 31
31
31
31
31
31
31

Insurance Expense
Prepaid Insurance
Supplies Expense
Supplies ($1900 $900)
Depreciation Expense Buildings
($2400 1/12)
Buildings
Depreciation Expense Furniture
($3000 1/12)
Furniture
Interest Expense
Interest Payable
[($35,000 12%) 1/12]
Unearned Rent Revenue
Rent Revenue
Salaries Expense
Salaries Payable
Ref.
722
130
631
126
619
Debit
200
200
1,000
1,000
200
142
621
J1
Credit
200
250
150
250
718
230
350
208
429
726
212
2,500
350
2,500
800
800
5-98
Accuracy checked
5-99
Accuracy checked
(b)
Cash
Date
May 31
Supplies
Date
May 31
31
Explanation
Balance
Ref.
Debit
Explanation
Balance
Adjusting
Ref.
J1
Debit
Prepaid Insurance
Date
Explanation
May 31
Balance
31
Adjusting
Ref.
J1
Debit
Land
Date
May 31
Ref.
Debit
Credit
Credit
1,000
Credit
200
No. 101
Balance
2,500
No. 126
Balance
1,900
900
No. 130
Balance
2,400
2,200
Credit
No. 140
Balance
15,000
Debit
Credit
No. 141
Balance
70,000
Accumulated Depreciation Buildings

Date
Explanation
Ref.
May 31
Adjusting
J1
Debit
Credit
200
Furniture
Date
May 31
Debit
Credit
Buildings
Date
May 31
Explanation
Balance
Explanation
Balance
Explanation
Balance
Ref.
Ref.
Accumulated Depreciation Furniture

Date
Explanation
Ref.
May 31
Adjusting
J1
Debit
Credit
250
Accounts Payable
Date
Explanation
May 31
Balance
Debit
Credit
Ref.

Date
Explanation
May 31
Balance
31
Adjusting
Ref.
J1
Salaries Payable
Date
Explanation
May 31
Adjusting
Ref.
J1
Interest Payable
Date
Explanation
May 31
Adjusting
Ref.
J1
Debit
Credit
2,500
Debit
Debit
No. 142
Balance
200
No. 149
Balance
16,800
No. 150
Balance
250
No. 201
Balance
5,300
No. 208
Balance
3,600
1,100
Credit
800
No. 212
Balance
800
Credit
350
No. 230
Balance
350
5-100
Accuracy checked
Mortgage Payable
Date
Explanation
May 31
Balance
Ref.
Debit
Credit
No. 275
Balance
35,000
Sue Phillips, Capital

Date
Explanation
May 31
Balance
Ref.
Debit
Credit
No. 301
Balance
60,000
Rent Revenue
Date
Explanation
May 31
Balance
31
Adjusting
Ref.
J1
Debit
Advertising Expense
Date
Explanation
May 31
Balance
Ref.
Debit
Credit
2,500
No. 429
Balance
9,200
11,700
Credit
No. 610
Balance
500

Date
Explanation
May 31
Adjusting
Ref.
J1
Debit
200
Credit
No. 619
Balance
200

Date
Explanation
May 31
Adjusting
Ref.
J1
Debit
250
Credit
No. 621
Balance
250
Supplies Expense
Date
Explanation
May 31
Adjusting
Ref.
J1
Debit
1,000
Credit
No. 631
Balance
1,000
Interest Expense
Date
Explanation
May 31
Adjusting
Ref.
J1
Debit
350
Credit
No. 718
Balance
350
Insurance Expense
Date
Explanation
May 31
Adjusting
Ref.
J1
Debit
200
Credit
No. 722
Balance
200
Salaries Expense
Date
Explanation
May 31
Balance
31
Adjusting
Ref.
J1
Debit
Credit
Utilities Expense
Date
Explanation
May 31
Balance
Ref.
800
Debit
Credit
No. 726
Balance
3,000
3,800
No. 732
Balance
1,000
5-101
Accuracy checked

(c)
MERCURY MOTEL
as at 31 May 2010
Debit
Cash
Supplies
Prepaid Insurance
Land
Buildings
Accumulated Depreciation Buildings
Furniture
Accumulated Depreciation Furniture
Accounts Payable
Salaries Payable
Interest Payable
Mortgage Payable
Sue Phillips, Capital
Rent Revenue
Advertising Expense
Supplies Expense
Interest Expense
Insurance Expense
Salaries Expense
Utilities Expense
Credit
$2,500
900
2,200
15,000
70,000
$ 200
16,800
250
5,300
1,100
800
350
35,000
60,000
11,700
500
200
250
1,000
350
200
3 800
1,000
$114,700
0000,00
0
$114,70
0
PROBLEM 4-3
(a)
Sept.
30
Accounts Receivable
Commission Revenue
200
Rent Expense
Prepaid Rent
600
Supplies Expense
Supplies
200
30
Accum. Depreciation Equipment
850
30
Interest Expense
Interest Payable
50
Unearned Rent
Rent Revenue
400
Salaries Expense
Salaries Payable
400
30
30
200
600
200
850
30
30
50
400
400
5-102
Accuracy checked
(b)
Interest of 12% per year equals a monthly rate of 1%; monthly interest is $50
($5,000 1%). Since total interest expense is $50, the note has been on issue
one month.
PROBLEM 4-4
1.
Dec. 31
Insurance Expense.................................................
4400
Prepaid Insurance..........................................
[($6000 3) = $2,000
[($4800 2) = 2400
$4400]
4400
2.
Dec. 31
Unearned Subscriptions.........................................
7000
Subscription Revenue....................................
7000
[Oct. 200 $50 3/12 = $2500
[Nov. 300 $50 2/12 = 2500
[Dec. 480 $50 1/12 = 2,000
$7000]
3.
Dec. 31
Interest Expense....................................................
1,200
Interest Payable.............................................
($40000 9% 4/12)
4.
Dec. 31
Salaries Expense..................................................
Salaries Payable...........................................
[5 $500 3/5 = $1500
[3 $800 3/5 = 1440
$2940]
1,200
2940
2940
PROBLEM 4-5
(a), (c) & (e)
Cash
Date
Nov.
1
8
10
12
20
22
25
29
Explanation
Balance
Ref.
J1
J1
J1
J1
J1
J1
J1
Accounts Receivable
Date
Explanation
Nov.
1
Balance
10
27
Ref.
J1
J1
Supplies
Date
Nov.
1
17
30
Ref.
J1
J1
Explanation
Balance
Adjusting
Debit
Credit
1,100
1,200
1,400
2,500
300
1,000
550
Debit
Credit
1,200
700
Debit
Credit
500
1,500
No. 101
Balance
2,790
1 690
2 890
4 290
1,790
1 490
490
1,040
No. 112
Balance
2,510
1 310
2,010
No. 126
Balance
2,000
2,500
1,000
5-103
Accuracy checked
Store Equipment
Date
Explanation
Nov.
1
Balance
15
Ref.
J1
Debit
3 000
Accumulated Depreciation Store Equipment

Date
Explanation
Ref.
Debit
Nov.
1
Balance
30
Adjusting
J1
Accounts Payable
Date
Explanation
Nov.
1
Balance
15
17
20
Ref.
J1
J1
J1

Date
Explanation
Nov.
1
Balance
29
30
Adjusting
Ref.
J1
J1
Salaries Payable
Date
Explanation
Nov.
1
Balance
8
30
Adjusting
Ref.
J1
J1
Credit
Debit
Credit
120
Credit
3 000
500
2,500
Debit
Credit
550
1,150
Debit
Credit
500
500
No. 153
Balance
10,000
13,000
No. 154
Balance
500
620
No. 201
Balance
2,100
5,100
5,600
3,100
No. 209
Balance
1,400
1,950
800
No. 212
Balance
500
0
500
P. Samone, Capital
Date
Explanation
Nov.
1
Balance
Ref.
Debit
Credit
Service Revenue
Date
Explanation
Nov. 12
27
30
Adjusting
Ref.
J1
J1
J1
Debit
Credit
1,400
700
1,150
Date
Explanation
Nov. 30
Adjusting
Ref.
J1
Debit
120
Credit
No. 615
Balance
120
Supplies Expense
Date
Explanation
Nov. 30
Adjusting
Ref.
J1
Debit
1,500
Credit
No. 631
Balance
1,500
Salaries Expense
Date
Explanation
Nov.
8
25
30
Adjusting
Rent Expense
Date
Explanation
Ref.
J1
J1
J1
Debit
600
1,000
500
Credit
Ref.
Debit
Credit
No. 301
Balance
12,800
No. 407
Balance
1,400
2,100
3 250
No. 726
Balance
600
1,600
2,100
No. 729
Balance
5-104
Accuracy checked
Nov.
22
J1
(b)
300
300
General Journal
Date
Nov. 8
10
12
15
17
20
22
25
27
29

Salaries Payable
Salaries Expense
Cash
Ref.
212
726
101
Debit
500
600
Cash
101
112
1,200
Accounts Receivable
1,400
Service Revenue
101
407
Store Equipment
Accounts Payable
153
201
3 000
Supplies
Accounts Payable
126
201
500
Accounts Payable
Cash
201
101
2,500
Rent Expense
Cash
729
101
300
Salaries Expense
Cash
726
101
1,000
Accounts Receivable
Service Revenue
112
407
700
Cash
101
209
550
Cash
J1
Credit
1,100
1,200
1,400
3 000
500
2,500
300
1,000
700
550
5-105
Accuracy checked

(d) & (f)
DIGITAL EQUIPMENT REPAIR

Trial Balances
as at 30 November 2010
Cash
Accounts Receivable
Supplies
Equipment
Accounts Payable
Salaries Payable
P. Samone, Capital
Service Revenue
Supplies Expense
Salaries Expense
Rent Expense
(e)
1.
2.
3.
4.
Nov.30
30
30
30
Before
Adjustment
Dr.
Cr.
$1,040
2,010
2,500
13,000
$ 500
3,100
1,950
12,800
2,100
1,600
300
$20,450
$20 450
After
Adjustment
Dr.
Cr.
$1,040
2,010
1,000
13 000
$ 620
3,100
800
500
12,800
3 250
120
1,500
2,100
000,000
300
$21,070
$21,070
Supplies Expense
Supplies ($2500 $1,000)
631
126
1,500
Salaries Expense
Salaries Payable
726
212
500
Store Equipment
615
120

Service Revenue
209
407
1,500
500
154
120
1,150
1,150
5-106
Accuracy checked
*PROBLEM 4-6
(a)
1.
June
2.
3.
4.
5.
6.
(b)
30
30
30
30
30
30
Supplies
Supplies Expense
1 300
Interest Expense
($20,000 12% 5/12)
Interest Payable
1,000
Prepaid Insurance
[($1800 12) 8]
Insurance Expense
1,200
Consulting Revenue
Unearned Consulting Revenue
1,100
Accounts Receivable
Graphic Revenue
2,000
1 300
1,000
1,200
1,100
2,000
1,500
($3000 2)
1,500
SALZER GRAPHICS COMPANY

as at 30 June 2010
Debit
Cash
Accounts Receivable ($14 000 + $2,000)
Supplies
Prepaid Insurance
Equipment
Notes Payable
Accounts Payable
Interest Payable
Unearned Consulting Revenue
Jill Salzer, Capital
Graphic Revenue ($52,100 + $2,000)
Consulting Revenue ($6000 $1100)
Salaries Expense
Supplies Expense ($3700 $1300)
Advertising Expense
Rent Expense
Utilities Expense
Insurance Expense ($1800 $1,200)
Interest Expense
Credit
$9,500
16,000
1,300
1,200
45,000
$1,500
20,000
9,000
1,000
1,100
22,000
54,100
4,900
30,000
2 400
1,900
1,500
1,700
1,500
600
1,000
$113,600
_
$113,600
5-107
Accuracy checked
Problem 4-7
(a)
(b)
Date
2010
December
31
Account Titles & Explanation
December
31
Catering Supplies
Catering Supplies Expense
8 000
December
31
Accumulated Depreciation Motor Vehicle
4 000
December
31
Accumulated Depreciation Catering
equipment
December
31
Prepaid Insurance
Insurance Expense
(3/12 * $4200)
December
31
Salaries Expense
Salaries Payable
15,000
December
31
Interest Expense
Interest Payable
2,000
December
31
Utilities Expense
Utilities Payable
500
December
31
Motor Vehicle Expense

Motor Vehicle Expenses Payable
800
December
31
Catering Revenue
Unearned Revenue
Accrued Revenue
Catering Revenue
Debit
Credit
22,500
22,500
8 000
4 000
10,000
10,000
1,050
1,050
15,000
2,000
500
800
10,000
10,000
Accrual accounting records transactions that change an entitys financial reports

in the periods in which the events occurred. Capturing the transactions in the
period they occur has resulted in a net profit for the business of the business of
$31 650 compared to the $42 400 reported under a cash based system.
BYP 4-1
(a and b)
Items that may have resulted in adjusting entries are:

1. prepaid expenses and other current assets (per balance sheet)
2. property, plant and equipment, net of depreciation (per balance sheet)
3. accrued expenses such as accounts payable and other current liabilities,
interest expense and revenue taxes payable.
(c) The latest annual report shows only two years Profit as a comparison: The
report states that Operating profit was $2,125 million (+61.6 per cent). The
Singapore Airlines Annual Report 2007-08 page 54 has an excellent graph of
the increase in profits over 5 years.
5-108
Accuracy checked
BYP 4-2 COMPARATIVE ANALYSIS PROBLEM - SA and CP

This will be dependant on the years chosen. Students should complete a table as
such:
Year
200?
$000s
A
B
C
D
E
Singapore Air
Year
Change
200?
$000s
$000s
Year
200?
$000s
Cathay Pacific
Year
Change
200?
$000s
$000s
Property, Plant
and Equipment
Depreciation
and
Amortisation
Liabilities
Net Profit
Cash and Cash
Equivalents
BYP 4-3

A Global Focus
No answer supplied
BYP 4-4
EXPLORING THE WEB
The categories are:

1.
2.
3.
4.
5.
6.
7.
8.
9.
Big Four
Professional
Associations
Education
Finance
Professors
Taxation
Audit and Law
Government
10.
11.
12.
13.
14.
15.
16.
17.
18.
Edgar
FASB
International
Publishing
Journals and Publications
Software
Other sites
Entertainment
Interest books
Student answers will vary depending on the category selected.
Australian Accounting Standards Board

http://www.aasb.com.au
Financial Services Institute of Australasia
http://www.aibf.com.au
CPA Australia
http://www.cpaaustralia.com.au/cps/rde/xchg
The Institute of Chartered Accountants in Australia
http://www.icaa.org.au/tech/index.cfm
Institute of Internal Auditors Australia
http://iia.asn.au/
The 2002 International Symposium on Audit Research
http://www.accounting.unsw.edu.au/conference/isar2002/
Insolvency Practitioners Association of Australia
http://www.ipaa.com.au/
5-109
Accuracy checked
BYP 4-5
(a)
GROUP DECISION CASE

TRAVEL WISE
Revenue Statement
For the Quarter Ended 31 March 2011
Revenue
Rental revenue ($90,000 $20,000)
Expenses
Wages expense [$29 800 + ($350 2)]
Advertising expense ($5200 + $110)
Supplies expense ($6200 $1 300)
Repairs expense ($4000 + $260)
Insurance expense ($7200 3/12)
Utilities expense ($900 + $180)
Depreciation expense
Interest expense ($12,000 10% 3/12)
Total expenses
Net profit
(b)
$70,000
$30,500
5,310
4,900
4 260
1,800
1,080
800
300
48 950
$21,050
The generally accepted accounting principles pertaining to the revenue

statement that were not recognised by Alice were the revenue recognition
principle and the expense recognition principle. The revenue recognition
principle states that revenue is recognised when it is earned. The fees of $20,000
for summer rentals have not been earned and, therefore, should not be reported
in revenue for the quarter ended 31 March. The expense recognition principle
dictates that expenses should be recognized in the accounting period in which
they are incurred. This means that the expenses should include amounts incurred
in March but not paid until April. The difference in expenses was $8250 ($48 950
$40 700). The overstatement of revenue ($20,000) plus the understatement of
expenses ($8250) equals the difference in reported profit of $28 250 ($49 300
$21,050).
BYP 4-6
Dear Kari Beth Menzies

Upon reviewing the accounts of your company at the end of the year, I discovered that
adjusting entries were not made.
Adjusting entries are made at the end of the accounting period to ensure that the
revenue recognition principles and expense recognition principles required under
generally accepted accounting principles are followed. The use of adjusting entries
makes it possible to report on the balance sheet the appropriate assets, liabilities, and
owners equity at the statement date and to report on the revenue report the proper
net profit (or loss) for the year.
Adjusting entries are needed because the trial balance may not contain an up-to-date
and complete record of transactions and events for the following reasons:
1.
Some events are not journalised daily because it is inexpedient to do so.

Examples are the use of supplies and the earning of wages by employees.
5-110
Accuracy checked
2.
3.
The expiration of some costs is not journalised during the accounting period
because these costs expire with the passage of time rather than as a result
of recurring daily transactions. Examples of such costs are building and
equipment depreciation, rent, and insurance.
Some expenses, such as the cost of utility service and property taxes, may
be unrecorded because the bills for the costs have not been received.
There are four types of adjusting entries:

1.
Prepaid expenses expenses paid in cash and recorded as assets before

they are used or consumed.
2.
Unearned revenue revenue received in cash and recorded as liabilities

before they are earned.
3.
Accrued revenue revenue earned but not yet received in cash or

recorded.
4.
Accrued expenses expenses incurred but not yet paid in cash or recorded.
I will be happy to answer any questions you may have on adjusting entries.
Signature
BYP 4-7
ETHICS CASE
No answer supplied
BYP 4-8
SUSTAINABILITY CASE
No answer supplied
BYP 4-9
FINANCIAL REPORTING QUALITY CASE
No answer supplied
5-111
Accuracy checked
Chapter 5
Completion of the accounting cycle
1.
No. A worksheet is not a permanent accounting record. The use of a worksheet

is an optional step in the accounting cycle.
2.
The worksheet is merely a device used to make it easier to prepare adjusting

entries and the financial statements.
3.
The amount shown in the adjusted trial balance column for an account equals
the account balance in the ledger after adjusting entries have been journalised
and posted.
4.
The net profit of $12,000 will appear in the income statement debit column and
the balance sheet credit column. A net loss will appear in the income statement
credit column and the balance sheet debit column.
5.
Formal financial statements are needed because the columnar data are not
properly arranged and classified for statement purposes. For example, a
Drawings account is listed with assets, assets and liabilities are not classified
into current and non-current items, and income statement columns do not show
classification of expenses in terms of nature and function (eg gross profit is not
determined).
6.
(1)
(2)
(3)
(4)
7.
Profit and Loss Summary is a temporary account that is used in the closing
process. The account is debited for expenses and credited for income. The
difference, either net profit or loss, is then closed to the capital account.
8.
The post-closing trial balance contains only balance sheet accounts. Its purpose
is to prove the equality of the permanent account balances that are carried
forward into the next accounting period (Assets = Liabilites + Owners Equity).
The amount of capital shown under the Owners Equity section reflects Income
and Expenses (Net Profit/Loss), Drawings, and owners additional investment.
9.
The accounts that will not appear in the post-closing trial balance are
Depreciation Expense; Elizabeth Arden, Drawings; and Service Revenue.
10.
The steps that involve journalising are: (1) Journalise the transactions, (2)
Journalise the adjusting entries, and (3) Journalise the closing entries.
11.
The three trial balances are the: (1) trial balance, (2) adjusted trial balance, and
(3) post-closing trial balance.
(Dr)
(Dr)
(Dr)
(Dr)
Individual revenue accounts and (Cr) Profit and Loss Summary.

Profit and Loss Summary and (Cr) Individual expense accounts.
Profit and Loss Summary and (Cr) Owners Capital (for net profit).
Owners Capital and (Cr) Owners Drawings.
*
5-112
Accuracy checked
Answers to Questions (continued)

12.
The standard classifications in a balance sheet are:

Assets
Liabilities and Owners Equity
Current Assets
Cash and cash equivalents
Trade and other receivables
Inventories
Financial assets
Non-Current Assets
Intangible assets
Investment property
Property, plant and equipment
Current Liabilities
Trade and other payables
Provisions
Financial liabilities
Non-Current Liabilities
Loans
Debentures
Owners Equity
Capital
*13.
Current assets are cash and other resources that are reasonably expected to be
realised in cash or sold or consumed in the business within one year of the
balance sheet date or the companys operating cycle, whichever is longer.
Current assets are listed in the order of their liquidity, from the most liquid to
least liquid items.
14.
Financial assets are items such as cash and accounts receivable. These are
classified as current financial assets. Other financial assets, classified as either
current or non-current, include investments in debt and investment securities
issued by other entities. They are classified as non-current if the conversion
into cash is not expected within one year or the operating cycle, whichever is
the longer. Property, plant and equipment are tangible resources of a relatively
permanent nature that are used in the business and not intended for sale.
*15.
The major differences between current liabilities and long term-liabilities are:
Difference
Current Liabilities
Non-current Liabilities
Source of
payment.
Existing current assets or

other current liabilities.
Other than existing current

assets or creating current
liabilities.
Time of expected
payment.
One year or the operating

cycle.
Beyond one year or the

operating cycle.
Nature of items.
Debts pertaining to the

operating cycle and other
short-term debts.
Mortgages, bonds and other

Non-current liabilities.
*16.
(a)
(b)
The owners equity section for a company is called shareholders equity.

The three accounts and the purpose of each are: (1) Share Capital is used
to record investments of assets in the business by the owners
(shareholders). (2) Reserves are increases in equity from sources other
than contributed capital from the owners and retained profits. (3)
Retained earnings is used to record net profit retained in the business.
*17.
The report form balance sheet differs from the account form balance sheet in
the location of the liabilities and owners equity section. In the report form this
5-113
Accuracy checked
section is placed below assets. In the account form the section is placed to the
right of assets.
18.
The cash flow statement reports the cash receipts, cash payments, and net
change in cash resulting from the operating, investing, and financing activities
during a period in a format that reconciles the beginning and ending cash
balances.
19.
Disagree. The cash flow statement is required. It is the fourth basic financial
statement.
20.
The cash flow statement is useful because it provides information to the

investors, creditors, and other users about: (1) the entitys ability to generate
future cash flows, (2) the entitys ability to pay dividends and meet obligations,
(3) the reasons for the difference between net profit and net cash provided
(used) in operating activities, and (4) the cash and noncash financing and
investing transactions during the period.
21.
The three types of activities are:

Operating activities include the cash effects of transactions that create income
and expenses and thus enter into the determination of net profit. They involve
cash flows related to day-to-day operations of the entity.
Investing activities include: (a) acquiring and disposing of investments and
property, plant and equipment and (b) lending money and collecting loans.
Financing activities include: (a) obtaining cash from issuing debt and repaying
amounts borrowed and (b) obtaining cash from shareholders and providing
them with a return on their investment.
22.
Examples of sources (inflows) of cash in a cash flow statement include cash

from operations; issue of debt; issue of shares; sale of investments; and the sale
of property, plant and equipment. Examples of uses (outflows) of cash include
payment of cash dividends; redemption of debt; purchase of investments; share
buybacks; and the purchase of property, plant and equipment.
23.
The cash flow statement presents investing and financing activities so that even
noncash transactions of an investing and financing nature are disclosed in notes
of the financial statements. If they affect financial conditions significantly (if
they are material), accounting rules require that they be disclosed separately in
the financial report.
24.
Examples of noncash transactions are: (1) issue shares for assets, (2)
conversion of bonds into ordinary shares, (3) issue of bonds or notes for assets,
and (4) noncash exchanges of property, plant and equipment.
25.
When total cash inflows exceed total cash outflows, the excess is identified as a
net increase in cash near the bottom of the cash flow statement. This is
important for working out the balance of cash at the end of period.
26
It is important that Net cash increase (decrease) = Cash inflows Cash

outflows; whereas the Net profit (loss) = Income Expenses. Income and
Expenses can include cash and accrual items. Also, not all cash inflows are
income, and not all cash outflows are expenses. Thus, a number of factors could
have caused an increase in cash despite the net loss. These are: (1) high cash
revenues relative to low cash expenses; (2) sales of property, plant and
equipment; (3) sales of investments; and (4) issue of debt or shares.
5-114
Accuracy checked
27
This transaction is reported in the notes to the financial reports under Noncash
investing and financing activities as follows: Retirement of notes payable
through issue of ordinary shares, $1 600,000.
5-115
Accuracy checked

BRIEF EXERCISE 5-1
The steps in using a worksheet are performed in the following sequence: (1) prepare a
trial balance on the worksheet, (2) enter adjustment data, (3) enter adjusted balances,
(4) extend adjusted balances to appropriate statement columns, and (5) total the
statement columns, compute net profit (loss), and complete the worksheet. Filling in
the blanks, the answers are 1, 3, 4, 5, 2.
BRIEF EXERCISE 5-2
The solution is on the following page.
BRIEF EXERCISE 5-3
Account
N. Lee, Capital
N. Lee, Drawings
Service Revenue
Supplies
Accounts Payable
Income Statement
Dr.
Cr.
Balance Sheet
Dr.
Cr.
X
X
X
X
X
X
X
BRIEF EXERCISE 5-4

Dec. 31
31
31
31
Service Revenue
Profit and Loss Summary
50,000

Salaries Expense
Supplies Expense
27,000

D. Bosna, Capital
23,000
D. Bosna, Capital
D. Bosna, Drawings
2,000
50,000
23,000
4,000
23,000
2,000
5-116
Accuracy checked
BRIEF EXERCISE 5-2

KEOGH COMPANY
Worksheet
Trial Balance
Account Titles
Accounts Receivable
Prepaid Insurance
Dr.
Adjustments
Cr.
(b)
Dr.
1,100
20,000
Cr.
Dr.
1,100
(a) 1,200
Salaries Payable
15,000
Service Revenue
5,800
800
Insurance Expense
Cr.
Dr.
(b) 1,100
20800
15,000
15,000
6,900
6,900
1,600
1600
(a) 1,200
1,200
1,200
3,100
22,700
Cr.
800
(c) 800
3,100
Dr.
1,100
800
4,100
20800
Cr.
Balance
Sheet
18,800
Net profit
Total
Income
Statement
18,800
(c) 800
Capital
Salaries Expense
Adjusted
Trial Balance
22,700
6,900
4,100
6,900 19,90019,900
5-117
Accuracy checked
BRIEF EXERCISE 5-5
O/B
O/B
Salaries Expense
23 000 (2)P&L
23
000

(2)Expense2700 (1)Revenue
0
50,000
(3)Capital
23000
50,000
50,000
Supplies Expense
4 000 (2)P&L 4 000
D. Bosna Capital
(4)Drawings O/B 30,000
2,000
(3)P&L23 000
Bal. 51,000
Service Revenue
(1)P&L50,000 O/B 50,000
O/B
D. Bosna Drawings
2,000 (4)Capital2,0
00
BRIEF EXERCISE 5-6

July
31
31
Golf Fees Revenue

14,600

Salaries Expense
Maintenance Expense
10,700
Golf Fees Revenue

Date
Explanation
31
July
31
July
Ref.
Debit
Credit
Balance
14,600
0
Credit
Balance
8 200
0
14,600
Ref.
Debit
Closing entry
Maintenance Expense
Date
Explanation
31
July
8,200
2,500
Closing entry
Salaries Expense
Date
Explanation
14,600
8 200
Ref.
Closing entry
Debit
Credit
2,500
Balance
2,500
0
BRIEF EXERCISE 5-7

The accounts that will appear in the post-closing trial balance are:
N. Lee, Capital
Supplies
Accounts Payable
5-118
Accuracy checked
BRIEF EXERCISE 5-8

The proper sequencing of the required steps in the accounting cycle is as follows:
1.
2.
3.
4.
5.
6.
7.
8.
9.
Analyse business transactions.

Journalise the transactions.
Post to ledger accounts.
Prepare a trial balance.
Journalise and post adjusting entries.
Prepare an adjusted trial balance.
Prepare financial statements.
Journalise and post closing entries.
Prepare a post-closing trial balance.
Filling in the blanks, the answers are

(a)
(b)
(c)
(d)
(e)
(f)
(g)
(h)
(i)
4
2
8
7
5
3
9
6
1
BRIEF EXERCISE 5-9

Current Assets
Cash
18 400
Accounting Receivable
12,500
Supplies
5,200
Prepaid Insurance
3,600
Short Term Financial Assets 6,700
Total Current Assets
46,400
BRIEF EXERCISE 5-10

(a)
(b)
(c)
(d)
Cash
Cash
Cash
Cash
inflow from financing activity, $300,000.

outflow from investing activity, $140,000.
inflow from investing activity, $20,000.
outflow from financing activity, $50,000.
BRIEF EXERCISE 5.11

(a)
(b)
(c)
(d)
(e)
Investing activity.
Investing activity.
Financing activity.
Non-cash activity.
Financing activity.
(f) Financing activity.
5-119
Accuracy checked
EXERCISE 5-1
TRINH COMPANY
(Partial) Worksheet
For the Month Ending 30 April 2010
Adjusted Trial
Balance
Account Titles
Cash
Accounts Receivable
Prepaid Rent
Equipment
Accum. Depreciation
Notes Payable
Accounts Payable
P. Trinh, Capital
P. Trinh, Drawings
Service Revenue
Salaries Expense
Rent Expense
Interest Expense
Interest Payable
Totals
Net profit
Totals
Dr.
14,752
7,840
2,280
23,050
Income
Statement
Cr.
Dr.
Cr.
Balance Sheet
Dr.
14,752
7,840
2,280
23,050
4,921
5,700
5,672
33,960
4,921
5,700
5,672
33,960
3,650
3,650
12,590
9,840
760
671
57
______
62,900
Cr.
___57
62,900
12,590
9,840
760
671
57
______
11,328
_1,262
12,590
______
12,590
_____
12,590
______
51,572
______
51,572
____57
50,310
_1,262
51,572
EXERCISE 5-2
TRINH COMPANY
Income Statement
Income
Service revenue
Expenses
Salaries expense
Rent expense
Interest expense
Total expenses
Net profit
$12,590
$9,840
760
671
57
11,328
$ 1,262
5-120
Accuracy checked
TRINH COMPANY
Statement of Changes in Equity
P. Trinh, Capital, 1 April
Less: Drawings
$33,960
3,650
30,310
1,262
$31,572
Add: Net profit for the period

P. Trinh, Capital, 30 April
TRINH COMPANY
Balance Sheet
as at 30 April 2010
Assets
Current assets
Cash
Accounts receivable
Prepaid rent
Total current assets
Non-current assets
Equipment
Less: Accumulated depreciation
Total non-current assets
Total assets
$14,752
7 840
2 280
24 872
$23 050
4,921
18 129
$43 001

Current liabilities
Notes payable
Accounts payable
Interest payable
Total current liabilities
Owners equity
P. Trinh, Capital
Total liabilities and owners equity
$ 5,700
5,672
57
11,429
31,572
$43,001
EXERCISE 5-3
(a)
Apr.
30
30
30
30
Service Revenue
12,590

Salaries Expense
Rent Expense
Interest Expense
11,328
12,590
9,840
760
671
57

P. Trinh, Capital
1,262
P. Trinh, Capital
P. Trinh, Drawings
3,650
1,262
3,650
5-121
Accuracy checked
(b)
(2)Expenses11
(1)Service Rev
328
12,590
(3)Capital
1,262
12,590
12,590
(c)
P. Trinh, Capital
(4)Drawings 3 650
O/B
33 960
(3)P&L
Bal.
1,262
31,572
TRINH COMPANY
Post-Closing Trial Balance
as at 30 April 2010
Debit
$14,752
7,840
2,280
23,050
Cash
Accounts Receivable
Prepaid Rent
Equipment
Notes Payable
Accounts Payable
Interest Payable
P. Trinh, Capital
$47,922
Credit
$ 4,921
5,700
5,672
57
31,572
$47,922
EXERCISE 5-4
(a)
Accounts Receivable
Service Revenue
600
Insurance Expense
Prepaid Insurance
400
900
Salaries Expense
Salaries Payable
500
(b)
600
400
900
500
Income Statement
Dr.
Accounts Receivable
Prepaid Insurance
Accum. Depreciation
Salaries Payable
Service Revenue
Salaries Expense
Insurance Expense
Cr.
Balance Sheet
Dr.
X
X
Cr.
X
X
X
X
X
X
5-122
Accuracy checked
EXERCISE 5-5
(a)
Accounts Receivable $27 000 ($34 000 $7000).

Supplies $3000 ($7000 $4000).
Accumulated Depreciation $22,000 ($12,000 + $10,000).
Salaries Payable $0 No liability recorded until adjustments are made.
Insurance Expense $8000 ($26 000 $18 000).
Salaries Expense $44 000 ($49 000 $5,000).
(b)
Accounts Receivable
Service Revenue
7,000
Insurance Expense
Prepaid Insurance
8,000
Supplies Expense
Supplies
4,000
7,000
8,000
4,000
10,000
10,000
Salaries Expense
Salaries Payable
5,000
5,000
EXERCISE 5-6
(a)
General Journal
Date
July 31
Commission Revenue
Rent Revenue
3
1

Salaries Expense
Utilities Expense
3
1
Debit
67,000
6,500
350
74,600
73 500
720
732
711
C. J. Lanza, Capital
301

3
1
Ref.
404
429
350
J15
Credit
55 700
14,900
4,000
1,100
350
301
C. J. Lanza, Drawings
1,100
16,000
306
16,000
(b)
Date
Explanation
July 31
Balance
Ref.
Debit
Credit
No. 301
Balance
45 200Cr
5-123
Accuracy checked
31
31
Close net loss

Close Drawings

Date
Explanation
July 31
Close income
J15
J15
1,100
16 000
Ref.
J15
Debit
74,600
31
Close expenses
J15
31
Transfer net loss
J15
(c)
44 100Cr
28 100Cr
No. 350
Balance
73
500 Cr
1,100
Dr
0
Credit
73 500
1,100
LANZA COMPANY
as at 31 July 2010
Debit
$14,840
8,780
15,900
Cash
Accounts Receivable
Equipment
Accounts Payable
Credit
$ 5,400
4,220
1,800
28 100
$39 520
__ ___
$39 520
EXERCISE 5-7
(a)
LANZA COMPANY
Income Statement
For the Year Ending 31 July 2010
Income
Commission revenue
Rent revenue
Total Income
Expenses
Salaries expense
Utilities expense
Total expenses
Net loss
$67,000
6,500
73,500
$55,700
14,900
4,000
74,600
($ 1,100 )
LANZA COMPANY
For the Year Ending 31 July 2010
C. J. Lanza, Capital, 1 August 2009

Less: Net loss for the period
Drawings
C. J. Lanza, Capital, 31 July 2010
$45,200
$ 1,100
16,000
5-124
Accuracy checked
17,100
$28,100
(b)
LANZA COMPANY
Balance Sheet
as at 31 July 2010
Assets
Current assets
Cash
Accounts receivable
Non-current assets
Equipment
Total assets
$14,840
8,780
23,620
$15,900
5,400
10,500
$34,120

Current liabilities
Accounts payable
Unearned rent revenue
Owners equity
$ 4,220
1,800
6,020
28,100
$34,120
EXERCISE 5-8
(a)
BETTER LIMOUSINE RENTAL SERVICES

Worksheet
For the year Ending 30 June 2010
Account titles
Cash
Accounts
Receivable
Office Supplies
Limousines
Accumulated
Depreciation
Limousines
Salaries Payable
Unearned Income
L. Dimos, Capital
L. Dimos,
Drawings
Limousine Service
Revenue
Salary expense
Trial Balance
Dr.
Cr.
Dr.
9,000
19,500
Adjustments
Cr.
(a)
1,350
3,120
57,900
(b) 720
33,180
2,700
49,020
Adjusted trial
balance
Dr.
Cr.
9,000
20,850
2,400
57,900
(c) 780
33,960
(d)
1,800
1,800
(e) 630
2,070
49,020
18,600
18,600
35,490
8,070
(a)
1,350
(e) 630
(d)
1,800
37,470
9,870
5-125
Accuracy checked
Motor Vehicle
expenses
Depreciation
expense
Supplies expense
4,200
120,39
0
4,200
120,39
0
(c) 780
780
(b) 720
5,280
720
124,32
0
5,280
124,32
0
5-126
Accuracy checked
EXERCISE 5-8 (continued)

(b)

General Journal
J20
Date

Credit
Debit
30 June 2010
Accounts Receivable
Limousine Service Revenue
Revenue earned on account.
1,350
Supplies expense
Office supplies
Supplies used during the period.
720
Accum. Depreciation
Depreciation expense for the period.
780
30 June 2010
30 June 2010
30 June 2010
30 June 2010
(c)
1,350
720
780
Salaries expense
Salaries Payable
Salaries expense incurred for the period.
1,800
1,800
Unearned income
Revenue earned during the period.
630
630

General Journal
J20
Date

Credit
30 June 2010

37,470

Salary expense
Motor Vehicle expenses
Supplies expense
15,570

L. Dimos, Capital
21,900
L. Dimos, Capital
L. Dimos, Drawings
18,600
30 June 2010
30 June 2010
30 June 2010
Debit
37,470
9,870
4,200
780
720
21,900
18,600
5-127
Accuracy checked
EXERCISE 5-8 (continued)

(d)
L. Dimos, Capital
Date
Explanation
1 July 2009
30 June 2010
Ref.
Balance
Profit and Loss summary
Drawings

Date
Explanation
Balance
30 June 2007
37470Cr
Debit
Credit Balance
21,900
18 600
Ref.
Debit
49 020Cr
70 920Cr
52,320Cr
Credit
Income
37470
Expenses
L. Dimos, Capital
15570
21,900
21,900Cr
0
(e)
Post-closing Trial Balance
as at 30 June 2010
Debit
$ 9 000
20 850
2 400
57 900
Cash
Accounts Receivable
Office Supplies
Limousines
Salaries Payable
Unearned Income
L.Dimos, Capital
Totals
$90 150
Credit
$33 960
1,800
2,070
52,320
$90 150
EXERCISE 5-9
(a)
June
30
30
30
30
Service Revenue
16,100

Salaries Expense
Supplies Expense
Rent Expense
13,100
16,100
8,800
1,300
3,000

Mary Stamos, Capital
3,000
Mary Stamos, Capital

Mary Stamos, Drawings
2,500
3,000
2,500
5-128
Accuracy checked
(b)
30 June Expenses 13100
30 June Service Revenue
16100
30 June Capital
3000
16100
16100
EXERCISE 5-10
(a)
TEN PIN BOWLING ALLEY

Balance Sheet
Assets
Current assets
Cash
Accounts receivable
Prepaid insurance
37,240
Non-current assets
Land
Building
Less: Acc. depr. building
Equipment
Less: Acc. depr. equipment
Total assets
$ 18,040
14,520
4,680
$64 000
$128 800
45,600
62 400
18 720
83 200
43 680
190 880
$228 120

Current liabilities
Current portion of mortgage payable
Accounts payable
Interest payable
Non-current liabilities
Mortgage payable
Total liabilities
Owners equity
A. Johns, Capital ($115,000 + $3440*)
*Net profit = $14 180 $780 $7360 $2600 = $3440
$ 13,600
12,300
2 600
28,500
81,180
109,680
118,440
$228,120
(b)
Current assets exceed current liabilities by $8740 ($37 240 $28 500). In
addition, approximately 50% of current assets are in the form of cash. In sum,
the entitys liquidity appears to be reasonably good.
EXERCISE 5-11
1.
2.
3.
Financing activities, (c).

Operating activities, (a).
Financing activities, (c).
5.
6.
7.
Noncash investing and financing activities, (d).

Operating activities, (a).
Noncash investing and financing activities, (d).
5-129
Accuracy checked
4.
Investing activities, (b).
5-130
Accuracy checked
PROBLEM 5-1
(a)
UNDERCOVER ROOFING
Worksheet
For the Month Ending 31 March 2010
Account Titles
Trial Balance
Dr.
Cash
Accounts Receivable
Stationery
Equipment
Accumulated
Depreciation
Accounts Payable
Unearned Income
I. Spy, Capital
I. Spy, Drawings
Service Revenue
Salaries Expense
Miscellaneous Expense
Totals
Stationery Expense
Salaries Payable
Totals
Net Profit
Totals
2,500
1,800
1,100
6
000
600
700
200
12
900
Cr.
Adjustments
Dr.
Cr.
(a) 960
1,200
1,400
300
7
000
3
000
12
900
(b) 200
(c) 170
(d) 350
Dr.
2,500
1,800
140
6
000
(c) 170
600
(a) 960
(b) 200
1 680
Adjusted
Trial Balance
(d)
350
1 680
1,400
1,400
130
7
000
3
170
1,050
200
960
200
13
450
Cr.
350
13
450
Income
Statement
Balance Sheet
Dr.
Dr.
Cr.
2,500
1,800
140
6
000
1,050
200
960
200
2 410
760
3 170
Cr.
1,400
1,400
130
7 000
3 170
600
3 170
350
10 280
760
11,040
3 170
11,04
0
11,04
0
5-131
Accuracy checked
Key: (a) Supplies Used; (b) Depreciation Expense; (c) Service Revenue Earned; (d) Salaries Accrued.
5-132
Accuracy checked

(b)
UNDERCOVER ROOFING
Income Statement
Income
Service revenue
Expenses
Salaries expense
Stationery expense
Miscellaneous expense
Total expenses
Net profit
$3,170
$1,050
960
200
200
2,410
$ 760
UNDERCOVER ROOFING
I. Spy, Capital, 1 March

Less: Drawings
$7,000
600
6,400
760
$7,160

I. Spy, Capital, 31 March
UNDERCOVER ROOFING
Balance Sheet
as at 31 March 2010
Assets
Current assets
Cash
Accounts receivable
Stationery
Non-current assets
Equipment
Less: Accum. depreciation equipment
1,400
Total assets
$2,500
1,800
140
4 440
$6,000
4,600
$9 040

Current liabilities
Accounts payable
Salaries payable
Unearned income
Owners equity
I. Spy, Capital
$1,400
350
130
1,880
7 160
$9 040
5-133
Accuracy checked

(c)
Mar. 31
31
31
31
(d)
Mar. 31
31
31
31
Stationery Expense
Stationery
960
200
Unearned Income
Service Revenue
170
Salaries Expense
Salaries Payable
350
960
200
170
350
Service Revenue
3,170

Salaries Expense
Supplies Expense
Miscellaneous Expense
2,410
3,170
1,050
960
200
200

I. Spy, Capital
760
I. Spy, Capital
I. Spy, Drawings
600
760
600
5-134
Accuracy checked
PROBLEM 5-2
(a)
EAGLE COMPANY
Partial Worksheet
For the Year Ending 31 December 2010
Adjusted
Trial Balance
Account
No.
101
Titles
Cash
Dr.
13,600
Cr.
112
Accounts Receivable
15,400
126
130
151
Supplies
Prepaid Insurance
Office Equipment
2,000
2,800
34,000
152
200
Acc. Depr. Off. Equip.

Notes Payable
8,000
20,000
201
212
230
301
Accounts Payable
Salaries Payable
Interest Payable
A. Eagle, Capital
6,000
3,500
800
25,000
306
A. Eagle, Drawings
400
Service Revenue
610
Advertising Expense
12,000
631
711
722
726
Supplies Expense
Insurance Expense
Salaries Expense
5,700
8,000
5,000
42,000
905
Interest Expense
Totals
___800
151,30
0
Dr.
Cr.
Balance
Sheet
Dr.
13,60
0
15,40
0
2,000
2,800
34,00
0
Cr.
8,000
20,00
0
6,000
3,500
800
25,00
0
10,000
10,00
0
88,000
_______
151,30
0
Net profit
Totals
(b)
Income
Statement
88,00
0
12,00
0
5,700
8,000
5,000
42,00
0
__800
73,50
0
14,50
0
88,00
0
______
88,00
0
______
______
77,80
0
______
88,00
0
77,80
0
______
63,30
0
14,50
0
77,80
0
EAGLE COMPANY
Income Statement
Income
Service revenue
Expenses
$88,000
5-135
Accuracy checked
Salaries expense
Advertising expense
Supplies expense
Insurance expense
Interest expense
Total expenses
Net profit
$42,000
12,000
8 ,000
5,700
5,000
800
73,500
$14,500

EAGLE COMPANY
A. Eagle, Capital, 1 January

Less: Drawings
$25,000
10,000
15,000
14 500
$29 500

A. Eagle, Capital, 31 December
EAGLE COMPANY
Balance Sheet
Assets
Current assets
Cash
Accounts receivable
Supplies
Prepaid insurance
Non-current assets
Office equipment
Total assets
$13 600
15,400
2,000
2,800
33,800
$34,000
8,000
26,000
$59,800

Current liabilities
Notes payable
Accounts payable
Salaries payable
Interest payable
Notes payable
Total liabilities
Owners equity
A. Eagle, Capital
$10,000
6,000
3,500
800
20,300
10,000
30,300
29,500
$59,800
5-136
Accuracy checked
5-137
Accuracy checked

(c)
General Journal
Date
Dec. 31
Service Revenue
31
31
31
Ref.
400
350
Debit
88,000

Advertising Expense
Supplies Expense
Insurance Expense
Salaries Expense
Interest Expense
350
610
631
711
722
726
905
73,500

A. Eagle, Capital
350
301
14,500
A. Eagle, Capital
A. Eagle, Drawings
301
306
10,000
J14
Credit
88,000
12,000
5,700
8,000
5,000
42,000
800
14,500
10,000
(d)
A. Eagle, Capital
Date
Explanation
Jan. 1
Balance
Dec. 31
Closing entry
31
Closing entry
Ref.
J14
J14
Debit
10,000
A. Eagle, Drawings
Date
Explanation
Dec. 31
Balance
31
Closing entry
Ref.
J14
Debit
10,000
Profit and
Date
Dec. 31
31
31
Ref.
J14
J14
J14
Debit
Loss Summary
Explanation
Closing entry
Closing entry
Closing entry
Service Revenue
Date
Explanation
Dec. 31
Balance
31
Closing entry
Ref.
J14
Advertising Expense
Date
Explanation
Dec. 31
Balance
31
Closing entry
Ref.
J14
Credit
25,000
14 500
Credit
10,000
Credit
88 000
73 500
14 500
Debit
Credit
88 000
88 000
Debit
12,000
Credit
12,000
No. 301
Balance
25,000
39 500
29 500
No. 306
Balance
10,000
0
No. 350
Balance
88 000
14 500
0
No. 400
Balance
88 000
0
No. 610
Balance
12,000
0
5-138
Accuracy checked

Supplies Expense
Date
Explanation
Dec. 31
Balance
31
Closing entry
Ref.
J14
Debit
5 700
5 700
Date
Explanation
Dec. 31
Balance
31
Closing entry
Ref.
J14
Debit
8 000
Insurance
Date
Dec. 31
31
Expense
Explanation
Balance
Closing entry
Ref.
J14
Debit
5,000
Salaries Expense
Date
Explanation
Dec. 31
Balance
31
Closing entry
Ref.
J14
Debit
42,000
Interest Expense
Date
Explanation
Dec. 31
Balance
31
Closing entry
Ref.
J14
Debit
800
(e)
Credit
Credit
8 000
Credit
5,000
Credit
42,000
Credit
800
No. 631
Balance
5 700
0
No. 711
Balance
8 000
0
No. 722
Balance
5,000
0
No. 726
Balance
42,000
0
No. 905
Balance
800
0
EAGLE COMPANY
Cash
Accounts Receivable
Supplies
Prepaid Insurance
Office Equipment
$ 8,000
Notes Payable
Accounts Payable
Salaries Payable
Interest Payable
A. Eagle, Capital
Totals
Debit
$13,600
15,400
2,000
2,800
34,000
______
$67,800
5-139
Accuracy checked
Credit
20,000
6,000
3,500
800
29,500
$67,800
PROBLEM 5-3
(a)
WILLIAMS COMPANY
Income Statement
Income
Service revenue
Expenses
Salaries expense
Insurance expense
Repair expense
Utilities expense
Total expenses
Net profit
$64,000
$37,000
2 ,600
2,200
2,000
1,700
45,500
$18 500
WILLIAMS COMPANY
David Williams, Capital, 1 January
Add: Net profit for the year
$36,000
18,500
54,500
14,000
$40,500
Less: Drawings
David Williams, Capital, 31 December
WILLIAMS COMPANY
Balance Sheet
Assets
Current assets
Cash
Accounts receivable
Prepaid insurance
Non-current assets
Equipment
Total assets
Current liabilities
Accounts payable
Salaries payable
Owners equity
David Williams, Capital
$17,400
13,500
3,500
34,400
$26,000
5,600
20,400
$54,800
$11,300
3,000
14,300
40,500
$54,800
5-140
Accuracy checked

(b)
General Journal
Date
Dec. 31
31
31
31

Service Revenue
Ref.
400
350
Debit
64 000

Repair Expense
Insurance Expense
Salaries Expense
Utilities Expense
350
622
711
722
726
732
45,500

350
301
18,500

David Williams, Drawings
301
306
14,000
Credit
64,000
2,000
2,600
2,200
37,000
1,700
18,500
14,000
(c)
31/12
000
David Williams, Capital No. 301

Drawings14 1/1 O/B
36 000
31/12P&L
31/12 Bal.
31/12 O/B
18 500
40 500
Salaries Expense
37 000 31/12
P&L37000
No. 726
No. 732
31/12 O/B
Utilities Expense
1,700 31/12
P&L1,700
Service Revenue
No. 400
P&L64 000 31/12 O/B 64 000
Repair Expense
No. 622
31/12 O/B
2,000 31/12
P&L 2,000
31/12
Depreciation Expense No. 711

31/12 O/B
2 600 31/12
P&L 2
600
Insurance Expense
P&L 2
31/12 O/B
David Williams, DrawingsNo. 306
31/12 O/B 14 000 31/12 Capital
14
000
Profit and Loss Summary No. 350

31/12Expenses
31/12Service
45,500 Revenue
64 000
31/12Capital18 500
64 000
64 000
2 200 31/12
200
No. 722
5-141
Accuracy checked
5-142
Accuracy checked

(d)
WILLIAMS COMPANY
Debit
$17,400
13,500
3,500
26,000
Cash
Accounts Receivable
Prepaid Insurance
Equipment
Accounts Payable
Salaries Payable
3,000
Totals
Credit
$5,600
11,300
______
$60 400
40, 500
$60 400
5-143
Accuracy checked
PROBLEM 5-4
(a)
JASON ROGERS MANAGEMENT SERVICES

Worksheet
For the Year Ending 31December 2010
Account Titles
Trial Balance
Dr.
Cash
Accounts Receivable
Prepaid Insurance
Land
Building
Motor Vehicle
Accounts Payable
Mortgage Payable
J. Rogers, Capital
J. Rogers, Drawings
Service Revenue
Rent Revenue
Salaries Expense
Advertising Expense
Utilities Expense
Totals
Insurance Expense
Depr. Expense Building
Accum. Depr. Building
Depr. Expense Motor
Vehicle
Accum. Depr. Motor
Vehicle
Interest Expense
Interest Payable
Totals
Net Profit
Totals
Adjustments
Cr.
Dr.
14 500
23 600
3,100
56 000
106 000
49 000
10 400
5,000
100,000
120,000
(d)
Adjusted
Trial Balance
Cr.
Dr.
(a)
1,700
14 500
23 600
1,400
56 000
106 000
49 000
Dr.
Cr.
(d)
2
200
_______
335,000
(a)
20,000
75,600
26,200
30,000
17 000
15,800
30,000
17 000
15,800
1,700
2,500
1,700
2,500
2,500
3 900
(b)
2,500
(c)3 900
(c)
3
900
2,500
3 900
3 900
9 000
_______
350 400
Cr.
10 400
2 800
100,000
120,000
75,600
26,200
(e) 9 000
______
19 300
Dr.
14 500
23 600
1,400
56 000
106 000
49 000
20,000
75,600
24 000
1,700
(b)
2,500
Balance Sheet
10 400
2 800
100,000
120,000
2
200
20,000
30,000
17 000
15,800
335,000
Cr.
Income
Statement
9 000
350 400
3 900
9 000
_______
79 900
21,900
101,800
_______
101,800
_______
101,800
_______
270 500
_______
270 500
9 000
248 600
21,900
270 500
(e) 9
000
19 300
Key: (a) Expired Insurance; (b) Depreciation Expense Building; (c) Depreciation Expense Motor Vehicle; (d) Rent Revenue Earned; (e) Accrued
5-144
Accuracy checked
Interest Payable.
5-145
Accuracy checked

(b)

Balance Sheet
Assets
Current assets
Cash
$ 14,500
Accounts receivable
23,600
Prepaid insurance
1,400
39,500
Non-current assets
Land
$ 56,000
Building
$106,000
Less: Accumulated depreciation building
2,500 103,500
Motor vehicle
49,000
Less: Accumulated depreciation motor vehicle
3,900
45,100
204,600
Total assets
$244,100
Current liabilities
Current maturity of mortgage payable
Accounts payable
Interest payable
Unearned rent revenue
Mortgage payable
Total liabilities
Owners equity
J. Rogers, Capital ($120,000 $20,000 + $21,900)
(c)
Dec. 31
$ 10,000
10,400
9,000
2,800
32,200
90,000
122,200
121,900
$244,100
Insurance Expense
Prepaid Insurance
1,700
31
Depreciation Expense Building

Accumulated Depreciation Building
2,500
31
Depreciation Expense Motor Vehicle

3,900
31

Rent Revenue
2,200
Interest Expense
Interest Payable
9,000
1,700
2,500
3,900
31
2,200
9,000
5-146
Accuracy checked

(d)
Dec. 31
31
Service Revenue
Rent Revenue
75,600
26,200

Salaries Expense
Advertising Expense
Interest Expense
Utilities Expense
Depreciation Expense Motor Vehicle
79,900
101,800
30,000
17,000
9,000
15,800
3,900
Depreciation Expense Building
Insurance Expense
31
31
(e)
2,500
1,700

J. Rogers, Capital
21,900
J. Rogers, Capital
J. Rogers, Drawings
20,000
21,900
20,000

Cash
Accounts Receivable
Prepaid Insurance
Land
Building
Accumulated Depreciation Building
Motor Vehicle
Accounts Payable
Interest Payable
Mortgage Payable
J. Rogers, Capital
Debit
$ 14,500
23,600
1,400
56,000
106,000
Credit
2,500
49,000
3,900
10,400
9,000
2,800
100,000
_______ 121,900
$250,500 $250,500
5-147
Accuracy checked
PROBLEM 5-5
(a)
General Journal
J1
Date
July 1
1
3
5
12
18
20
21

Cash
Eve Tsai, Capital
Ref.
101
301
Debit
12,000
Equipment
Cash
Accounts Payable
157
101
201
6 000
Cleaning Supplies
Accounts Payable
128
201
1,300
Prepaid Insurance
Cash
130
101
1,200
Accounts Receivable
Service Revenue
112
400
2,500
Accounts Payable
Cash
201
101
1,800
Salaries Expense
Cash
726
101
1,200
Cash
101
112
1,400
Accounts Receivable
Service Revenue
112
400
3,000
Petrol Expense
Cash
633
101
200
Eve Tsai, Drawings

Cash
306
101
900
Accounts Receivable
25
31
31
Credit
12,000
3,000
3,000
1,300
1,200
2,500
1,800
1,200
1,400
3,000
200
900
5-148
Accuracy checked

(b) & (c)
Account Titles
Cash
Accounts Receivable
Cleaning Supplies
Prepaid Insurance
Equipment
Accounts Payable
Eve Tsai, Capital
Eve Tsai, Drawings
Service Revenue
Petrol Expense
Salaries Expense
Totals
Accum. Depr.
Equipment
Insurance Expense
Cleaning Supplies
Expense
Salaries Payable
Totals
Net Profit
Totals
TSAIS WINDOW WASHING

Worksheet
For the Month Ending 31 July 2010
Trial Balance
Adjustments
Adjusted Trial
Balance
Income
Statement
Dr.
Dr.
Dr.
Dr.
Cr.
5,100
4 100
1 300
1,200
6 000
(a) 1,500
Cr.
(d)
(c)
700
100
200
1,200
20,00
0
Dr.
Cr.
5,100
5,600
600
1,100
6 000
2,500
12,000
5,500
20,000
Cr.
5,100
5,600
600
1,100
6 000
2,500
12,000
900
Cr.
Balance Sheet
(a) 1,500
(b) 200
_____
3,100
7 000
200
1,800
(e) 600
(c) 100
(d) 700
900
200
(e) 600
3,100
100
700
22,300
7 000
900
200
1,800
200
(b)
2,500
12,000
200
200
600
22,300
200
100
700
3 000
4 000
7 000
7 000 19 300
7 000 19 300
15
4
19
600
300
000
300
(a) Service Revenue Earned; (b) Depreciation Expense; (c) Insurance Expired; (d) Cleaning Supplies Used; (e) Unpaid
Salaries.
5-149
Accuracy checked

(a), (e) & (f)
Cash
Date
July 1
1
5
18
20
21
31
31
Explanation
Accounts Receivable
Date
Explanation
July 12
21
25
31
Adjusting
Ref.
J1
J1
J1
J1
J1
J1
J1
J1
Debit
12,000
Ref.
J1
J1
J1
J2
Debit
2,500
3 000
1,200
1,800
1,200
1,400
200
900
1,400
Ref.
J1
J2
Debit
1 300
Prepaid Insurance
Date
Explanation
July 5
31
Adjusting
Ref.
J1
J2
Debit
1,200
Ref.
J1

Date
Explanation
Ref.
July 31
Adjusting
J2
Accounts Payable
Date
Explanation
July 1
3
18
Ref.
J1
J1
J2
Salaries Payable
Date
Explanation
July 3
Adjusting
Ref.
J2
Credit
3 000
1,500
Cleaning Supplies
Date
Explanation
July 3
31
Adjusting
Equipment
Date
Explanation
July 1
Credit
Credit
700
Credit
100
Debit
6 000
Debit
Debit
Credit
Credit
200
Credit
3 000
1 300
1,800
Debit
Credit
600
No. 101
Balance
12,000
9 000
7 800
6 000
4 800
6,200
6 000
5,100
No. 112
Balance
2,500
1,100
4 100
5,600
No. 128
Balance
1 300
600
No. 130
Balance
1,200
1,100
No. 157
Balance
6 000
No. 158
Balance
200
No. 201
Balance
3 000
4 300
2,500
No. 212
Balance
600
6-150
Accuracy checked
Eve Tsai, Capital

Date
Explanation
July
1
31
Closing
31
Closing
Eve Tsai, Drawings
Date
Explanation
July
31
31
Closing
Ref.
J1
J3
J3
Ref.
J1
Debit
4 000
900
Debit
900
J3
Pofit and Loss Summary

Date
Explanation
July 31
Closing
31
Closing
31
Closing
Ref.
J3
J3
J3
Service Revenue
Date
Explanation
July 12
25
31
Adjusting
31
Closing
Ref.
J1
J1
J2
J3
Debit
Credit
7 000
3 000
4 000
Debit
Credit
2,500
3 000
1,500
7 000
Ref.
J1
J3
Debit
200
Cleaning Supplies Expense

Date
Explanation
July 31
Adjusting
31
Closing
Ref.
J2
J3
Debit
700
Date
Explanation
July 31
Adjusting
31
Closing
Ref.
J2
J3
Debit
200
Credit
200
Credit
700
Credit
200
Expense
Explanation
Adjusting
Closing
Ref.
J2
J3
Debit
100
Salaries Expense
Date
Explanation
July 20
31
Adjusting
31
Closing
Ref.
J1
J2
J3
Debit
1,200
600
Credit
16 000
15,100
No. 306
Balance
900
900
Petrol Expense
Date
Explanation
July 31
31
Closing
Insurance
Date
July 31
31
Credit
12,000
No. 301
Balance
12,000
Credit
100
Credit
1,800
0
No. 350
Balance
7 000
4 000
0
No. 400
Balance
2,500
5,500
7 000
0
No. 633
Balance
200
0
No. 634
Balance
700
0
No. 711
Balance
200
0
No. 722
Balance
100
0
No. 726
Balance
1,200
1,800
0
6-151
Accuracy checked
(d)

Income Statement
Income
Service revenue
Expenses
Salaries expense
Cleaning supplies expense
Petrol expense
Insurance expense
Total expenses
Net profit
$7,000
$1,800
700
200
200
100
3,000
$4,000

Eve Tsai, Capital, 1 July

Add: Investments
Less: Drawings
$
$12,000
900
Net income recognised directly in equity

Profit for the period
Total recognised income and expense for the period
4,000
Eve Tsai, Capital, 31 July
11,100
0
4,000
$15,100

as at 31 July 2010
Assets
Current assets
Cash
Accounts receivable
Cleaning supplies
Prepaid insurance
Non-current assets
Equipment
Total assets
$5,100
5,600
600
1,100
12 400
$6 000
200
5,800
$18 200
6-152
Accuracy checked

Balance Sheet (contd)
as at 31 July 2010

Current liabilities
Accounts payable
Salaries payable
Owners equity
Eve Tsai, Capital
(e)
$ 2,500
600
3,100
15,100
$18,200
General Journal
Date
July 31
31
31
31
31

Accounts Receivable
Service Revenue
Ref.
112
400
Debit
1,500
Equipment
711
158
200
Insurance Expense
Prepaid Insurance
722
130
100

Cleaning Supplies
634
128
700
Salaries Expense
Salaries Payable
726
212
600

Service Revenue
Ref.
400
350
Debit
7 000

Salaries Expense
Insurance Expense
Petrol Expense
350
726
711
722
634
633
3 000

Eve Tsai, Capital
350
301
4 000
Eve Tsai, Capital

Eve Tsai, Drawings
301
306
900
J2
Credit
1,500
200
100
700
600
(f)
General Journal
Date
July 31
31
31
31
J3
Credit
7 000
1,800
200
100
700
200
4 000
900
6-153
Accuracy checked
(g)

as at 31 July 2010
Debit
$ 5,100
5,600
600
1,100
6 000
Cash
Accounts Receivable
Cleaning Supplies
Prepaid Insurance
Equipment
Accounts Payable
Salaries Payable
Eve Tsai, Capital
Credit
200
2,500
600
15,100
$18 400
$18 400
PROBLEM 5-6
(a)
LOUIS ZIMMER COMPANY

Cash flow statement
For the Year Ended 31 December 2010
Cash flows from operating activities
Cash receipts from customers
Cash payments
To suppliers
$166,000
For expenses
14,500
For interest
1,000
For income taxes
7,000
Net cash provided in operating activities
17,500
$206,000
(188,500)
Cash flows from investing activities

Sale of equipment
8,500
Cash flows from financing activities

Redemption of notes
Issue of ordinary shares
Payment of dividends
Net cash used in financing activities
(8,000)
4,000
(4,000)
(8 000)
Net increase in cash

Cash at beginning of period
Cash at end of period
$31,000
18,000
13,000
6-154
Accuracy checked
PROBLEM 5-7
ERNEST BANKS COMPANY
Cash flow statement
For the Year Ended 31 December 2010
Cash flows from operating activities
Cash receipts from customers
Cash payments
To suppliers
For expenses
For interest
For income taxes
Net cash provided in operating activities
$609 000
$502,500
65,000
5,500
8 000
Cash flows from investing activities

Purchase of equipment
Sale of PPE assets
Net cash used by investing activities
(60,000)
62,500
Cash flows from financing activities

Dividends paid
Redemption of notes payable
Issue of ordinary shares
Net cash used in financing activities
(8 500)
(30,000)
18 000
(581,000)
28 000
2,500
(20 500)

Cash at beginning of period
Cash at end of period
BYP 5-1
10,000
13 000
$23 000
(a)
Total current assets were $3 336 million at 30 June 2005 and $2512 million at 30
June 2004.
(b)
Current assets are properly listed in the order of liquidity. As you will learn in the
next chapter, inventory is considered to be less liquid than receivables. Thus, it is
listed below receivables and before other current assets.
(c)
The asset classifications are similar to the text: (1) cash assets, split between
cash, receivables and inventories, (2) non-current assets, split between (3)
investments, (4) property, plant and equipment, and (5) intangible assets.
(d) Cash assets includes cash at bank and cash on deposit as shown in Note 10, in the
section Notes to the Financial Statements.
(e) Total non-current liabilities were $4936 million at 30 June 2005, and $1783 million
at 30 June 2004.
*
Please note: Annual Reports from 2005 have been used as an example. The
students are asked to access the most recent report from the website.
6-155
Accuracy checked
BYP 5-2
COMPARATIVE ANALYSIS PROBLEM
(a)
(in millions)
1.
2.
3.
4.
(b)
Total
Total
Total
Total
Fosters
Group
Limited
current assets
property, plant & equipment
current liabilities
shareholders equity
3 336
2,554
1,865
4,994
Burns Philp
and
Company
Limited
823
1,026
735
890
Current assets are cash and other resources that are reasonably expected to be
realised in cash or sold or consumed within one year or the companys
operating cycle, whichever is longer. Current liabilities are obligations that are
reasonably expected to be paid from existing current assets or through the
creation of other current liabilities.
In both Fosters Group Limited and Burns Philp and Company Limiteds case,
current assets were greater than current liabilities. From this information, it
appears that both are in approximately the same liquidity position, although
Fosters Group Limited is in a slightly better position.
Fosters Group Limiteds Shareholders Equity represents a larger percentage of
$4994
than Burns Philp and Company Limited 20.2%
total assets 42.5%
$11745
$890
$4400 . As a result Fosters Group Limited has less debt relative to its total
assets than Burns Philp and Company Limited. It therefore appears that Fosters
Group Limited is less likely to default on a debt obligation.
* Please note: Fosters report from 2005 and Burns Philp report from 2004 have
been used here as an example. The students are asked to access the most
recent reports from the website.
BYP 5-3

A Global Focus
The following are some of the differences between Pumas balance sheet and the
balance sheet presentation of Australian companies:
1. Its statements are presented using Euro rather than Australian dollars.
2. Its current assets are almost listed in order of liquidity inventories appears
before trade receivables.
3. It uses the term subscribed capital instead of share capital.
4. It uses the term accumulated profits instead of retained earnings.
5. It lists minority interests before parent interest.
BYP 5-4
EXPLORING THE WEB
The solution is dependent upon the entities chosen by the student.
6-156
Accuracy checked
BYP 5-5
(a)
GROUP DECISION CASE

EVERCLEAN SERVICE
Balance Sheet
Assets
Current assets
Cash
$6,500
Accounts receivable ($9000 + $5700)
Cleaning supplies ($5200 $2400)
Prepaid insurance ($4800 2/3)
Non-current assets
Cleaning equipment ($22,000 + $4000)$26,000
Less:
Accum. depreciation cleaning
equipment ($4000 + $2,000)
6,000
Delivery trucks ($34 000 + $5,000)
39,000
Less: Accum. depreciation delivery trucks
($5,000 + $5,000)
10,000
Total assets
14,700
2,800
3,200
27,200
$20,000
29,000
49,000
$76,200

Current liabilities
Notes payable due within one year
Accounts payable ($2500 + $700)
Interest payable ($25,000 10% 6/12)
Notes payable, due 1 July 2007
Total liabilities
Owners equity
Laurie Fields, Capital
$10,000
3,200
1,250
14,450
15,000
29,450
46,750 *
$76,200
EVERCLEAN SERVICE
Balance Sheet
*Capital balance as reported

Add: Earned but not invoiced fees
$54,000
5,700
59,700
Less: Cleaning supplies used

Insurance expired ($4800 1/3)
Depreciation ($2,000 + $5,000)
Expenses incurred but unpaid
Interest accrued
Total
Capital balance as adjusted
$2,400
1,600
7,000
700
1,250
12,950
$46,750
6-157
Accuracy checked
(b) Everclean Service met the terms of the bank loan because current assets exceed
current liabilities by $12,750 ($27 200 $14 450) at 31 December 2010.
BYP 5.6 John Fairfax Holdings
From their latest accounts what was there(a) to (f)
BYP 5.7
ABC Learning
Comment on change in cash position 2006-2007

BYP 5.8 Poquito Trading Co
Comment on the cash statement vs the profit from operations
6-158
Accuracy checked
1 Chapter 6
2 Financial statement analysis
ASSIGNMENT CLASSIFICATION TABLE

Brief
Exercise
s
Exercise
s
Learning Objectives
Question
s
1.
Discuss the need for comparative

analysis.
1, 2, 3, 5
2.
Identify the tools of financial

statement analysis.
2, 3, 5, 6
3.
Explain and apply horizontal

analysis.
3, 4, 5
1, 2, 3, 4
1, 2, 3
4.
Identify and compute ratios,

describe their purpose and use in
analysing a firms liquidity,
profitability and solvency, and
appreciate the ratio interrelationships.
5, 6, 7, 8,
9, 10, 11,
12, 13, 14,
15, 16
5, 6, 7, 8
4, 5, 6, 7,
8
5.
Understand the concept of normal

earnings (earnings persistence)
and indicate how unusual items
not typical of regular operations
are presented.
17
6.
Recognise the limitations of

financial statement analysis.
18
Problems
1, 2, 3, 4,
5
ASSIGNMENT CHARACTERISTICS TABLE

Proble
m
Numbe
r
Level
Time
Allotted
(min.)
Description
Compute ratios from balance sheet and income

statement.
Simple
20-30
Perform ratio analysis, and evaluate financial

position and operating results.
Simple
20-30
Compute ratios, and comment on overall liquidity

and profitability.
Moderate
30-40
Compute selected ratios, and compare liquidity,
Moderate
50-60
6-159
Accuracy checked
profitability, and solvency for two companies.

5
Compute numerous ratios.
Simple
6-160
Accuracy checked
30-40
1.
(a)
(b)
2.
(a)
Van is not correct. There are three characteristics: liquidity, solvency and
profitability.
The three parties are not primarily interested in the same
characteristics of an entity. Short-term creditors are primarily
interested in the liquidity of the entity. In contrast, long-term creditors
and owners are primarily interested in the profitability and solvency of
the entity.
Comparison of financial information can be made on an intra-entity
basis, an inter-entity basis, and an industry average basis (or norms).
(1)
(2)
(3)
(b)
An intra-entity basis compares an item or financial relationship

within an entity in the current year with the same item or
relationship in one or more prior years.
The industry averages basis compares an item or financial
relationship of an entity with industry averages (or norms)
published by financial rating services or trade associations.
An inter-entity basis compares an item or financial relationship of
one entity with the same item or relationship in one or more
competing entities.
The intra-entity basis of comparison is useful in detecting changes in

financial relationships and significant trends within an entity.
The industry averages basis provides information as to an entitys
relative performance within the industry.
The inter-entity basis of comparison provides insight into an entitys
competitive position.
3.
Horizontal analysis (also called trend analysis) measures the dollar and
percentage increase or decrease of an item over a period of time. In this
approach, the amount of the item on one statement is compared with the
amount of that same item on one or more earlier statements. Vertical
analysis expresses each item within a financial statement in terms of a
percent of a relevant total or other common basis within the same statement.
4.
(a)
(b)
5.
A ratio expresses the mathematical relationship between one quantity and

another. The relationship is expressed in terms of either a percentage
(200%), a rate (2 times), or a simple proportion (2:1). Ratios can provide
clues to underlying conditions that may not be apparent from an inspection
of the individual components of a particular ratio. The qualitative aspects of a
ratio become more evident when the ratio is compared to the same ratio in
earlier periods or to competitors ratios or to industry ratios.
6.
(a)
(b)
7.
$960,000 1.245 = $1,195 200, 2011 profit.

$960,000 .06 = $16 000,000, 2011 sales revenue.
Liquidity ratios:Current ratio, acid-test ratio, receivables turnover,

inventory turnover and creditors turnover.
Solvency ratios:Debt to total assets, interest coverage ratio and cash to
debt coverage.
Celia is correct. A single ratio by itself may not be very meaningful and is
best interpreted by comparison with: (1) past ratios of the same entity, (2)
ratios of other entities, or (3) industry norms or predetermined standards. In
1-161
Accuracy checked
addition, other ratios of the entity are necessary to determine overall

financial well-being.
1-162
Accuracy checked
8.
(a)
(b)
(c)
Liquidity ratios measure the short-term ability of the entity to pay its
maturing obligations and to meet unexpected needs for cash.
Profitability ratios measure the profit or operating success of an entity
for a given period of time. Profitability can be assessed from either the
owners perspective (i.e., ROI), or from the perspective of the
efficiency of management in managing the assets of the business (i.e.,
ROA).
Solvency ratios measure the ability of the entity to survive over a long
period of time.
9.
The current ratio relates current assets to current liabilities. The acid-test ratio
relates cash, short-term investments, and net receivables to current liabilities.
The current ratio includes inventory and prepaid expenses while the acid-test
ratio excludes these. The acid-test ratio provides additional information about
short-term liquidity and is an important complement to the current ratio. If the
business need to pay its current obligations immediately, the acid-test ratio
provides the best indication of the businesses capacity to do so.
10.
Bloom Company does not necessarily have a problem. The receivables turnover
ratio can be misleading in that some companies encourage credit and revolving
charge sales and slow collections in order to earn a healthy return on the
outstanding receivables in the form of high rates of interest. It is important to
assess the trend. If receivables turnover is slowing over time without a change
in credit policy this may indicate a deterioration in liquidity as customers are
paying more slowly.
11.
(a)
(b)
(c)
(d)
(e)
12.
The payout ratio is cash drawing (dividends paid) divided by net profit. In a
growth company, the payout ratio is often low because the company is
reinvesting earnings in the business.
13.
(a) The increase in profit margin is good news because it means that a
greater percentage of net sales is going towards profit.
(b) The decrease in inventory turnover signals bad news because it is taking
the entity longer to sell the inventory and consequently there is a greater
chance of inventory obsolescence.
(c) An increase in the current ratio signals good news because the entity
improved its ability to meet maturing short-term obligations.
(d) The increase in the debt to total assets ratio is bad news because it
means that the company has increased its obligations to creditors and has
lowered its equity buffer.
(e) The decrease in the interest coverage ratio ratio is bad news because it
means that the entitys ability to meet interest payments as they fall due
has weakened.
(f) An increase in creditors turnover is good news because the entity is
paying its obligations more quickly which suggests the company is in a
sound liquidity position.
Asset (sales) turnover.

Inventory turnover.
Return on owners equity.
Interest coverage ratio.
Creditors turnover.
1-163
Accuracy checked

14.
Return on total
assets
(7.6%)
Profit
Average Assets
Return on owners equity

(12.8%)
Profit
Owner' s Equity
1-164
Accuracy checked
The difference between the two rates can be explained by looking at the
denominator value and by remembering the basic accounting equation, A = L
+ OE. The asset value is the larger of the two denominator values; therefore, it
will also give the smaller return. The company is using borrowed funds
(leverage) in addition to owners equity and is generating a profit in excess of
the borrowing cost from the assets funded by debt.
15.
(a)
(b)
The current ratio and the acid-test ratio, which indicate an entitys
liquidity and short-term debt-paying ability.
The return on owners equity (ROE) indicates the performance of the
owners investment.
16.
Return on owners equity in influenced by leverage. The business generates a

profit from the assets it employs. Assets can be funded by either owners
equity or borrowings (A = L + OE). If assets are funded by borrowings
(leverage) and the profit generated from those assets exceeds the interest
cost of borrowing, return on owners equity will exceed the ROA. However, if
the profit from assets funded by borrowing is less than the cost of borrowing,
the return on owners equity be less than the ROA. Comparing the return on
total assets with the rate of interest paid for borrowed money indicates the
profitability of a strategy to fund assets with borrowings (This is often called
trading on the equity).
17.
Discontinued operations refers to the disposal of a significant segment of the

entity such as the cessation of an entire activity or the elimination of a major
class of customers. It is important to report discontinued operations
separately from continuing operations because the discontinued segment will
not affect future profits.
18.
(1)
(2)
(3)
(4)
19.
Qantas is a service business and carries minimal inventory. The inventory

turnover ratio would therefore not provide meaningful information.
Use of estimates which may be inaccurate.

Use of cost which is not adjusted for price-level changes.
Atypical data in the statements.
Diversification of entities.

BRIEF EXERCISE 6.1
Horizontal analysis:
Increase
or (Decrease)
Accounts receivable
Inventory
Total assets
(1)
30 June 2011
30 June 2010
Amount
Percentage
$ 540,000
$ 840,000
$3 640,000
$ 400,000
$ 600,000
$2 800,000
$140,000
$240,000
$840,000
35% (1)
40% (2)
30% (3)
140 000
240 000
840 000
= .35(2)
= .40(3)
= .30
400 000
600 000
2 800 000
1-165
Accuracy checked
BRIEF EXERCISE 6.2

Net profit
2010
2009
2008
$508 000
$400,000
$500,000
Increase or (Decrease)
(a)
(b)
20082009
20092010
100 000
= .20
500 000
Amount
Percentage
(100,000)
(108 000)
(20%)
(27%)
108 000
= .27
400 000
BRIEF EXERCISE 6.3
Net profit
2010
2009
Increase
$650,000
30%
650 000 X
X
.30 X 650 000 X
1.30X 650 000
X 500 000
.30
2009 Net profit = $500,000

BRIEF EXERCISE 6.4
Comparing the percentages presented results in the following conclusions: The net
profit for Kinnan increased in 2010 because of the combination of an increase in
sales revenue and a decrease in both cost of sales and expenses. However, the
reverse was true in 2011 as sales revenue decreased while both cost of sales and
expenses increased. This resulted in a decrease in profit.
BRIEF EXERCISE 6.5
(a)
Working capital = Current assets Current liabilities

Current assets
Current liabilities
Working capital
(b)
$42 918 000

40 644 000
$2 274 000
Current ratio:
Current assets
$42 918 000
Current liabilities $40 644 000

1.06 : 1
The current ratio for Ho Chi Inc indicates that for every $1 of current liabilities, Ho Chi
Inc has $1.06 of current assets. Ho Chi Inc has more than sufficient current assets to
meet their short-term obligations.
1-166
Accuracy checked
(c)
Acid-test ratio:
Cash Short - term investment s Receivables (net) $8 041 000 $1 947 000 $12 545 000
Current liabilities
$40 644 000
$22 533 000

$40 644 000
.55 : 1
The quick ratio shows that Ho Chi Inc has only 55 cents of liquid current assets to
meet their current liabilities. This shortfall may indicates an inability to meet
immediate obligations.
BRIEF EXERCISE 6.6
(a)
Asset turnover =
(b)
Profit margin =
Net sales revenue
Average assets
$88 000 000
Asset turnover = $14 000 000 $18 000 000
2
Asset turnover = 5.5 times
Profit
Net sales revenue

$11 440 000
Profit margin =
$88 000 000
Profit margin = 13%
BRIEF EXERCISE 6.7

(a)
Accounts receivable turnover =
Net credit sales

Average net receivable s
2011
(b)
(1)
$3 850 000
= 7.2 times
$535 000 *
*($520,000 + $550,000) 2
(2)
Average collection period

365
= 50.7 days
7.2
2010
$3 100 000
= 6.14 times
$505 000 * *
**($490,000 + $520,000) 2
365
= 59.4 days
6.14
Able Company should be pleased with the effectiveness of its credit and
collection policies because it has resulted in improved liquidity. The company
has decreased the average collection period by 8.7 days and the collection
period of approximately 51 days is well within the 60 days allowed in the
credit terms.
1-167
Accuracy checked
BRIEF EXERCISE 6.8

(a)
Inventory turnover =
(1)
Cost of sales
Average inventory
2011
2010
$4 480 000
$960 000 $1 020 000 = 4.5 times
(2)
(b)
$4 561 000
$860 000 $960 000
= 5.0 times
Average days to sell the inventory

365
365
= 81.1 days
= 73 days
4.5
5.0
Management should be concerned with the fact that inventory is moving slower
in 2011 than it did in 2010. The trend signals deterioration in liquidity. The
decrease in the turnover could be because of poor pricing decisions (i.e.,
overpriced inventory not selling) or because the company is stuck with obsolete
inventory (i.e., damaged or out of fashion inventory).
BRIEF EXERCISE 6.9

Payout ratio =
Cash dividends
Profit
X
$54 000
X = $54 000 (.20) = $10 800
Drawings = $10 800
.20 =
Return on assets =
.15 =
.15X =
X =
X =
Average assets =
Profit
Average assets
$54 000
X
$54 000
$54 000
.15
$360,000
$360,000
1-168
Accuracy checked
EXERCISE 6.1
(a)
MARY CO.
Condensed Balance Sheets
as at 31 December
2011
2010
Amount
Percentage
Assets
Current assets
Equipment
Total assets
$125,000
380,000
$505,000
$100,00
0
330,000
$430,00
0
($25,000
)
50,000)
( 75,000
)
$91,000
140,000
231,000
$
70,000
95,000
165,000
($21,000
)
45,000)
(66 000)
274 000
265,000
( 9 000)
$505,000
$430,00
0
($75,000
)
25.0%)
15.2%)
17.4%
Liabilities
Current liabilities
Long-term liabilities
Total liabilities
(30.0%)
(47.4%)
(40.0%)
Owners Equity
Owners equity
Total liabilities and
shareholders equity
(b)
3.4%)
(17.4%
The business has increased its asset base. The increase has been funded
primarily through a combination on short and long term borrowings.
1-169
Accuracy checked
EXERCISE 6.2
(a)
RAMSEY CORPORATION
Condensed Balance Sheets
as at 30 June
Assets
Current assets
Property, plant &
equipment (net)
Other non-current
assets
Total assets
Liabilities
Current liabilities
Long-term liabilities
Total liabilities
Owners equity
Total liabilities & Owners
equity
Percentage
Change
from 2010
2011
2010
Increase
(Decrease)
$76 000
$80,000
$(4 000)
(5.0%)
99 000
25,000
$200,000
90,000
40,000
$210,000
(9 000)
(15,000)
$(10,000)
(10.0%)
(37.5%)
(4.8%)
$ 40 800
143 000
183 800
$ 48 000
150,000
198 000
$ (7 200)
(7 000)
(14 200)
(15.0%)
(4.7%)
(7.2%)
16,200
12,000
4 200
35.0%
$200,000
$210,000
$(10,000)
(4.8%)
(b) Results from Horizontal Analysis reveal the company has used other non-current
assets (possibly investments) to purchase property plant and equipment and to pay
down liabilities. The reduction in both current assets (5%) and current liabilities (15%)
might suggests better working capital management.
EXERCISE 6.3
(a)
ACCRA COMPANY
Condensed Income Statements
For the Years ended 30 June
Net sales revenue

Cost of sales
Gross profit
Expenses
Profit
(b)
2011
$600,000
480,000
120,000
57 200
$62 800
2010
$500,00
0
420,000
80,000
44 000
$36 000
During 2011
Amount
Percentage
$100,000
20.0%
60,000
14.3%
40,000
50.0%
13 200
30.0%
$26 800
74.4%
While revenue increased by 20%, the corresponding increase in cost of sales

was only 14.3%, causing the dramatic increase in gross profit by 50%.While
1-170
Accuracy checked
expenses increased by 30%, the relative increase was less than the 50%
increase in gross profit thus allowing a 74% increase in overall profit.
1-171
Accuracy checked
EXERCISE 6.4
(a)
Current ratio = 2.2:1 ($2057 $950)

Acid-test ratio = 1.1:1 ($1030 $950)
Receivables turnover = 7.7 times ($5634 $710.5)*
Inventory turnover = 4.1 times ($3766 $917)**
Creditors turnover= 5.28 times ($2800
$530)***
*($699 + $722) 2
**(888 + 946) 2
**(510 + 550) 2
(b)
The current ratio assists in evaluating liquidity and short-term debt paying
capacity. For every dollar of current liabilities Dollar value has $2.20 of current
assets in 2010. The acid-test ratio indicates that all immediate liabilities can be
paid with existing quick assets (.1.:1). While it is difficult to make conclusions
in the absence of trend information or industry comparison, results suggests the
firm is in a sound liquidity position.
The company inventory turnover of 4.1 times per year and receivables turnover
of 7.7 times per year are superior to the industry average which suggest the
company is more efficient in generating liquidity. Creditors turnover of 5.28
times per year is slower than the industry average of 6.8. While this may
indicate difficulty in making payments, it is more likely given the other
information that the company chooses to delay the payment of creditors as a
source of cheap finance.
When combined the results suggest that Dollar value has a solid liquidity
position.
EXERCISE 6.5
(a)
Current ratio as of 1 February 2010 = 2.8:1 ($140,000 $50,000).

Feb.
(b)
3
7
11
14
18
2.8:1
2.2:1
2.2:1
2.6:1
2.3:1
No change in total current assets or liabilities.

($112,000 $50,000).
($100,000 $38 000).
($100,000 $43 000).
Acid-test ratio as of 1 February 2010 = 2.5:1 ($123 000 $50,000).

Feb.
3
7
11
14
18
2.5:1
1.9:1
1.8:1
2.1:1
1.9:1

($95,000 $50,000).
($92,000 $50,000).
($80,000 $38 000).
($80,000 $43 000).
1-172
Accuracy checked
EXERCISE 6.6
(a)
2010
2011
$140 000
= 2.3:1.
$60 000
(i)
$145 000
= 3.6:1.
$40 000
(ii)
$85 000
= 2.1:1.
$40 000
(iii)
$400 000
$65 000 (1)
(iv)
$170 000
$198 000
= 3.6 times.
= 3.3 times.
$55 000 (2)
$51 000 (2)
(v)
$160 000
$140 000
= 7.62 times.
= 6.4 times.
$21 000 (3)
$22 000 (3)
(1)
(2)
(3)
(b)
$90 000
= 1.5:1.
$60 000
= 6.2 times.
$360 000
$55 000 (1)
$70 000 $60 000

2
$60 000 $50 000

2
$60 000 $50 000

2
$18 000 $24 000
2
$50 000 $52 000

2
$24 000 $20 000
2
= 6.6 times.
There has been a marked improvement in liquidity from between 2010 and
2011. Both the current and acid test ratios have improved significantly
suggesting that Marcus Company can comfortably cover current liabilities.
Marcus is generating cash more quickly through the more efficient management
of both receivables and inventory. At the same time Marcus is paying of its trade
creditors more quickly reflected by the improvement in the creditors turnover
ratio.
1-173
Accuracy checked
EXERCISE 6.7
(a) (i)
(ii)
Profit margin
Black Company =
$60 000
= 7.5%
$800 000
White Company =
$42 000
= 5.8%
$720 000
Asset turnover
Black Company =
$800 000
= 1.4 times (1.3793)
$580 000
White Company =
$720 000
= 1.4 times (1.44)
$500 000
Assume that total assets at the beginning of the financial year is the same as total
assets at the end of financial year. Therefore, the total assets used to calculate asset
turnover is the total assets as at 30 June 2011 (not the average).
(iii)
Return on assets
Black Company =
$60 000
= 10.3%
$580 000
White Company =
$42 000
= 8.4%
$500 000
Assumed that total assets at the beginning of the financial year is the same as total
assets at the end of financial year. Therefore, the total assets used to calculate return
on assets is the total assets as at 30 June 2011 (not the average).
(iv)
Return on owners equity

Black Company =
$60 000
= 13.9%
$430 000
White Company =
$42 000
= 12.9%
$325 000
Since owners equity data for 2010 are not available for the two companies, it is
assumed that total owners equity at the beginning of financial year is the same as
owners equity at the end of financial year. Therefore, the total owners equity used to
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Accuracy checked
calculate return on equity is the total owners equity as at 30 June 2011 (not the
average).
(b)
Black Companys profit margin is higher than White Company. In 2011, Black
Company generated 7.5 cent of net profit from every dollar of sales compared
to only 5.8 cent for White Company. Both companies are equally efficient in
using their assets to generate sales, with asset turnover ratio of 1.4 times. Black
Companys return on assets is higher than White Company (10.3% to 8.4%). The
higher return is generate by the higher profit margin. Black Companys return
on owners equity is also higher than White Company (13.9% to 12.9%). These
shows that in general, Black Company is more profitable than White Company.
EXERCISE 6.8
(a)
Inventory turnover = 3.2 =
Cost of sales
$200 000 $180 000
3.2 $190,000 = Cost of goods sold

Cost of goods sold = $608 000.
(b)
Net sales (credit)

Receivables turnover = 8.4 = $72 500 $126 000
8.4 $99 250 = Net sales (credit) = $833 700.
(c)
Profit
Return on owners equity = 22% = $513 500 $501 000
2
.22 $507 250 = Profit = $111,595.
(d)
Return on assets = 20% =

Average assets =
$111 595 [see (c) above]

Average assets
$111 595
= $557 975
.20
Total assets (31 Dec. 2011) $605 000

= $557 975
2
Total assets (31 Dec. 2011) = ($557 975 2) $605,000 = $510 950.
1-175
Accuracy checked
PROBLEM 6.1
(a)
$199 000
Return on owners equity = $465 400 $566 700
$199 000
Return on common shareholders equity =
$516 050
Return on common shareholders equity = 38.6%.
(b)
$199 000
Return on assets = $852 800 $970 200
(c)
Current ratio =
(d)
Acid-test ratio =
(e)
$199 000
= 21.8%.
$911 500
$369 900
= 1.82:1
$203 500
$236 900
= 1.16:1
$203 500
$1 818 500
Receivables turnover = ($102 800 $107 800 )
$1 818 500
Receivables turnover =
$105 300
Receivables turnover = 17.3 times.
(f)
$1 011 500
Inventory turnover = $115 500 $133 000
(g)
Interest coverage ratio =
(h)
Asset turnover =
(i)
Debt to total assets =
(j)
Profit margin
$1 011 500
= 8.1 times.
$124 250
$301 000
= 16.7 times.
$18 000
$1 818 500
= 2.0 times.
$911 500 *
*($852 800 + $970 200) 2
(1)
(k)
(1)
$403 500
= 41.6%.
$970 200
$199 000
= 10.94%
$1 818 500
This ratio is normally calculated using profit before tax, However in the text tax is ignored.
Gross profit margin =
$807 000
= 44.38%
$1 818 500
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Accuracy checked
(l)
$ 862 400
Creditors turnover = ($160 000 $145 400 )
$ 862 400
Receivables turnover =
$152 700
Receivables turnover = 5.65 times.
The performance of Taylor Tool Company has improved in 2011, as evidenced by the
increase in profits by $14,500. This profit increase is mainly contributed by the boost
in sales revenue and increase in gross profit. Although selling/administrative and
interest expenses also increase in 2011, the increase in gross profit is able to absorb
the increase in expenses, resulting in the overall profit increase.
Taylor Tools total assets increase by $117,400 or 13.8% in 2011. Total liabilities
increase by $16,100 or 4.2% and total owners equity increase by $101,300 or 21.8%.
The increase in equity is mainly due to the 73% increase in retained earnings. Those
figures show that Taylor Tool expands its asset base in 2011 using owners equity
rather than borrowing money from creditors.
PROBLEM 6.2
(a)
2010
2011
(1) Profit margin.

$32 000
= 4.92%
$650 000
$48 000
= 6.86%
$700 000
(2) Asset turnover.

$650 000
$533 000 $600 000
$700 000
$600 000 $640 000
= 1.147 times
(3) Payout ratio.

$20 000 *
= 62.5%
$32 000
*($113 000 + $32,000 $125,000)
$28 000 **
= 58.3%
$48 000
**($125,000 + $48 000 $145,000)
(4) Debt to total assets.

$165 000
= 27.5%
$600 000
$155 000
= 24.2%
$640 000
(5) Return on assets
Return on assets
$32 000
$32 000
= $533 000 $600 000 =
=
$566 500
5.65%.
(b)
= 1.129 times
$48 000
$48 000
= $600 000 $640 000 =
=
$620 000
7.74%.
The underlying profitability of the company appears to have improved. Return

on assets has increased from 5.65% to 7.74% While the company is marginally
1-177
Accuracy checked
less efficient in generating sales from the assets employed (declining asset
turnover) the profit generated from each dollar of sales has increased
significantly (4.92% to 6.86% reflecting a 39% increase in profit margin).
The company appears to be involved in attempting to reduce its debt burden
as its debt to total assets ratio has decreased. Similarly, its payout ratio has
decreased, which suggests the company is retaining a greater proportion of
profits within the business to fund assets purchases and reduce liabilities.
PROBLEM 6.3
LIQUIDITY
2010
2011
Change
Current
$343 000
= 1.9:1
$182 000
$374 000
=1.9:1
$198 000
No change
Acid-test
$195 000
= 1.1:1
$182 000
$216 000
= 1.1:1
$198 000
No change
Increase
$850 000
= 9.2 times
$92 000 * *
**($90,000 + $94 000) 2
Receivables $790 000

= 8.9 times
turnover
$89 000 *
*($88 000 + $90,000) 2
Inventory
turnover
$575 000
= 4.7 times
$121 500
$620 000
= 4.9 times
$127 000
Increase
An overall increase in short-term liquidity has occurred because both receivables

and inventory are being converted to cash more quickly.
PROFITABILITY
Profit margin
$35 000
= 4.4%
$790 000
$36 000
= 4.2%
$850 000
Decrease
Asset
turnover
$790 000
= 1.2 times
$639 000
$850 000
= 1.3 times
$666 000
Increase
Return on
assets
$35 000
= 5.5%
$639 000
$36 000
= 5.4%
$666 000
Decrease
Profitability has remained relatively the same.
1-178
Accuracy checked
PROBLEM 6.4
(a)
Ratio
Targa
Wally
(All Dollars Are in Millions)

(1)
(2)
(3)
Current
Receivables turnover
Average collection
period
Inventory turnover
Days in inventory
Profit margin
Asset turnover
Return on assets
Return on owners
equity
Debt to total assets
Interest coverage ratio
(4)
(5)
(6)
(7)
(8)
(9)
(10)
(11)
1.4:1
($9648 $7054)
20.4
($39 176 $1916)
17.9 days
(365 20.4)
1.0:1
115.6
3.2 days
6.3 x
($27 246
$4349)
57.9 days
(365 6.3)
3.5%
($1374 $39 176)
1.8 x
($39 176
$21,822a)
6.3%
($1374 $21,822a)
19.1% ($1374 $7189.5b)
67.5%
($16,294 $24
154)
5.8
($2680 $464)
7.8 x
($171,562 $22,028)
46.8 days
(365 7.8)
3.1%
($6854 $217 799)
2.7 x ($217 799 $80 790.5c)
8.5%
($6854 $80 790.5c)
20.6%
($6854 $33 222.5d)
57.9%
($48 349 $83 451)
9.1 x
($12,077 $1326)
($24 154 + $19 490) 2

($7860 + $6519) 2
(b)
($28 246 $27 282)

($217 799 $1884)
(365 115.6)
($83 451 + $78 130) 2

($35 102 + $31 343) 2
The comparison of the two companies, in general, shows the following:

Liquidity
Targas current ratio of 1.4:1 is slightly better than Wallys 1.0:1. However,
Wally has a better inventory turnover ratio than Targa and its receivables
turnover is significantly better than Targas.
Solvency
Wally betters Targa in both of the solvency ratios. Thus, it is more solvent than
Targa.
Profitability
Wally earns a slight lower profit margin than Targa but because the store
generates higher sales for every dollar of assets employed, the overall return
on assets is higher. While Wally also earns a higher return on owners equity
the difference is not as large because Targo is more higher geared.
1-179
Accuracy checked
PROBLEM 6.5
$215 000
= 1.5:1.
$145 000
(a)
Current ratio =
(b)
Acid-test ratio =
(c)
$600 000
Receivables turnover = ($92 000 $74 000)
(d)
$415 000
Inventory turnover = $84 000 $70 000 = 5.4 times.
(e)
Profit margin ratio =
(f)
$600 000
Asset turnover = $638 000 $560 000
(g)
$35 400
Return on assets = $638 000 $560 000
(h)
$600 000
Return on owners equity = $373 000 $350 000
(i)
Debt to total assets =
(j)
Interest coverage ratio =

(3)
$21 000 $18 000 $92 000

= 0.90:1.
$145 000
$35 400
= 5.9%.
$600 000
= 1.0 times.
= 5.9%.
9.8%.
$265 000
= 41.5%.
$638 000
$61 200 (3)
$7800
$35 400 + $18 000 + $7800
= 7.2 times.
= 7.8 times.
1-180
Accuracy checked
PROBLEM 6.6
2008
1
2
3
4
6
7
(b)
Current Ratio
$5,616.20 $7,603.90
$5,587.40 $6,939.20
Profit Margin
$969.00 $16,191.90
$672.60 $15,060.40
Expense Ratio
$14,817.60 $16,191.90
$14.030.40 $15,060.40
Return to Assets
$969.00 [($19,700.10 + $19.493.70)
2]
$672.60 [($19,493.70 + $19,605.70)
2]
Return to Equity
$969.00 [($5,731.20 + $5,634.90)
2]
$672.60 [($5,634.90 + $6,189.10)
2]
Debt to total assets ratio
$13,956.20 $19,700.10
$13,853.90 $19,493.70
Interest Coverage Ratio
Asset Turnover
$16,191.90[($19,700.10 +
$19.493.70) 2]
$15,060.40[($19,493.70 +
$19,605.70) 2]
2007
0.74:1
0.81:1
6.0%
4.5%
92.0%
93.2%
4.9%
3.4%
17.1%
11.4%
70.9%
71.1%
In 2008 finance
income exceeded
finance costs, so
Qantas had a net
finance income
rather than a net
finance expense.
($672.80 + $292.30
+ $108.00)
$10.80=
90.4 times
0.82
0.77
Overall, profitability has increased both on the shareholders perspective and on

the entitys perspective.
As for solvency, Qantas has high debt to total assets ratio. The figures are similar
over the two year period. Whilst 70% is high, it is not unusual or excessive for
the industry Qantas is in (the aviation industry). More importantly, Qantas is able
to meet its interest obligation comfortably with its profits more than 90 times
larger than the interest expense.
1-181
Accuracy checked
BYP 6.1
(a)
EXPLORING THE WEB
The Corporations Act required companies to prepare an annual financial report

comprising
financial statements
notes accompanying the financial statements
directors declaration about the financial statements
The Corporations Act also requires companies to send to members (in addition to the
financial report) a
directors report
auditors report
The financial report, directors report and auditors report are collectively referred to as
the annual report.
(b)
Optional elements include:
Financial highlights
Letter to shareholders
Corporate message
Report of management
Certain shareholder information
The ASX Listing Rules also require information to be disclosed such as the
names and holdings of substantial shareholders.
(c)
Management discussion . This series of short, detailed reports discusses and

analyses the companys performance. It covers results of operations, and the
adequacy of liquid and capital resources to fund operations.
(d)
Auditors report . This summary of the findings of an independent firm of

public accountants shows whether the financial statements are complete,
reasonable, and are in accordance with generally accepted accounting
principles (GAAP) at a set time.
(e)
Selected financial data . This information summarises a companys financial

condition and performance over five years or longer. Data for making
comparisons over time may include revenue (sales), gross profit, net profit,
earnings per share, dividends per share, financial ratios such as return on
equity and debt to asset ratio, number of shares on issue, and the market
price per share.
(f)
The students answers to this will depend on the year of the annual report.
1-182
Accuracy checked
BYP 6.2
(a)
GROUP DECISION CASE
The current-ratio increase is a favorable indication as to liquidity, but alone

tells little about the going-concern prospects of the client. From this ratio
change alone, it is impossible to know the amount and direction of the
changes in individual accounts, total current assets, and total current
liabilities. Also unknown are the reasons for the changes.
The acid-test ratio decrease is an unfavorable indication as to liquidity,
especially when the current-ratio increase is also considered. This decline is
also unfavorable as to the going-concern prospects of the client because it
reflects a declining cash position and raises questions as to reasons for the
increases in other current assets, such as inventories.
The change in asset turnover cannot alone tell anything about either solvency
or going-concern prospects. There is no way to know the amount and direction
of the changes in sales and assets. An increase in sales would be favorable for
going-concern prospects, while a decrease in assets could represent a number
of possible scenarios and would need to be investigated further.
The decrease in the ratio of sales to shareholders equity is unfavorable. The
decrease could be caused by a decrease in sales, an increase in
shareholders equity, or a combination of the two. The most likely case is a
decrease in sales, but we cannot determine this with certainty from the
ratios. If there was a decrease in sales, of particular concern is the effect on
earnings. But, we see that net profit increased by 32%. This means that, if
there was a decrease in sales, the companys management was able to more
than offset the decline with a reduction in expenses.
The increase in net profit is a favorable indicator for both solvency and goingconcern prospects, although much depends on the quality of receivables
generated from sales and how quickly they can be converted into cash. If
there has been a decline in sales, a significant factor is that management has
been able to reduce costs to produce an increase in earnings. Indirectly, the
improved profit picture may have a favorable impact on solvency and goingconcern potential by enabling the client to borrow currently (if it needs to do
so) to meet cash requirements.
The 32-per cent increase in earnings per share, which is identical to the
percentage increase in net profit, is an indication that there has probably
been no change in the number of shares of ordinary shares on issue. This, in
turn, indicates that financing was not obtained through the issue of shares. It
is not possible to reach conclusions about solvency and going-concern
prospects without additional information about the nature and extent of
financing.
The increase in the book value per share is a favorable indicator for both
solvency and the going-concern potential of the company.
The collective implications of these data alone are that the client entity is
about as solvent and as viable a going concern at the end of the current year
as it was at the beginning although there may be a need for short-term
operating cash.
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(b)
Although a quick evaluation of a reporting entity can be made using only a

few ratios and comparing these with past ratios and industry statistics, the
creditors should realise the limitations of such analysis even from the best
prepared statements carrying a qualified accountants unqualified opinion.
A limitation on comparisons with industry statistics or other companies within
the industry exists because material differences can be created through the
use of alternative (but acceptable) accounting methods. Further, when
evaluating changes in ratios or percentages, the evaluation should be directed
to the nature of the item being evaluated because very small differences in
ratios or percentages can represent significant changes in dollar amounts or
trends.
The creditors should evaluate conclusions drawn from ratio analysis in light
of the current status of, and expected changes in, such things as general
economic conditions, the clients competitive position, the publics demand
(for the product itself, increased quality of the product, control of noise and
pollution, etc.), and the clients specific plans.
BYP 6.3
To:
Whoever
From:
Accounting Student
Subject:
Financial Statement Analysis
There are two fundamental considerations in financial statement analysis: (1) the
bases of comparison and (2) the limitations of financial statement analysis. Each of
these considerations is explained below.
1.
2.
Bases of comparison. The bases of comparison are:

a.
Intra-entity This basis compares an item or financial relationship within

an entity in the current year with the same item or relationship in one or
more prior years.
b.
Inter-entity This basis compares an item or financial relationship of

one entity with the same item or relationship in one or more competing
entities.
c.
Industry averages This basis compares an item

relationship of an entity with industry averages (or norms).
or
financial
Limitations in financial statement analysis are:

a.
Estimates Financial statements contain estimates which may be

inaccurate.
b.
Cost Financial statements are based on cost which may be affected by

significant inflation or deflation.
c.
Alternative accounting methods Variations among entities in the

application of generally accepted accounting principles may hamper
comparability.
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d.
Atypical data Fiscal year-end data may not be typical of the financial
condition during the year.
e.
Diversification of entities Many entities are so diversified they cannot

be classified by industry.
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BYP 6.4
(a)
ETHICS CASE
The stakeholders in this case are:
Mike Singletary, CEO of Singletary Industries.

Curtis Conway, public relations director.
You, as CFO of Singletary Industries.
Shareholders of Singletary Industries.
Potential investors in Singletary Industries.
Any readers of the press release.
(b)
The CEOs press release is deceptive and incomplete and to that extent his
actions are unethical.
(c)
As CFO you should at least inform Curtis, the public relations director, about
the biased content of the release. He should be aware that the information he
is about to release, while factually accurate, is deceptive and incomplete. Both
the CFO and the public relations director (if he agrees) have the responsibility
to inform the CEO of the bias of the about to be released information.
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3 Chapter 7
4 Management Accounting and Performance Measurement
1.
The core activities of the management accounting function include:
2.
Providing financial and non-financial information for planning, decisionmaking and control
Calculating the cost of products and services
Determining the behaviour of costs as activity levels change
Preparing budgets and comparing actual performance with budgets
Providing relevant data for management decision-making.
The differences between financial accounting and management accounting are:

Financial accounting
Externally focused
Financial statements (Income Statement,
Statement of Financial Position and Cash
Flow Statement) that comply with A-IFRS,
are produced annually, consolidated to
whole of entity level, and audited
Historical information
3.
The limitations of financial reports (Income Statement, Statement of Financial

Position and Cash Flow Statement) for management planning, decision-making
and control are:
4.
Management accounting
For internal management use
Reports that are not subject to A-IFRS
requirements or to audit, but which are
presented to suit the needs of a
particular business.
Include non-financial as well as financial
information.
Produced for each business unit and
contain sufficient detail to provide useful
management information, typically on a
monthly (or more frequent) basis.
Past and present information, and future
projections
They are highly aggregated (a) to the entity level; (b) for a financial year,
and (c) with only headline figures presented (e.g. sales, expenses).
Managers need information about the profitability of products and
services, business units, customers, and business processes.
They are a lagging indicator of performance, produced too late to
influence current decisions.
Financial data alone is limited, and needs to be supplemented by nonfinancial information such as customer satisfaction, quality, on time
delivery, productivity, employee retention, etc.
They are based on past data, with an absence of any future projections.
Service and knowledge based organisations are important to the Australian

economy. There are no right/wrong answers. Students are expected to briefly
summarise (using 2-3 PowerPoint slides) information derived from internet
sources. This provides the opportunity for tutors to raise the following issues:
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The relative value of different Internet sites, eg Wikipedia, Australian

Bureau of Statistics, web blogs, etc.
The age or recency of the data and possible biases in the data presented
The importance of proper referencing of the source of data
The ability to summarise key points on a slide (good practice is to limit a
single slide to 4-6 bullet points, each containing no more than a few
words)
Examples only:
The service economy represents around 85 per cent of Australias total
employment, generates around three quarters of industry value added and on
existing statistics accounts for more than 20 per cent of exports (Australian
Services Roundtable, Media Release 4 December 2008),
http://www.servicesaustralia.org.au/pdfFilesHomePage/ServicingOurFutureMedia
Release.pdf downloaded 20th January 2009.
4.1.1.1
the contribution of knowledge-based industries to GDP is 48% for

Australia (Speech by Australian Minister for Trade, Mark Vaile, The
Economist Intelligence Unit, Canberra, 31 October 2,000),
http://www.trademinister.gov.au/speeches/2,000/001031_eiu.html
, downloaded 20th January 2009.
How is a knowledge-based economy measured? For a range of ideas see
http://www.environment.gov.au/soe/2006/publications/drs/indicat
or/268/index.html
4.1.1.2
5. Non-financial performance measures can supplement financial

information to help managers make decisions:
Identifying the key business drivers of business performance and

success, rather than relying on standardised financial data driven
by generic financial reporting standards
Linking performance with corporate strategy and goals, and
comparing actual performance with those goals
Considering long-term as well as short-term performance
Comparing performance trends over time, and benchmarking with
competitors or industry averages
Providing leading indicators of business performance (financial
reports provide lagging information about financial performance,
which is a result of non-financial performance)
Non-financial information provides useful information about
customers, business processes and innovation/improvement.
4.1.1.3
6.
The main features of the Balanced Scorecard are:

Linking performance measures with strategy and goals
Balancing financial performance measures with non-financial
measures across three other perspectives on the business:
customers, business processes, and innovation/improvement.
The relationship between the four perspectives is that
innovation/improvement is seen to improve business processes,
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7.
which in turn produces more satisfied customers and ultimately

financial success.
Comparing (benchmarking) performance with competitors and
industry averages
Developing measures of performance within each of the four
perspectives that are relevant to the business and its strategy
In the Balanced Scorecard, financial measures are still important,
but are recognised as lagging indicators, whereas non-financial
measures are leading indicators. The balance between the four
perspectives is important.
Identify at least 5 non-financial measures used by Qantas. Explain what each

means and how they relate to financial performance.
As for Question 4, there are no right/wrong answers but students should be
encouraged to do some Internet research and to distinguish and discuss nonfinancial measures from financial performance, and to recognise the
relationship between non-financial and financial performance.
Standard airline measures include:
Number of aircraft
Number of destinations (routes)
Number of passengers carried
Revenue Passenger Kilometres (RPK) - The distance a passenger travels
on a flight. One passenger travelling 10,000km produces 10,000 RPKs.
Three hundred passengers each travelling 10,000 kilometres, produce
three million RPKs
Available Seat Kilometres (ASK) - The seat capacity of an aircraft
multiplied by the distance travelled. A 400-seat aircraft flying 10,000km
produces 4,000,000 ASKs
Revenue seat factors. Passenger yield is the total revenue from
passengers divided by the total RPKs. It is expressed in cents/RPK.
Source: http://www.qantas.com.au/info/about/investors/trafficStats Downloaded

20th January 2009.
Useful information (including what RPK, ASK and passenger yield means) is
available from http://www.qantas.com.au/infodetail/about/FactFiles.pdf
8.
Non-financial measures for a legal services firm:

Tutors should encourage students to think creatively, asking themselves what a
law firm does, and what the key criteria for success are. Importantly, students
should think of measures for each of the three non-financial perspectives. For
example:
Customer (client)
perspective
Number of clients
Client retention
(number of years,
repeat business,
Business process
perspective
Meeting
commitment re
completion of work
Quality of work
(need for
corrections, etc.)
Innovation/improve
ment perspective
Staff retention
Staff training
investment
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etc.)
Client satisfaction
(survey)
9.
10.
Actual time spent

compared to
estimates or
standard times
Papers published in
law journals/awards
A cost centre is a business unit which is responsible for cost control, i.e.
maintaining costs within the agreed budget. A profit centre is responsible for
achieving the target profit. Budget costs may be exceeded if sales are
increased, provided that profit is higher than budgeted. An investment centre is
responsible, not only for profit, but also for the return on investment (or residual
income). Consequently, an investment centre must not only act as a profit
centre, but needs to manage its investment base (reducing the investment base
will increase ROI or RI even with a static profit).
Responsibility accounting involves holding managers accountable (responsible)
for the performance of their business unit. Managers are evaluated on how
successful their business unit is. If managers are accountable, they should have
the authority to make decisions consistent with that accountability, e.g. if they
are accountable for costs, they should be able to control the costs for which
they are responsible. Controllability is the ability of a manager to exercise
control over (influence increases and decreases) in that for which s/he is
responsible (costs, revenues and/or investments depending on whether the
business unit is a cost centre, profit centre or investment centre). The principle
is that managers should not be held accountable (responsible) for costs,
revenues or investments over which they have no control.
11.
Return on investment is the net profit as a percentage of the investment in the

business unit. It does not take into account the cost of capital for that
investment. Residual income deducts the notional cost of capital for the division
from its net profit to arrive at a residual income (i.e. what remains after
deducting from profits the cost of capital on the business units investment). A
negative residual income indicates that the business unit is eroding shareholder
value. Residual income overcomes the goal congruence problem whereby
divisional managers may not act in the best interests of the entity as a whole.
12.
As for previous questions requiring research, there are a variety of possible

answers. Tutors should ensure that students:
Identify what is meant by ERP and SAP, and the difference between them
Outline the benefits, which is the questions requirement and
importantly, differentiating between the features (characteristics) and the
benefits (advantages to the user) of such a system students should
explain how the benefits are achieved
Summarise the key issues in a single page, and
Show the source of their information and recognise any biases in those
sources.
For example:
ERP or enterprise resource planning is a computer-based information system
that centralises and integrates data across the whole organisation, from
customer order, through purchasing, production/distribution and accounting.
They can comprise both financial and non-financial information and reports can
be produced for management information to suit the needs of individual
managers. Importantly, an ERP replaces stand-alone software packages that can
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result in inconsistent data. ERP systems can also collect data along the supply
chain (including suppliers and customers).
SAP is a company, that along with Oracle, provides ERP systems to a wide range
of organisations.
The benefits of an ERP system like SAP include:
Helping to reduce costs by having a single information system,

eliminating duplication and inconsistent data
More reliable, accurate and timely information to support management
decisions
Improve strategic planning by more effective resource utilisation (e.g.
improved capacity management
Information sharing across departments, so that opportunities can be
grasped
Customer satisfaction due to improved quality and on-time delivery
Reduced inventory by purchasing to satisfy production requirements
Improved purchasing by suing supplier information
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Sources: http://www.sysoptima.com/erp/erp_benefits.php
http://www.mosaic21.com/faq.htm#3
http://www.benefitsoferp.com/
Tutors should compare these sources with peer-reviewed academic research on
the benefits of ERP. An example is
Velcu, O. (2007) Exploring the effects of ERP systems on organizational
performance: Evidence from Finnish companies. Industrial Management and
Data Systems, vol 107 no 9, p 1316-1334.
This journal is available through the Library. Tutors may use this as an
opportunity to show students how to access electronic journals through the
Library.
It is not necessary for students to read the article, but they should be aware of
the difference between academic research and websites that may be biased in
promoting particular systems.
13.
A vertical or hierarchical perspective on business follows the pattern of an

organization chart, through each department or business unit, with its own
responsibilities, e.g. marketing, operations and finance for the company as a
whole, or for a geographic territory, or a particular product or service. This
perspective is important for financial reporting, holding managers responsible
for their business unit performance whether as cost, profit or investment
centres). A horizontal or business process approach ignores these organization
structures and looks at the process of accepting a customers order, fulfilling
that order and invoicing and debt collection, even though the single process
that relates to that customer order crosses many departmental boundaries (a
similar example can be considered for purchasing goods or services from a
supplier). This is an important perspective because there can be duplication (or
even gaps) between what takes place in different departments and business
units that affect the quality, timeliness and cost of the process.
14.
Any reasonable attempt to show diagrammatically how transactions are

recorded is acceptable (see Figure 7.12 in the text as an example). The
processes that should be covered include:
The business event (e.g. making a sale, purchasing goods, paying an

expense, etc.)
The source document for the transaction (e.g. invoice, cheque, purchase
order, etc.)
Data processing of the source document (which involves allocating a
general ledger code)
Production of transaction reports (cash books, purc hase journals, etc)
and ledger
Production of financial statements from the ledger (and whether the
general ledger code identifies the transaction as income, expense, asset
or liability).
This question provides the opportunity to quickly revise issues learned in

financial accounting in the first six weeks of the Unit.
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15
There are many possible answers here. Other than the obvious accountant and
financial controller, job titles for management accounting roles include
business analyst, financial analyst, internal consultant, controller, etc.
Tutors should use current examples from the press.
16
Again, there are many possible answers. Encourage students to use their life
experience of any organisation and think about the questions that could be
asked about that business. As a non-financial manager, I may want answers to
questions like:
How much money is my business unit making?

Where are most of my sales coming from (products, customers,
geographic areas, etc.)?
What is the cost of the products/services we sell, and which are most
(and least) profitable?
Which customers are the most (and least) profitable?
What would the likely competitor and customer response be if prices
were increased?
What are my main costs and what control do I have over them?
Who are my main suppliers? And what position am I in to negotiate prices
with them?
How efficient (productive) are we? What excess capacity do we have?
How am I held accountable by my managers? (Sales, profits, ROI, RI, etc.)
What are the targets I am expected to achieve? (Financial and nonfinancial)?
What information systems are available to me to access information
about this business unit?
17. Reducing the value of inventory in the Statement of Financial Position will
increase the cost of goods sold and hence reduce profits, and consequently lead
to a lower tax charge for the company. This is both a legal and an ethical issue.
From a legal point of view, undervaluing inventory so as to reduce profits is likely
to be considered as fraudulent. This is because the financial statements will
misrepresent the position of the company to its lenders, to the Australian
Taxation Office, and to other stakeholders including suppliers.
From an ethical perspective, the ethical standards of integrity, professional
competence, and professional behaviour would be breached. An accountant
should not breach these standards or condone acts taken by others that breach
those standards.
The accountant would be advised to first bring these matters to the attention of
the MD. If the MD insists on a false accounting, the accountant would have no
option other than to resign. If the accountant succumbs to the MD, perhaps in
fear of losing his or her job, then the accountant may be held liable at law to the
authorities and ethically to his or her professional body for a breach of ethics. The
consequent loss of reputation to the accountant personally would impact his or
her employability in the future.
E1
The information provided should be presented to show the cost of sales and gross
profit, i.e. the contribution towards the allocated corporate costs (which are not
controllable by the managers).
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Sales
Cost of sales
Gross profit/
Contribution
Corporate costs
allocated to
divisions
Net profit
Electrical
275,000
40%
110,000
Homewares
150,000
30%
45,000
Furnishings
250,000
50%
125,000
Total
675,000
280,000
165,000
105,000
125,000
395,000
100,000
70,000
65,000
235,000
65,000
35,000
60,000
160,000
Each division is making a profit. More importantly, each division is making a

contribution to corporate costs. If gross profit was negative, the division should
be immediately closed as each sale is losing the company money. However, even
if there is a net loss, provided the division is making some contribution to
corporate costs, it should be retained.
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E2
To compare the performance of each division, the following Table compares

profits, profits as a percentage of sales, return on investment (ROI) and residual
income (RI) for the four divisions. Each is a valid method of evaluating
performance, yet each can give a different answer. Tutors should encourage
students to compare what each method tells us.
Sales
Divisional profit
Profit % sales
Divisional
investment
ROI
Northern
2,000,000
500,000
Highest
absolute profit
25%
Highest return
on sales
10,000,000
Southern
3,000,000
150,000
Eastern
3,000,000
250,000
Western
1,500,000
300,000
5%
8.3%
20%
2,000,000
1,500,000
3,000,000
5%
7.5%
10%
800,000
160,000
16.7%
Highest ROI
120,000
-300,000
-10,000
Cost of capital
8%
RI
130,000
Highest RI
240,000
60,000
The best performing division is Eastern, based on ROI and RI measures. This is
despite Northern having higher absolute profits, because of the high investment
required in Northern to achieve its profits.
E3
The Balanced Scorecard (BSC) is a set of performance measures that provides
four perspectives on the business: financial, customer, business process, and
learning and growth. The last three of these are leading indicators that should
result in financial performance, which is a lagging measure. The importance of
balance in the BSC is that there should be measures from each of these
perspectives.
Although there is no single way in which the firms performance measures could
be allocated to the four perspectives, the following is an indicative approach:
Financial
Net profit
Profit per partner
Fee revenue
Fee revenue per partner
Expenses per partner
Customer
Number of new clients
Process
Time not chargeable to
clients
Time spent correcting
errors
Learning & growth

Staff turnover
Time spent on training
As can be seen, the performance measures are dominated by financial

measures. The BSC is therefore unbalanced. There is a particular absence of
customer measures which are very important to a professional service firm.
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Some additional performance measures to round out the existing ones into a
more balanced BSC are:
Customer measures: Turnover of clients (i.e. covering the loss of clients

as well as new clients); Average revenue per client (which could be
classed as a financial or customer measure); Client satisfaction (e.g. from
a survey); Referrals (where existing clients recommend new clients to the
firm).
Process measures: Actual time spent compared to quoted timer (some
professional service firms estimate the time to be spent on a clients job
before work commences); time between receiving instructions from a
client and commencing (or completing) the work.
Learning & growth: Employee morale (e.g. from a survey); Staff
qualifications.
There are no right or wrong answers here. Students should think innovatively
about appropriate performance measures, with a focus on those indicators
which are most likely to demonstrate performance (strengths and weaknesses),
and maintaining balance between the four perspectives.
E4 Proudozzie Ltd (Part 1)
c.
Each division, other than South, is making a profit. ROI returns vary enormously,
due not only to different net profits, but also the different levels of investment in
each division. We can see from the ROI calculations that only East and West
divisions are contributing an ROI that is greater than the cost of capital of 12%.
The RI approach shows that North, but particularly South, are generating
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substantial negative residual incomes, and hence are eroding shareholder

value. Proudozzie Ltd as a whole is making a negative residual value, largely
due to the substantial losses in the South division. This needs to be addressed
by the company as a matter of urgency.
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5 Chapter 8
6 Cost and Costing
1.
(a)
(b)
(c)
Direct costs are those that are readily traceable to products/services.

Indirect costs are incurred as costs of purchasing products/services but
indirect costs are not readily traceable to particular products/services and
are therefore treated as production overhead.
Product costs are those direct and indirect costs that are traced (for direct
costs) or allocated (for indirect costs) to products/services. They form the
cost of sales which are deducted from sales revenue to calculate gross
profit. Period costs are non-production costs that are costs of an
accounting period rather than costs of production. They are deducted
from gross profit (e.g. selling, administration, finance, IT, HR and similar
expenses) to calculate net profit.
Fixed costs are those costs that remain constant despite increases or
decreases in the volume of sales of products or services (usually within a
defined relevant range). Variable costs are those costs which increase or
decrease in proportion to increases or decreases in sales volume.
2.
The statement is incorrect. Selling expenses are not costs of producing products
or services. They are not part of the cost of sales but are treated as period
costs, i.e. costs of an accounting period (of time).
3.
Fixed costs are $100,000 in a period where 25,000 units are sold. The average
fixed cost per unit is $4 ($100,000/25,000). However, this does not make the
fixed costs a variable cost, because even if volume was more or less than
25,000 (but within the relevant range) the total fixed costs would still be
$100,000. For example, if 27,000 units were sold, the average fixed cost per
unit would fall to $3.70 ($100,000/27,000)
4.
Relevant range is the upper and lower levels of activity within which costvolume-price (CVP) relationships can be predicted. Variable costs per unit and
total fixed costs are constant within the relevant range. A simple way to
understand relevant range is to think of a business that makes a decision about
whether to operate on 1, 2 or 3 shifts (8, 16 or 24 hours per day). The variable
costs per unit and total fixed costs will likely be different depending on the
choice of working hours. One needs to be selected for planning, decision making
and control purposes. Outside the relevant range, CVP relationships will need to
be recalculated.
5.
See below. It is sufficient for students to draw a freehand chart and to show
approximately the position of the fixed costs, variable cost, total costs and sales
revenue lines, being able to approximate the breakeven point in units and
dollars from that graph.
Students should be encouraged to use Excel to graph the CVP relationships,
even though being able to do so using Excel will not be examined.
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6.
The overhead allocation problem arises because in the production of

products/services, the direct costs traceable to products/services may be a
small proportion of total costs of production. Indirect costs therefore have to be
allocated to products/services using some basis, in order to calculate a full
product cost, as is required by accounting standards. How overheads are
allocated is problematic because in many businesses, a variety of
products/services are sold using different types and costs of labour, some using
high technology whilst others are labour intensive. There may be many different
products/services, some sold in high volume and others in low volume.
Allocations of overheads using an arbitrary basis can have detrimental effects
on pricing, competitive position and ultimately business viability.
7.
Under absorption costing, overheads are typically related using an arbitrary (but
easy to identify) measure of activity, most commonly direct labour hours. Whilst
this is simple to use, it is only really applicable where direct labour is a major
component of total production costs and is logically related to total overhead in
some way. An example is professional service firms where direct labour is a
large part of total costs and overheads (office space, support staff and computer
facilities) are often in proportion to the levels of direct staff. Whilst the method
is simple, in many businesses where there is a large variety of products/services
selling in different volumes, at different prices and with different costs, so the
result can be over-and under-costing (and therefore pricing) of products/services
with one or more subsidising others, which can result in a
loss of
competitiveness.
Activity-based costing looks at business processes, collects the costs of those
processes, and identifies the causes of those processes (the cost driver). For
each product/service, the consumption of business processes is identified and
cost drivers applied to those processes. Therefore, products/services that use
more processes will incur a higher proportion of overhead, and processes with
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higher costs will contribute to this. Those products/services that cause

overheads to be incurred therefore have higher costs (whereas under
absorption costing all overheads are averaged over all products/services). This
is a much more accurate method of overhead allocation. However it is costly to
implement. It requires expertise and staff allocated to identifying the
appropriate business processes, cost drivers and the use of each business
process by different products/services. It also requires a computer system that
collects costs of (horizontal) business processes as well as (vertically) by
department/responsibility centre.
E1
E2
Variable costs are $2 per unit ($10,000/5,000)

for December 10,000 @ $2 = $20,000
Fixed costs do not change with activity, for December $30,000
As total costs are $75,000 mixed costs for December are $25,000 ($75,000 $20,000 - $30,000)
Selling price $25 per hour. Variable costs $7 per hour.
(a)
(b)
(c)
Contribution margin per hour is $18 ($25 - $7).

Contribution margin ratio is .72 (i.e. 72%) ($18/$25)
Contribution margin statement:
Sales
250 hours @ $25
Less variable costs
1,750
Contribution
Less fixed costs
Net profit
$6,250
250
$7
$4,500
$3,000
$1,500
E3
(a)
Using CVP analysis

150,000 + 100,000
(20-12)
(b)
Or,
250,000
8
31,250 units
$625,000
Sales value 31,250 @ $20 = $625,000

150,000 + 100,000
(20-12)/20
250,000
0.4
E4
(a)
(b)
(c)
Direct labour cost per hour is $300,000/2,500 hours = $120 per direct
labour hour
Overhead per hour is $400,000 (Total $700,000 less direct costs
$300,000)/2,500 = $160 per direct labour hour
Cost of client job. Total cost of job is direct labour 30 hours @ $120 = $3,600
plus overhead 30 @ $160 = $4,800, a total cost of $8,400.
1-201
Accuracy checked
E5
Activity
Marketing
Admin support
Cost $
350,000
400,000
Cost driver
500
10,000
Computer
services
250,000
50,000
Cost per cost driver

$700 per client job
$40 per consultant
day
$5 per computer
transaction
A client job requires

Marketing: 1 job @ $700
700
Admin support: 30 consultant days @ $40
1,200
Computer services: 5,000 computer transactions @ $525,000
Total overhead
$26,900
Note: this is the overhead content, it does not include the direct costs, which
have not been given.
E6
Sales
Variable costs 60%
Gross profit
(contribution)
Customer-specific
marketing, selling &
distribution costs
Contribution
Fixed corporate
costs allocated as
10% of sales
Customer
profitability
Customer A
200,000
120,000
80,000
Customer B
300,000
180,000
120,000
Customer C
400,000
240,000
160,000
Total
900,000
540,000
360,000
100,000
80,000
80,000
260,000
-20,000
20,000
40,000
30,000
80,000
40,000
100,000
90,000
-40,000
10,000
40,000
10,000
Note that each of the three customers makes the same 40% contribution
margin as a percentage of sales. Whilst all companies should focus on reducing
their cost of sales generally, this question highlights the customer-specific costs
that impact on customer profitability.
Customer A makes a contribution to customer-specific costs but these

costs are higher than the contribution it generates. This customer
therefore is making a loss for the company. The company should either
(a) increase prices to A, (b) reduce the customer-specific costs, or (c)
discontinue sales to A if neither (a) or (b) is possible. As the contribution
of A is negative, the company will be better off without A as the
remaining contribution from B and C will be $120,000 ($40,000 +
$80,000) less the fixed corporate costs of $90,000, a profit of $30,000
instead of the current $10,000.
Customer C is the most profitable, so the companys strategy should be
to focus on increasing sales to C.
Customer B is making a small contribution and a small profit. However, to
improve its performance, sales levels could be increased, or costs
reduced.
1-202
Accuracy checked
P1
a.
Units sold
Total costs
Variable costs
Fixed costs
Jan
25,00
0
50,00
0
43750
6,250
Feb
Change
35,000
10,000
67,500
61250
6,250
17,500
1.75
b.
Breakeven
c.
Profit
$10,000/mth
P2
(a)
FC $6250
Unit cont $4 - $1.75
FC $6250 + Profit
$10,000
Unit cont $4 - $1.75
Units/mth
Units
p.a.
2778
33333
Units/mth
Units
p.a.
7222
86667
Sales
@ $4
$133,3
33
Sales
@ $4
$346,6
67
Brisbun
Contribution (200,000-100,000) = 100,000/10,000 = $10/unit (50%)
Breakeven 75,000/10 = 7500 units
7500 units @ $20 = $150,000
Adlayde
Contribution (200,000-50,000) = 150,000/10,000 = $15/unit (75%)
Breakeven 125,000/15 = 8333 units
8333 units @ $20 = $166,660
(b)
Adlayde has the highest risk because its fixed costs are higher, hence a higher
breakeven point.
(c)
Adlayde will make more profits because, past the breakeven point, the higher
contribution (75% compared to 50%) means that profits will be earned faster for
the same number of units sold as Brisbun.
e.g. at 12,000 units:
Brisbun: 12,000 @ $10 = $120,000 75,000 = $45,000 profit
Adlayde: 12,000 @ $15 = $180,000 125,000 = $55,000 profit
Note: once past the breakeven point, all contribution is profit and Adelaide
produces $5 more contribution per unit than does Brisbun.
(d)
The relevant range is important because it identifies the upper and lower limits
within which cost behaviour is constant, especially the level of fixed costs. The
comparison in (b) & (c) assumes that the increased number of units can be
produced within each firms relevant range and that both firms relevant range
are the same.
1-203
Accuracy checked
P3
a.
Expense:
Salaries & Wages
consultants
Total $
1,500,000
Direct
1,500,000
Indirect
Salaries & Wages support

staff
350,000
Travel to client offices
175,000
Advertising and promotion
250,000
250,000
Office rental
300,000
300,000
Research costs in relation

to client problems
General administration
200,000
Total expenses
350,000
175,000
200,000
125,000
2,900,000
125,000
1,875,000
1,025,000
Consultants would complete timesheets in relation to each client. They would

also record their travel costs to individual client premises. Research costs would
also be identifiable with specific clients. All other costs are incurred for the
business as a whole and cannot be attributed to specific clients.
b.
(i)
(ii)
(iii)
c.
20 consultants x 230 days = 4600 consultant days less 25% nonchargeable days = 3,450 chargeable consultant days. The cost per
consultant day is $1,500,000/3,450 = $435 per day (rounded to nearest
whole dollar).
Indirect costs or overhead are then allocated on the basis of a percentage
of the direct cost of consultants, i.e. $1,025,000/$1,500,000 = 68.3%
The selling price of consultants per day is $435 plus overheads $297
(68.3% of $435) = $732 plus 25% markup of $183 (25% of $732) = $915
Consultants have worked 60 days @ $915

$54,900
Travel $3000 and Research $15,000
18,000
Total price charged to client
$72,900
The profit for Mega is 60 days @ $183 (the markup on consultant time and
overheads) = $10,980
1-204
Accuracy checked
P4
Faculty
Arts
Business
Education
Languages
Cost pools
Enrolment
Library
I.T.
Subject
administration
Graduation
Faculty
Enrolment
Library
I.T.
Subject
administration
Graduation
No. of students
Cost per student
Students
1,000
2,000
1500
500
Overhea
d$
20
0,000
20
0,000
35
0,000
15
0,000
10
0,000
Book loans
25%
20%
35%
20%
Cost driver
No. of students
No. of book loans
No. hours online
No. of subjects
No. students
graduating
I.T.
35%
40%
15%
10%
Subjects
9
8
6
12
No.
drivers
Cost per
driver
5,000
2
5,000
12
5,000
4
0,000
$40.00
1,250
$80.00
Graduatio
ns
150
650
400
50
$8.00
$2.80
$3.75
Arts
40,000
50,000
122,500
Business
80,000
40,000
140,000
Educatio
n
60,000
70,000
52,500
Languages
20,000
40,000
35,000
Total
200,000
200,000
350,000
33,750
12,000
60,000
52,000
33,750
32,000
22,500
4,000
258,250
1,000
$258.25
372,000
2,000
$186.00
248,250
1500
$165.50
121,500
500
$243.00
150,000
100,000
1,000,00
0
5,000
$200.00
Under ABC, Arts and Languages students incur an overhead cost greater than the
$200 average, whilst Business and Education students have a lower overhead cost
component in their fees. Therefore, these differential costs would be reflected in
student fees.
The reasons for the difference to the average overhead cost per student are that:
Actual costs are traced to students in each faculty using the cost pools and cost
drivers; and there are less students in Arts and Languages, therefore their costs per
student are higher.
1-205
Accuracy checked
7 Chapter 9
8 Accounting beyond the current year
1.
Strategic management accounting links management accounting techniques

with the strategy of an organization. It differs from traditional management
accounting in two important ways. First, it looks beyond the accounting period
to the life cycle of products/services and uses techniques to ascertain
profitability over product/service life cycles. Second, it looks beyond the
boundaries of the organization to the supply chain, incorporating supplier and
customer costs to make judgements about profitability of the total supply chain
and where profits are located. It also looks at competitors and makes
judgements about relative prices, costs, investments etc. in order to improve
competitive performance.
2.
Just-in-Time (JIT) relies on a philosophy of not holding inventories just in case

they are needed, or in anticipation of possible future orders (called a push
approach). Instead JIT purchases inventory when it is needed, i.e. just in time to
satisfy a customer order (a pull approach). JIT enables inventories of finished
goods to be reduced, resulting in lower costs.
3.
Target costing takes place during the pre-production planning phase for a new
product. It ascertains market demand and likely prices, deducts a target profit
and arrives at a target cost. Before going into production, buyers, engineers,
accountants etc. work together to ensure that a product can be produced for
the target cost. Kaizen takes place during the production phase when large
improvements are often not possible. Kaizen focuses on making continuous,
often small, but incremental cost improvements through improved purchasing
and productivity, reduced wastage, etc.
4.
Investment in prevention costs will prevent may problems from recurring, and
will reduce the cost of waste, rework, warranty claims and reputational damage
to a business. Costs incurred in these later processes (inspecting quality,
correcting problems, etc.) usually cost more and are repetitive because the
cause of quality problems has not been identified earlier.
5.
The main purpose of budgeting is to plan for the future. The budget is a oneyear more detailed slice of the business strategy, with detailed financial
projections related to that strategy. It provides the level of expectation for
business performance and is used as the standard against which actual
performance is judged.
The benefits of budgeting
It is an important means by which organisational plans are communicated

throughout the organisation
It provides a common plan through which co-ordination amongst different
business units takes place, especially between purchasing, production
and sales
1-206
Accuracy checked
It is a means by which managers can be motivated and held accountable

for their actual performance
It provides the ability to highlight variations from expectation and take
corrective action where actual performance does not meet the
expectation
1-207
Accuracy checked
6.
A fixed budget covers a fixed period of time, typically a year ahead. Towards the
end of the year anew budget for the following year is prepared. A rolling budget
continually adds additional months to the budget so that at any time during the
year there is always a forecast 12 months ahead. With a fixed budget, half way
through the year there will only be a six-month forecast remaining.
7.
Any attempt at a flowchart should be recognised here. The important steps to

be included are:
8.
Forecasting sales
Forecasting production costs (purchasing and inventory requirements)
Forecasting expenses for all departments
Preparing budgeted financial statements
Seeking Board approval.
Personal budget
Any reasonable attempt is acceptable. Students should be encouraged to use
Excel to do a budget, using appropriate formulae.
Example:
1-208
Accuracy checked
ANSWERS TO QUESTIONS (continued)

9.
Budgets do cause behavioural problems. This is often because a budget is

imposed by top managers and those accountable for performance do not agree
with it, especially if they are rewarded or penalised for performance compared
with budget. Budgets are a source of power in organisations (often held by
accountants) so the ability of accountants to grant or withhold resources
(money, people, etc) can cause friction between people and departments.
When managers do contribute to the budget process, they often build in slack
such as be reducing expectations of sales volume and/or inflating budgeted
costs, so that their actual performance might be seen in a more beneficial light.
Because senior managers know this happens they may set unrealistic targets.
Therefore, there is the opportunity for bias in setting budgets and game
playing that goes on around the setting of budgets. Genuine participation by
managers at all levels in the budget process is considered to be the most
important way in which dysfunctional consequences of budgeting can be
overcome.
10.
11.
The Beyond Budgeting website has a lot of information.

Tutors should use this as an opportunity to explore the criticisms of budgets and
that whilst the BBRT suggest abandoning budgets, they do not suggest
abandoning planning, setting targets and managing by using a sophisticated
business model.
For example
The word budgeting is not used in its narrow sense of planning and control, but
as a generic term for the traditional command and control management model
(with budgeting at its core). In this context it describes both a management
culture and a performance management system. This might become clearer
when you understand how Dr Jan Wallander, architect of the management
model at Swedish bank Handelsbanken, saw the problems of budgeting. The
basic idea in the Handelsbanken model is decentralization, noted Wallander. If
the issues are studied from this viewpoint, the abolition of budgets emerges as
a mere detail, something simple and obvious; one of several aspects of the
basic idea.
Source: http://www.bbrt.org/beyond-budgeting/bbwhat.html downloaded 21st
January 2009
The BBRT has identified a set of twelve principles (see below). The first six
principles are concerned with taking the right leadership actions to address the
drivers of change, and the second six align management processes with
leadership actions. The contrasts in the table (i.e. the dos and donts) show the
differences in practice between the Beyond Budgeting and Command and
Control models.
1-209
Accuracy checked
Leadership actions
1. Customers
Focus everyone on their customers, not on hierarchical relationships
2. Processes
Organize as a lean network of accountable teams, not as centralized

functions
3. Autonomy
Give teams the freedom and capability to act, don't micro-manage

them
4. Responsibility
Create a high responsibility culture at every level, not just at the

centre
5. Transparency
Promote open information for self-management, don't restrict it

hierarchically
6. Governance
Adopt a few clear values, goals and boundaries, not fixed targets
Aligning management processes with leadership actions

1. Goals
Set relative goals for continuous improvement, don't negotiate fixed

contracts
2. Rewards
Reward shared success based on relative performance, not fixed

targets
3. Planning
Make planning an continuous and inclusive process, not a top-down

annual event
4. Controls
Base controls on relative indicators and trends, not variances

against a plan
5. Resources
Make resources available as needed, not through annual budget

allocations
6. Coordination
Coordinate interactions dynamically, not through annual planning

cycles
Source: http://www.bbrt.org/beyond-budgeting/bbprinc.html
January 2009
12.
downloaded
21st
There are no right/wrong answers here, but students should be encouraged to

discuss the behavioural aspects of budgets and target-setting, especially as
they impact on the sales managers performance bonus. The Board will want to
set stretch targets whilst the sales manager may want to introduce some
budget slack.
Last years sales $12 million plus board of directors desired 10% increase =
$13.2 million. The sales manager will prefer a lower target, so that s/he can
maximise performance bonus of 5% on sales above budget, rather than 2% on
sales within the budget.
The sales manager is likely to present a strong case that a 10% increase is
always difficult to achieve, but that intense competition means that increasing
sales from competitors is only likely to be done at the same or even reduced
price levels, which may reduce overall sales revenue. Provided sales revenue
increases sufficiently, any erosion of selling price could be compensated (as
total revenue is sales volume times selling price). The risk is that sales volume
drops (or fails to increase) despite constant or falling prices in order to meet
competition.
1-210
Accuracy checked
The sales manager may look at past budgets and actual sales performance to
determine whether or not past budgets were achieved. Any (strategic
management accounting) information about competitors will also be useful (e.g.
their capacity to increase sales, their actions in the market, their relative prices,
costs and profitability, etc.)
13.
Tutors should encourage students to consider the problem from both sides: the
sales manager (Q11) and the company (Q12). The company will want to
motivate and adequately compensate the sales manager without providing
more compensation than is necessary 9as part of cost control).
The accountant would also likely consider trends in sales over time and
experience as to whether past budget targets have been achieved or not. The
accountant would also look at the sales managers past earnings to estimate
future earnings based on sales targets. The managing director would probably
not like to see the sales managers earnings reduce as this would be
demotivating.
The managing director would be advised that stretch targets are more likely to
motivate the sales manager to take the necessary efforts to increase sales, and
that a performance bonus of 5% above that level will provide further motivation.
14. Budgetary control is about managing actual performance in line with budget
projections. This takes place by top managers monitoring actual performance,
and asking questions about variations to ensure that responsible managers can
provide adequate explanations for those variations. Managers need to
understand the causes of variations from budget and then need to make sure
that corrective action is taken where necessary to achieve the targets. This
process is called feedback.
E1
Sales
+ Closing stock
inventory
- Opening stock
Purchase
@ $15
Units
10,000 (120,000/12) per month
15,000 (10,000 + 5,000) one and a half months closing
25,000 Purchasing requirement
12,000
13,000
$195,000 Budgeted cost of purchases
E2
Hours
Price
Revenue
Direct labour
Gross profit
Rental and
office
expenses
Management
and
marketing
expenses
Qtr 1
5,000
$100
500,000
125,000
375,000
250,000
Qtr 2
5,000
$100
500,000
125,000
375,000
250,000
Qtr 3
5,000
$110
550,000
125,000
425,000
250,000
Qtr 4
3500
$110
385,000
125,000
260,000
250,000
Total
18500
1,935,000
500,000
1,435,000
1,000,000
50,000
50,000
50,000
50,000
200,000
1-211
Accuracy checked
Net profit
75,000
75,000
125,000
-40,000
235,000
E3
Revenue
Qtr 1
500,000
Qtr 2
500,000
Qtr 3
550,000
Qtr 4
385,000
Receipts same qtr

Next qtr
Total receipts
333,334
120,000
453,334
333,334
166,666
500,000
366,667
166,666
533,333
256,667
183,333
440,000
Direct labour
Rental and office
expenses (excl depn)
Management and
marketing expenses
Capital expenditure
Loan repayment
Total payments
125,000
200,000
125,000
200,000
125,000
200,000
125,000
200,000
1,926,6
67
500,000
800,000
50,000
50,000
50,000
50,000
200,000
475,000
375,000
150,000
525,000
375,000
Cash flow
-21,667
125,000
8,333
65,000
100,000
150,000
1,750,0
00
176,667
100,000
Total
1,935,0
00
1-212
Accuracy checked
E4
Operating profit
+ Depreciation
125,000
35,000
160,000
- Working capital increase:

Debtors increase 20,000
Inventory increase 5,000
Creditors increase (8,000)
-17,000
- Capital expenditure
- Income tax
- Loan repayments
Opening bank overdraft
Forecast cash at end of year
-50,000
-35,000
-25,000
33,000
-15,000
18,000
E5 Proudozzie Ltd (Part 2)
b.
North and East divisions are making small profits, West is making a good profit
but South is making a considerable loss. However, each division is making a
controllable profit, i.e. it is generating a profit that contributes towards allocated
corporate expenses. Closure of any one division will cause company profits as a
whole to fall, as the contribution from divisional controllable profit will be lost.
c.
In Chapter 7 (Part 1 of Proudozzie Ltd), we noted that each division except

South was making a profit.
The ROI and RI calculations (from Chapter 7) are shown below:
These figures show that only East and West divisions are contributing an ROI that is
greater than the cost of capital of 12%. South is generating a substantial negative
residual income which is eroding shareholder value for the company as a whole.
However, as we saw (b above), each division (including South) is making a positive
contribution to allocated corporate expenses.
1-213
Accuracy checked
The key issue for the company is improving the performance of South, whose
controllable profit is the lowest of all divisions. This appears to be mainly due to the
very high level of divisional expenses (about 45% of sales revenue). There may be
lessons to be learned from the performance of West which is by far the best
performing division. There is a clear need for South to increase sales and/or reduce
divisional expenses.
In addition however, there is a very high level of corporate overhead which is eroding
the profits of all the divisions except West. The company needs to review and if
possible reduce its corporate expenses.
1-214
Accuracy checked
1-215
Accuracy checked
1-216
Accuracy checked
9 Chapter 10
10 Introduction to Finance
1.
Finance is the science or study of the management of money.
2.
Finance is concerned with human behaviour, which is a defining feature of all social
sciences.
3.
Finance is concerned with human behaviour. Human behaviour is uncertain; hence,

uncertainty exists in finance. Finance is also concerned with the future. As the future cannot
be predicted, uncertainty exists in finance.
4.
Finance is a social science that deals with human behaviour and is concerned with the
future. As human behaviour and the future cannot be predicted, uncertainty exists in
finance. As uncertainty exists in finance, there are no immutable laws in finance.
5.
As uncertainty exists in finance, the future cannot be predicted perfectly. As such, any
model developed to predict the future will never be 100% accurate.
6.
No. There is a chance that your friend will not receive the $1500 promised from the person
claiming to be in the Nigerian government.
7.
No. There is a chance that the National Australia Bank will go bankrupt and will not be able
to pay the $1065 it owes your friend in one years time.
8.
Finance is a social science not a physical science. A social science is concerned with
human behaviour and finance is concerned with the future. Therefore, as human behaviour
and the future can never be predicted with certainty, there is always uncertainty in finance.
As there is always uncertainty in finance, no model will be right 100% of the time. Further,
there will never be a finance model developed (now or in the future) that can predict the
future with 100% accuracy, as uncertainty is always present in finance.
9.
A social science is concerned with human behaviour whereas a regular science is not.
10.
Technically this statement is correct. The reason is that no model will be right 100% of the
time, therefore all models are technically false.
11.
No. Although no model in finance will be right 100% of the time, a good model will still be of
some value in understanding the financial markets.
1-217
Accuracy checked
12.
Economics is concerned with the allocation of scarce resources; finance is concerned with
the allocation of scarce resources over time. Another way to distinguish finance and
economics is that economics focuses on exchanges in which money is one of the items
traded. Conversely, in finance, money appears on both sides of the trade.
13.
Economics is concerned with the allocation of scarce resources whereas finance is

concerned with the allocation of scarce resources over time.
14.
The decision to manufacture cars or boats has both an economic and a financial element. A
company must decide whether it has the resources to manufacture cars or boats this is
the economic element of the decision. Then, the company must weigh up the future
benefits of manufacturing cars or boats this is the financial element of the decision. Note
that in weighing up the future benefits, the company is considering the allocation of scarce
resources over time, hence it is a financial decision.
15.
With economics, money appears on one side of the trade whereas with finance, money
appears on both sides of the trade.
16.
Buying a car from a dealer is an economic transaction as money appears on one side of
the trade. You give the dealer money and the dealer gives you a car. A loan from a bank to
fund the purchase of a car is a financial transaction. The bank gives you money now and
you repay the bank money in the future, hence, money appears on both sides of the trade.
17.
(a)
(b)
(c)
(d)
(e)
Economic transaction
Economic and finance transaction
Finance transaction
Economic transaction
Finance transaction
18.
(a)
Money only appears on one side of the trade, which is the money used to buy the
boat.
There are effectively two transactions here. The first is an economic transaction
where a boat is purchased for a sum of money. The second is a finance transaction
where the sum of money for which the boat is purchased is loaned for a year.
Money appears on both sides of the trade. Money is borrowed now and will be
repaid in the future.
Money only appears on one side of the trade. The other side of the trade are the
shares in CSL.
Money appears on both sides of the trade. Money is borrowed now and will be
repaid in the future.
(b)
(c)
(d)
(e)
19.
There are effectively two transactions here. The first is an economic transaction where a
boat is purchased for a sum of money. The second is a finance transaction where the sum
of money for which the boat is purchased is loaned for a year.
1-218
Accuracy checked
20.
The company has to decide whether it has the resources now to manufacture televisions or
computers this is the economic component of the decision. In addition, the company has
to weigh up the anticipated benefits of manufacturing televisions or computers this is the
financial component of the decision. The anticipated benefits will occur in the future so the
company is deciding on the allocation of scarce resources over time, hence, this is the
financial component of the decision.
21.
Time, uncertainty, options and information.
22.
Time is present because an amount has been borrowed now that must be repaid in the
future. Uncertainty exists because the bank cannot know whether the borrower will default
on the loan payments. The loan contract will allow the bank to the change the terms of the
loan and hence the bank has options. In addition, most loans allow the borrower some
flexibility in how they repay the loan and hence the borrower has options. The bank will
seek out information on the borrower to attempt to minimise the chance that their borrowers
will default.
23.
Yes. This transaction contains three of the elements of a financial transaction: time,
uncertainty and information. Time is relevant, as money now is traded for money in the
future. Uncertainty is present, as the borrower could default. Information is present, as the
bank will do a credit check on the borrower. The fourth element of a financial transaction,
options, is not present, as neither party to the loan can change the loan agreement.
However, it is still a financial transaction, as only one element of the four needs to be
present for it to be a financial transaction.
24.
If shares are bought in a company that is expected to pay dividends in the future, then an
investment in shares can be considered a financial transaction. The reason is that money is
traded now (to buy the shares) for money in the future (the dividends received in the future).
25.
An investment in shares can be considered an economic transaction, as an investment in

shares represents an ownership interest in a company. Companies are typically comprised
of real assets such as buildings and machinery, so money is traded for an ownership
interest in the real assets of the company.
26.
Time is relevant, as money now, which is paid to buy the shares, is traded for money in the
future (the dividends that Westpac will pay). Uncertainty is present, as the investor can
never know for sure what the future share price will be. Options are present, as the investor
has the right to sell their shares whenever they want in the future. Information is present, as
an astute investor will do some research on Westpac first before buying the shares.
27.
The purpose of accounting is to provide information that can be used to make financial
decisions.
28.
An investor may analyse the profits that the company has reported over time to help them
decide whether to buys shares in a company or not.
29.
A bank may analyse the companys financial statements to help it decide whether to lend
the company money or not. For example, the bank may perform an accounting ratio
analysis using the companys financial statements. Alternately, the bank may analyse the
companys cash budget to get a feel for the cash flows of the company.
1-219
Accuracy checked
30.
Accounting, particularly financial accounting, can be considered backward looking, as the

financial statements are produced using historical information. Finance is invariably forward
looking, as it typically involves analysing cash flows that are expected to occur in the future.
31.
The benefit of focusing on cash flows is that cash flows involve a real transfer of money.
Therefore, by analysing cash flows, one can get a sense of the cash coming in and out of
an entity. Thus, cash flows give a better indication of the day-to-day solvency of an entity.
32.
The benefit of focusing on profit is that it gives a more broad view of the profitability of the
company, as profit figures generally smooth out the temporal fluctuations in cash flows.
Thus, profit is a better measure of the long-term solvency of an entity.
33.
The global financial crisis originated in the financial markets. However, the crisis also
affected the economies of the world. Thus, the spread of the crisis from the financial
markets to the real economy is an example of the link between finance and economics.
34.
Some commentators have argued that had the risk of CDOs been faithfully represented by
accountants, then many investors would have avoided this financial product and the severity
of the crisis could have been reduced.
Commentators have also argued that fair value accounting rules could have also
contributed to the severity of the crisis. During times of panic and stress in the financial
markets, many financial assets are valued well below their intrinsic value. Forcing
companies to report the market or fair value of their assets gave the impression that
companies were in a much worse financial position than they actually were and this affected
the severity of the crisis.
35.
Investments and corporate finance.
36.
Investments subjects look at finance from the individual investors point of view whereas
corporate finance subjects look at finance from the corporations point of view.
37.
The function of a bank is to intermediate (or channel) funds from suppliers of funds to users
of funds.
38.
The major function of financial markets is to channel funds from suppliers to users.
39.
As the company wishes to raise long-term funding, that is with a maturity of a year or
greater, the company should use the capital market to raise the funds.
40.
International finance focuses on international aspects of finance whereas domestic finance

does not.
41.
A derivative asset is a financial asset whose value is derived from the value of an
underlying real asset.
42.
Assume you hold a one years future contract on wheat, that is you have entered a contract
that allows you to buy wheat in one years time for a price set today. If the value of wheat
increases, then the value of your contract will increase because you have already set the
price at which you can buy wheat in a years time.
1-220
Accuracy checked
43.
Studying finance will be useful to any career in business because almost all business
related careers will have some financial aspect associated with them. Additionally, any
business related career will most likely involve communicating with finance specialists.
44.
Financial services and managerial finance. Financial services is concerned with the design
and delivery of advice and financial products to various groups. Managerial finance is
concerned with the financial management duties within a firm whose core business is not
finance.
1-221
Accuracy checked
11 Chapter 11
12 Financial Mathematics
1.
Money has time value because any money received now (or in the past) can be invested to
earn interest.
2.
$100 today is worth more than $100 in 3 months time. The reason is that money has time
value. Specifically, the $100 today could have been invested in a bank for 3 months and due
to the interest earned, would be worth more than $100 in 3 months time.
3.
1) A dollar is worth more (less) the sooner (later) it is received. 2) You cannot add amounts
received at different points in time, you can only add amounts received at the same point in
time.
4.
No. Amounts can only be added at the same point in time not at different points in time.
5.
Debt is a financial contract in which one party to the transaction (the borrower) makes a
specific promise to the other party to the transaction (the lender) about the payment of future
cash flows. The distinguishing feature of debt as opposed to other financial contracts is that
a specific promise is made about the payment of future cash flows.
6.
No. You can only use the term interest rate when referring to a return on a debt contract. An
investment in shares is not a debt contract
7.
No. The defining feature of a debt contract is a promise of future cash flows between two
parties. There is no promise of future cash flows with a share investment and hence, a share
investment is not a debt contract.
8.
A present value refers to an amount at a previous point in time and not necessarily at t = 0.
9.
$1000
0
10.
$1600
3
$1900
5
Years
When we move an amount forward in time, the value of the amount increases. Thus, when
we move an amount forward in time, the amount grows or compounds. Further, if
compound interest is applied, the value of the amount compounds over time because
interest is earned upon interest. This is where the term compounding originates.
1-222
Accuracy checked
11.
When we move an amount backward in time, the value of the amount decreases. Thus,
when we move an amount backward in time, the amount is discounted due to the operation
of interest. This is where the term discounting originates.
1-223
Accuracy checked
12.
FV = PV(1 + i)
FV = 7500(1 + 0.065)
FV = 7500(1.065)
FV = $7987.50
13.
Interest = 7987.5 7500 = $487.50
14.
(a)
FV = PV(1 + i)
540 = PV(1.08)
PV = 540/1.08
PV = 500
Therefore, principal = $500
(b)
Interest = 540 500 = $40
15.
FV = PV(1 + i)
PV + interest = PV(1 + i)
PV + 270 = PV(1.09)
270 = 0.09PV
PV = 270/0.09
PV = $3000
16.
FV = PV(1 + i)
PV + interest = PV(1 + i)
PV + 400 = PV(1.08)
400 = 0.08PV
PV = 400/0.08
PV = 5000
FV = 5000 + 400
FV = $5400
17.
FV = PV(1 + it)
FV = 15000(1 + 0.055x4)
FV = 15000(1.22)
FV = $18300
18.
FV = PV(1 + i)t
FV = 15000(1.055)4
FV = $18582.37
19.
The future value when interest is compounded once per year is greater than when interest
is compounded once for the entire 4-year investment (i.e. simple interest). This is because
with compound interest, interest is earned upon interest. Whereas, with simple interest,
interest is only earned on the initial investment.
20.
(a)
FV = PV(1 + it)
FV = 1000(1 + 0.08x3)
FV = 1000(1.24)
FV = $1240
1-224
Accuracy checked
(b)
FV = PV(1 + i)t
FV = 1000(1.08)3
FV = $1259.71
1-225
Accuracy checked
21.
(c)
FV = PV(1 + it)
FV = 180000(1 + 0.045x15)
FV = 180000(1.675)
FV = $301500
(d)
FV = PV(1 + i)t
FV = 180000(1.045)15
FV = $348350.84
(a)
FV = PV(1 + i)t
FV = 2000(1.11)4
FV = $3036.14
(b)
Opening balance
Interest in first year
2000
2000 x 0.11
= $220
(c)
Balance at the end of the first year

Interest in second year
2000 + 220
2220 x 0.11
= $2220
= $244.2
(d)
Balance at the end of the second year 2220 + 244.2

Interest in third year
2464.2 x 0.11
= $2464.2
= $271.062
(e)
Balance at the end of the third year

Interest in fourth year
= $2735.262
= $300.87882 = $300.88
2464.2 + 271.062
2735.262 x 0.11
To check that your answer is correct, calculate the balance at the end of the fourth year and
compare to your answer in (a).
Balance at the end of the fourth year
2735.262 + 300.88 = $3036.14
22.
23.
The interest component is increasing over time, from $220 in year 1 to $300.88 in year 4.
The reason the interest component is increasing over time is that the interest is being
compounded each year. Each year interest is earned upon interest so over time, the interest
amount increases.
(a)
(b)
(c)
FV = PV(1 + it)
FV = 2000(1 + 0.11x4)
FV = $2880
interest = 2000 x 0.11 = $220
interest = 2000 x 0.11 = $220
24.
FV = 1500(1.07)(1.08)
FV = $1733.4
25.
FV = 18000(1.05)(1.055)(1.06)(1.065)
FV = $22509.70
26.
FV = 13000(1.07)3(1.06)
FV = $16881.09
1-226
Accuracy checked
27.
28.
(a)
(b)
(c)
FV = 35000(1.08)(1.07)(1.06)
FV = $42872.76
interest = 35000 x 0.08 = $2800
interest = (35000 + 2800) x 0.07 = $2646
(d)
interest = (35000 + 2800 + 2646) x 0.06 = $2426.76
interest1 = 5000 x 0.1 = $500

interest reinvested1 = 500/2 = 250
interest2 = 5250 x 0.1 = $525
interest reinvested2 = 525/2 = 262.5
interest3 = (5250 + 262.5) x 0.1 = $551.25
interest reinvested3 = 551.25/2 = 275.625
FV4 = (5250 + 262.5 + 275.625) x 1.1 = $6366.94
29.
The distinguishing feature of simple interest is that interest is computed on the initial sum
invested for the entire period of the investment.
30.
The distinguishing feature of compound interest is that interest is computed each period on
the principal amount and on the interest earned up to that point.
31.
The distinguishing feature of compound interest is that interest is computed each period on
the principal amount and on the interest earned up to that point, that is, interest is earned
upon interest. The consequence of this is that the value of the investment compounds over
time, that is, the rate of growth of an investment increases over time. The benefit of
compounding is that the rate of growth in the investment increases over time resulting in a
much larger future value than if simple interest is applied.
32.
The special case where the time value of money is constant is when interest rates are zero.
33.
This statement is almost always true. In a developed economy, someone somewhere in the
economy will offer you a positive interest rate on an investment, so money will always have
a positive time value. However, during times of financial turmoil, there may be certain
financial instruments that have a negative interest rate. This occurred recently during the
global financial crisis where certain US Treasury Notes had negative interest rates.
However, this was a very rare event. In almost all cases, interest rates will be positive and
therefore, money will have a positive time value.
34.
With the time value of money, $100 received today is worth more than $100 received in the
future because $100 received today can be invested and interest can be earned. With
inflation (and assuming inflation is positive), $100 received today is worth more than $100
received in the future because it can buy more today.
35.
The nominal interest rate is the interest rate before considering inflation. The real interest
rate is the interest rate after considering inflation.
1-227
Accuracy checked
36.
No. The real interest rate can be negative and it is not unusual for it to be so. The real
interest rate is negative when inflation is greater than the nominal interest rate. A negative
real interest rate is much more likely to occur than a negative nominal interest rate.
37.
FV = PV(1 + i)t
10000 = 5000(1.075)t
10000/5000 = (1.075)t
2 = (1.075)t
ln(2) = ln(1.075)t
ln(2) = t x ln(1.075)
t = ln(2)/ln(1.075)
t = 9.58 years
1-228
Accuracy checked
38.
FV = PV(1 + it)
10000 = 5000(1 + 0.075t)
10000/5000 = 1 + 0.075t
2 = 1 + 0.075t
1 = 0.075t
t = 13.33 years
39.
It takes longer for the $5000 to grow to $10000 with simple interest than compound interest
because with simple interest, interest is computed on the initial sum invested. In contrast,
with compound interest, interest is computed each period on the principal invested and on
the interest earned to that point. Therefore, with compound interest the growth in the
investment is faster than with simple interest.
40.
(a) FV = PV(1 + it)

20000 = 13000(1 + 0.06t)
20000/13000 = 1 + 0.06t
20000/13000 1 = 0.06t
t = (20000/13000 1)/0.06
t = 8.97 years
(b) FV = PV(1 + i)t
20000 = 13000(1.06)t
20000/13000 = (1.06)t
ln(20000/13000) = ln(1.06)t
ln(20000/13000) = t x ln(1.06)
t = ln(20000/13000)/ln(1.06)
t = 7.39 years
It takes longer for the $13000 to grow to $20000 when interest is compounded once for the
life of the investment (i.e. simple interest) than when interest is compounded once per year
(i.e. compound interest). This is because with simple interest, interest is computed once for
the entire investment based on the initial principal whereas with compound interest, interest
is computed each period on the principal invested and on the interest earned to that point.
Therefore, with compound interest, the growth in the investment is faster than with simple
interest.
41.
(a) FV = PV(1 + it)

7500 = 2500(1 + 5i)
7500/2500 = 1 + 5i
3 = 1 + 5i
2 = 5i
i = 0.4
i = 40% per annum (p.a.)
1-229
Accuracy checked
(b) FV = PV(1 + i)t

7500 = 2500(1 + i)5
7500/2500 = (1 + i)5
3 = (1 + i)5
31/5 = 1 + i
i = 31/5 1
i = 0.2457
i = 24.57% p.a.
(c)
42.
With simple interest, the implicit interest rate of the investment (40% p.a.) is higher than
the implicit interest rate of the investment if compound interest is applied (25% p.a.).
The reason for this is that with compound interest, interest is earned on the initial sum
invested and on the interest earned to that point whereas with simple interest, interest
is only earned on the initial sum invested. Thus, the implicit interest rate with compound
interest is lower than with simple interest because due to the benefits of compounding,
a lower compound interest rate is required for the investment to grow to the same
amount as when simple interest is applied.
(a) FV = PV(1 + it)

60000 = 50000(1 + 3i)
60000/50000 = 1 + 3i
1.2 = 1 + 3i
0.2 = 3i
i = 0.0667
i = 6.67% p.a.
(b) FV = PV(1 + i)t
60000 = 50000(1 + i)3
60000/50000 = (1 + i)3
1.2 = (1 + i)3
(1.2)1/3 = 1 + i
i = (1.2)1/3 1
i = 0.0627
i = 6.27% p.a.
43.
PV = FV/(1 + i)
PV = 1000000/(1.08)
PV = $925925.93
44.
PV = FV/(1 + i)t
PV = 40000/(1.07)8
PV = $23280.36
1-230
Accuracy checked
45.
PV = FV/(1 + it)
PV = 40000/(1 + 0.07x8)
PV = 40000/(1.56)
PV = $25641.03
46.
The present value is lower when compound interest is applied than when simple interest is
applied. The reason for this is that with compound interest, interest is earned on the initial
sum invested and on the interest earned to that point whereas with simple interest, interest is
only earned on the initial sum invested. The consequence of this is that the degree of
discounting is greater with compound interest than with simple interest; therefore, the present
value with compound interest is lower than with simple interest.
47.
(a) PV = FV/(1 + it)

PV = 5000/(1 + 0.065x5)
PV = 5000/(1.325)
PV = $3773.58
(b) PV = FV/(1 + i)t
PV = 5000/(1.065)5
PV = $3649.40
1-231
Accuracy checked
(c)
PV = FV/(1 + it)
PV = 75000/(1 + 0.085x12)
PV = 75000/(2.02)
PV = $37128.71
(d) PV = FV/(1 + i)t

PV = 75000/(1.085)12
PV = $28177.63
48.
PV = 50000/(1.05)(1.055)(1.06)(1.065)
PV = $39982.76
49.
PV = 20000/(1.07)3(1.06)
PV = $15401.85
50.
(a)
51.
PV = 5000/(1.065)3
PV = $4139.25
(b)
FV = 5000(1.065)3
FV = $6039.75
(c)
The PV is lower than the FV. With a PV, you are discounting the amount and thus,
you will have a lower amount in the past. With a FV you are compounding (or
growing) the amount and thus, you will have a larger amount in the future.
(a)
You cannot compare a simple interest rate with an interest rate compounded
annually. You can only compare interest rates of the same compounding frequency.
(b)
FV = 1(1 + 0.14x7) = $1.98

FV = 1(1.1)7 = $1.95
You should invest at 14% p.a. simple for 7 years because $1 invested at 14% p.a. simple
grows to more than $1 invested at 10% p.a. compound over 7 years.
52.
6% p.a. x 5 years = 30% per 5 years
53.
8% p.a. compounded monthly. If the interest rate is the same, you should invest at the
interest rate that is compounded more frequently, as it will result in a larger FV because you
will receive more interest upon interest.
54.
(a)
7% p.a. compounded quarterly is the superior rate.
(b)
FV = 700(1.07)2
FV = $801.43
FV = 700(1 + 0.07/4)4x2
FV = 700(1.0175)8
FV = $804.22
interest difference = 804.22 801.43 = $2.79
1-232
Accuracy checked
55.
(a)
FV = 10000(1.04)100
FV = $505049.48
(b)
FV = 10000(1 + 0.04/365)365x100
FV = $545861.86
56.
FV = PV(1 + j/m)mt
FV = 50000(1 + 0.09/(1/5))1/5(5)
FV = $72500
57.
FV = PV(1 + it)
FV = 50000(1 + 0.09x5)
FV = $72500
58.
Because if interest is compounded once during the investment, then it is a simple interest
investment. 9% p.a. for 5 years compounded once every 5 years means that interest is only
compounded once for the entire investment, which by definition is a simple interest
investment.
59.
FV = 250000(1.09)(1 + 0.09/4)4(1 + 0.09/12)12

FV = $325807.02
60.
PV = 80000/(1 + 0.08/12)12x14
PV = $26199.58
61.
PV = 80000/(1 + 0.08/2)2x14
PV = $26678.20
62.
The PV is higher when interest is compounded semi-annually as opposed to monthly. This is

because when interest is compounded semi-annually, less interest upon interest is earned so
the discounting is not as great.
63.
FV = PV(1 + j/m)mt
5000 = 4000(1 + 0.075/2)2t
5000/4000 = (1 + 0.075/2)2t
1.25 = (1.0375)2t
ln(1.25) = ln(1.0375)2t
ln(1.25) = 2t x ln(1.0375)
2t = ln(1.25)/ln(1.0375)
t = 3.03 years
64.
FV = PV(1 + j/m)mt
5000 = 4000(1 + 0.075/12)12t
5000/4000 = (1 + 0.075/12)12t
1.25 = (1 + 0.075/12)12t
ln(1.25) = ln(1 + 0.075/12)12t
ln(1.25) = 12t x ln(1 + 0.075/12)
12t = ln(1.25)/ln(1 + 0.075/12)
t = 2.98 years
65.
It takes less time to grow with monthly compounding than with semi-annual compounding
because more interest upon interest is earned with monthly compounding, resulting in faster
growth to the same future value.
66.
(a)
FV = PV(1 + j/m)mt
1-233
Accuracy checked
8500 = 6000(1 + j/4)4x4

8500/6000 = (1 + j/4)16
(8500/6000)1/16 = 1 + j/4
j/4 = (8500/6000)1/16 1
j = 8.80% p.a.
(b)
FV = PV(1 + j/m)mt
8500 = 6000(1 + j/365)365x4
8500/6000 = (1 + j/365)365x4
(8500/6000)1/365x4 = 1 + j/365
j/365 = (8500/6000)1/365x4 1
j = 8.71% p.a.
(c)
The interest rate required to reach the same future value is lower with daily
compounding as opposed to quarterly compounding, as more interest upon interest is earned
with daily compounding meaning that a lower interest rate is required to reach the same
future value.
67.
(a)
FV = PV(1 + it)
10000 = 7000(1 + 0.08t)
10000/7000 1 = 0.08t
t = 5.36 years
(b)
FV = PV(1 + i)t
10000 = 7000(1.08)t
10000/7000 = (1.08)t
ln(10000/7000) = ln(1.08)t
ln(10000/7000) = t x ln(1.08)
t = ln(10000/7000)/ln(1.08)
t = 4.63 years
(c)
FV = PV(1 + j/m)mt
10000 = 7000(1 + 0.08/365)365t
10000/7000 = (1 + 0.08/365)365t
ln(10000/7000) = ln(1 + 0.08/365)365t
ln(10000/7000) = 365t x ln(1 + 0.08/365)
365t = ln(10000/7000)/ln(1 + 0.08/365)
t = 4.46 years
(d)
It takes less time to grow with daily compounding than with yearly compounding,
and in turn, it takes less time to grow with yearly compounding than with compounding once
for the entire investment. The reason is that more interest is earned upon interest the more
frequently that interest is compounding, resulting in faster growth to the same future value.
68.
(a)
FV = PV(1 + it)
20000 = 16000(1 + 5i)
20000/16000 1 = 5i
i = 5% p.a.
(b)
FV = PV(1 + j/m)mt
20000 = 16000(1 + j/(1/2.5))1/2.5(5)
20000/16000 = (1 + 2.5j)2
(1.25)1/2 1 = 2.5j
j = 4.72% p.a.
1-234
Accuracy checked
(c)
FV = PV(1 + j/m)mt
20000 = 16000(1 + j/4)4x5
20000/16000 = (1 + j/4)20
(1.25)1/20 = 1 + j/4
j/4 = (1.25)1/20 1
j = 4.49% p.a.
(d)
The interest rate required to reach the same future value is lower with quarterly
compounding as opposed to interest compounded twice for the investment and in turn, the
interest rate required to reach the same future value is lower with compounding twice for the
investment as opposed to simple interest. The reason is the more frequently interest is
compounded, the lower the interest rate required to reach the same future value, as the
more frequently interest is compounded, the more interest upon interest is earned.
69.
(a)
i = (1 + j/m)m 1
i8 = (1 + 0.08/(1/2))1/2 1 = 7.70% p.a.
i7.9 = (1 + 0.079)1 1 = 7.90% p.a.
i7.8 = (1 + 0.078/2)2 1 = 7.95% p.a.
i7.7 = (1 + 0.077/365)365 1 = 8.00% p.a.
Choose 7.7% p.a. compounded daily
(b)
7.7.% p.a. compounded daily is the best rate because it has the highest effective annual
interest rate.
70.
(a)
(b)
i = 8% p.a.
(c)
i = (1 + 0.08/4)4 1 = 8.24% p.a.
(d)
71.
72.
i = (1 + j/m)m 1
i = (1 + 0.08/(1/5))1/5 1 = 6.96% p.a.
i = (1 + 0.08/100000)100000 1 = 8.33% p.a.
Continuously compounded interest. The more frequently that interest is compounded, the
more interest upon interest that is earned and the greater the future value. Therefore, holding
all else constant, continuously compounded interest is preferred, as it is the most frequently
that interest can be compounded.
Compound interest is when interest is compounded more than once during the period of the
investment. Continuously compounded interest is when interest is compounded so frequently
that the time period between two compounding periods approaches zero.
73.
Simple interest is when interest is compounded once for the entire investment. Continuously
compounded interest is when interest is compounded so frequently that the time period
between two compounding periods approaches zero.
74.
Yes. You cannot compound interest more frequently than when it is continuously
compounded. So continuous compounding represents the limit to the benefits of
compounding. Additionally, there is virtually no difference in the effective interest rate earned
if interest is compounded one-million times a year or continuously. Therefore, in practice the
limit to the benefits of compounding is effectively reached before one compounds
continuously.
1-235
Accuracy checked
75.
FV = PVejt
FV = 180e0.045x7
FV = $246.65
76.
PV = FVe-jt
FV = 45000e-0.065x9
FV = $25069.76
77.
FV = PVejt
5000 = 4000e0.075t
5000/4000 = e0.075t
1.25 = e0.075t
ln(1.25) = 0.075t
t = 2.98 years
78.
79.
80.
81.
It takes less time to grow with continuous compounding than with semi-annual compounding
because more interest upon interest is earned with continuous compounding, resulting in
faster growth to the same future value.
FV = PVejt
8500 = 6000e4j
8500/6000 = e4j
ln(8500/6000) = 4j
j = 8.71% p.a.
The interest rate required to reach the same future value is lower with continuous
compounding as opposed to quarterly compounding, as more interest upon interest is earned
with continuous compounding meaning that a lower interest rate is required to reach the
same future value. Reported to two decimal places, the interest rate with continuous and
daily compounding is the same. This is an example of the limit to the benefits of
compounding when the frequency of compounding becomes large, in this case daily. With
continuous compounding the rate is 8.707667% p.a. compared with 8.708706% p.a. with
daily compounding. We see that the continuously compounded rate is lower, as expected, but
not by much.
i = ej 1
i1 = e0.01 1 = 1.005% p.a.
i5 = e0.05 1 = 5.127% p.a.
i10 = e0.1 1 = 10.517% p.a.
i20 = e0.20 1 = 22.140% p.a.
82.
83.
As the rate becomes larger, the difference between the effective annual rate and the
continuously compounded rate becomes larger. The reason is that the higher the interest
rate, the greater the benefit from compounding continuously, as more interest upon interest is
earned and thus, the greater the difference between the effective annual rate and the
continuously compounded rate.
i = ej 1
i + 1 = ej
j = ln(1 + i)
j1 = ln(1 + 0.01) = ln(1.01) = 0.995% p.a.
j5 = ln(1 + 0.05) = ln(1.05) = 4.879% p.a.
j10 = ln(1 + 0.1) = ln(1.1) = 9.531% p.a.
1-236
Accuracy checked
j20 = ln(1 + 0.2) = ln(1.2) = 18.232% p.a.

84.
As the rate becomes larger, the difference between the effective annual rate and the
continuously compounded rate becomes larger. The reason is that the higher the interest
rate, the greater the benefit from compounding continuously, as more interest upon interest is
earned and thus, the greater the difference between the effective annual rate and the
continuously compounded rate.
1-237
Accuracy checked
85.
Method 1:
$50000
$55000
year
FV = PV(1 + i)
FV = 50000(1.07)
FV = $53500
Therefore, you should choose the $55000 in 1 years time as it is worth more than $50000
today, as $50000 compounds to $53500 in 1 years time if interest rates are 7% p.a.
Method 2:
$50000
$55000
year
PV = FV/(1 + i)
PV = 55000/(1.07)
PV = $51401.87
Therefore, you should choose the $55000 in 1 years time as it is worth more than $50000
today, as $55000 discounts to $51401.87 1 year ago if interest rates are 7% p.a.
As we have reached the same conclusion using both methods, we can be confident that our
conclusion is correct.
86.
FV = PV(1 + i)t
FV = 3000(1.08)2
FV = $3499.2
1-238
Accuracy checked
Thus, you should choose $5000 in 4 years time as it is worth more than $3000 in 2 years
time.
87.
$3000
0
$5000
3
years
88.
$500
$600
$700
$800
$900
years
FV0 = 500(1.05)5 = $638.14

FV1 = 600(1.05)4 = $729.30
FV2 = 700(1.05)3 = $810.34
FV3 = 800(1.05)2 = $882
FV4 = 900(1.05)1 = $945
Total future value (t = 5) = 638.14 + 729.30 + 810.34 + 882 + 945 = $4004.78
89.
$500
$600
$700
$800
$900
years
FV0 = 500(1.05)4 = $607.75

1-239
Accuracy checked
FV1 = 600(1.05)3 = $694.58

FV2 = 700(1.05)2 = $771.75
FV3 = 800(1.05)1 = $840
FV4 = 900(1.05)0 = $900
Total future value (t = 4) = 607.75 + 694.58 + 771.75 + 840 + 900 = $3814.08
90.
The cash flows received and the timing of the cash flows in questions 88 and 89 are
identical. The only difference is that is question 88, the future value of the cash flows is
calculated in year 5 whereas in question 89, the future value is calculated in year 4. The
future value of the cash flows in year 5 is greater than in year 4 because the cash flows have
been compounded for an extra year. That is, interest has been earned on the cash flows for
an extra year.
1-240
Accuracy checked
91.
$10 000
0
$13 000
10 years
FV3 = 10000(1.08)7 = $17138.24

FV7 = 13000(1.08)3 = $16376.26
Total future value (t = 10) = 17138.24 + 16376.26 = $33514.45
92.
$10 000
$13 000
years
PV3 = 10000/(1.08)3 = $7938.32

PV7 = 13000/(1.08)7 = $7585.38
Total present value (t = 0) = 7938.32 + 7585.38 = $15523.70
93.
The future value (at t = 10) is greater than the present value (at t = 0) for cash flows that are
of the same amount and that occur at the same point in time. This is because the future
value is always greater than the present value for cash flows that are of the same amount
and that occur at the same point in time due to the time value of money.
94.
$2000
$3500
1-241 4
years
Accuracy checked
PV = 2000/(1.055)2 + 3500/(1.055)4
PV = 1796.90 + 2825.26
PV = $4622.16
95.
$2200
0
years
(a)
$2300
$2900
PV1 = FV/(1 + i) = 2300/(1.055) = $2180.09

PV5 = FV/(1 + i)t = 2900/(1.055)5 = $2218.89
The optimum time to pay for the TV is after one year, because it has the lowest PV at t
= 0.
(b)
PV1 = FV/(1 + i) = 2300/(1.06) = $2169.81

PV5 = FV/(1 + i)t = 2900/(1.06)5 = $2167.05
The optimum time to pay for the TV is after five years, because it has the lowest PV at t
= 0.
(c)
The optimum time to pay for the TV changed from one year to five years as interest
rates increased from 5.5% p.a. to 6% p.a. As interest rates increase, the PV of a future cash
flow becomes lower. This is because the higher the interest rate the greater the discounting
and, all else constant, the lower the PV.
96.
$30000
$30500
0.5
$31000
1-242
year
Accuracy checked
PV0.5 = FV/(1 + i)t = 30500/(1.04)0.5 = $29907.71

PV1 = FV/(1 + i) = 31000/(1.04) = $29807.69
(a)
The optimum time to pay back your bookmaker is after one year, because it has the
lowest PV at t = 0.
PV0.5 = FV/(1 + i)t = 30500/(1.05)0.5 = $29764.95
PV1 = FV/(1 + i) = 31000/(1.05) = $29523.81
(b)
The optimum time to pay back your bookmaker is after one year, because it has the
lowest PV at t = 0.
97.
$50000
0
$55000
$60000
years
FV1 = 50000(1.085)(1.09) = $59132.50

FV2 = 55000(1.09) = $59950
Thus, the optimum time to receive the cash is in 3 years time, because it has the highest FV
at t = 3.
98.
-$1 000 000
$400 000
$350 000
$300 000
$250 000
years
1-243
Accuracy checked
NPV = -1000000 + 400000/(1.1) + 350000/(1.1)2 + 300000/(1.1)3 + 250000/(1.1)4

NPV = -1000000 + 363636.36 + 289256.20 + 225394.44 + 170753.36
NPV = $49040.36
The project should go ahead because the Net Present Value (NPV) of the project is positive.
That is, the present value of the cash inflows from the project is greater than initial outlay on
the project.
1-244
Accuracy checked
99.
-$10m
0
$3m
$3m
$3m
$2m
$2m
$2m
years
NPV = -10m + 3m/(1.12) + 3m/(1.12)2 + 3m/(1.12)3 + 2m/(1.12)4 + 2m/(1.12)5 + 2m/(1.12)6

NPV = -10000000 + 2678571.43 + 2391581.63 + 2135340.74 + 1271036.16 + 1134853.71 +
1013262.24
NPV = $624645.91
The company should build the new plant because the Net Present Value (NPV) of the project
is positive. That is, the present value of the cash inflows from the project is greater than initial
outlay on the project.
1-245
Accuracy checked
13 Chapter 12
14 Investments
1.
The commitment of funds to an asset that will be held for a period of time.
2.
The process by which a commitment of funds is made in an asset.
3.
The study of the investment process.
4.
To make money.
5.
Invest it.
6.
To make money and to increase your future wealth.
7.
A measure of the relative satisfaction from, or desirability of, consumption of goods and
services.
8.
Happiness
9.
Wealth. By maximising wealth, an investor will be able to maximise their current and future
consumption and therefore, maximise their utility.
10.
A form of investing that favours firms that state that their objectives are to foster socially
responsible, environmentally friendly and ethical behaviour.
11.
The objective is not only to maximise wealth but also to take the well-being of others into
consideration.
12.
Not investing in sin industries like gaming and alcohol. Investing in firms that pursue social,
environmental or ethical objectives.
13.
1) The finance segment in the evening news. 2) The amount of space devoted in newspapers
to finance. 3) The proliferation of finance information on the internet.
14.
The ageing of the population. The ageing of the population means that people will have to try
to fund their own retirement rather than relying on a government pension. In order to try to
fund their own retirement, people are investing more today to try to increase their future
wealth.
15.
Security analysis and portfolio management.
1-246
Accuracy checked
16.
It involves the valuation and analysis of investible assets.
17.
It involves the selection and management of a group of assets.
18.
Vintage cars, art or gold. The value of all of these assets in the future is uncertain. Thus, if
you buy them today their price might increase in the future, thus, they are all investible
assets.
19.
To estimate the value of the asset today and to estimate the future value of the asset.
20.
To ascertain whether you should invest in the asset or not.
21.
If you expect the value of the asset to increase substantially in the future, then you may buy
an overvalued asset, as you still expect a reasonable profit.
22.
If you buy low, that is for a low price and sell high, that is for a high price, you will make a
profit.
23.
A group of assets.
24.
Security analysis focuses on each asset in isolation whereas portfolio management focuses
on a group of assets.
25.
To minimise the chances of a very negative outcome.
26.
The first step is to decide which assets to purchase. The second step is to monitor the
performance of the portfolio and perhaps change the assets or the proportion of each asset
in the portfolio.
27.
Individual and institutional investors.
28.
An individual investor invests on their own behalf whereas an institutional investor invests on
the behalf of others.
29.
Institutional investors are in the business of making money and they are generally trained to
do so. Thus, they are generally more skilful than individual investors are.
30.
Superannuation funds and managed funds.
31.
Superannuation funds primarily receive money from their clients through compulsory
employer superannuation contributions; whereas, managed funds receive money from
individuals who are looking for someone to invest their money.
1-247
Accuracy checked
32.
Because it is the key means by which people will be able to fund their own retirement. With
the ageing of the population, if not enough people can fully or partially fund their own
retirement, the impact on the Australian economy could be catastrophic.
33.
Because managed fund investors are voluntarily choosing to place their money with
managed funds, so they will carefully choose which fund manager to invest with.
34.
Because typically, superannuation fund investors do not have much choice as to where they
can invest their money and they are generally forced to invest the money by the government.
Therefore, it is not surprising that they are not indentifying funds that subsequently perform
well either out of ambivalence or because they do not have much flexibility on which fund to
choose.
35.
A security is an asset that is traded in the financial markets.
36.
Treasury notes, promissory notes and bank-accepted bills.
37.
Because the money market is a market for securities with a maturity of less than a year and
equities generally last longer than a year; hence, equities are generally not traded in the
money market.
38.
Because there is an explicit promise by the government of a future cash flow, where this
explicit promise is the defining feature of a debt contract.
39.
Because it can be traded (bought/sold) in the money market.
40.
A Treasury note is issued by the government whereas a promissory note is issued by a

corporation.
41.
Because a promissory note is unsecured, so if the issuer defaults, the holder of the note has
no claim on the assets of the company. Thus, only large companies of good credit standing
can issue promissory notes, as people will only buy promissory notes from companies that
are unlikely default.
42.
The chance of the federal government going bankrupt is lower than the chance of a large
company going bankrupt. Thus, the default risk of a Treasury note is lower than a promissory
note, making a Treasury note cheaper to issue, as the interest rate that the buyer will require
will be lower because the risk of default is lower.
43.
A bank-accepted bill is accepted by a third party, typically a bank, whereas a promissory note
is not.
44.
The acceptance of the bill by a third party, typically a bank, means that the bank is obliged to
repay the bill if the company cannot. Thus, in essence the bank attaches its credit rating to
the bill by accepting it. This means that people will now be prepared to buy the bill, as the
1-248
Accuracy checked
default risk of the bill is now very low. Through this mechanism, a small company of low credit
standing can raise money in the debt markets.
45.
Level of interest rates.
46.
Treasury bonds, corporate bonds and debentures.
47.
Treasury bonds are long-term, that is they have a maturity of a year a greater, whereas
Treasury notes are short-term, that is they have a maturity of less than a year. In addition,
Treasury bonds typically pay coupons, whereas Treasury notes do not.
48.
The chance of the federal government going bankrupt is lower than the chance of a large
company going bankrupt. Thus, the default risk of a Treasury bond is lower than a corporate
bond, making a Treasury bond cheaper to issue, as the interest rate that the buyer will
require will be lower because the risk of default is lower.
49.
Debentures are secured, whereas corporate bonds are not.
50.
Corporate bond. A corporate bond is unsecured whereas a debenture is not. All else
constant, an unsecured instrument is more expensive to issue than a secured instrument.
The reason is that the buyer of the unsecured instrument will require a higher return because
their risk is higher, as if the issuer defaults, the holder of the unsecured instrument gets
nothings, whereas with the secured instrument the holder has a claim on some of the
companys assets.
51.
Typically, the minimum issue price for a debt security is around $100,000. Individual investors
do not generally buy single securities that cost $100,000, as the price is too high, so debt
securities are usually only purchased and traded by institutional investors.
52.
They could buy units in an investment in a debt security, such as a corporate bond through a
managed fund.
53.
A proportional ownership interest in a publicly listed company.
54.
Australian Securities Exchange (ASX).
55.
They are paid last. They are paid last if the company winds up, that is they are only paid after
all other claims, such as those by debt-holders are paid. Further, they can only receive
dividends if there are profits left over after all other financial obligations, such as interest and
tax are met.
56.
Secured debt-holders are paid first, then unsecured debt-holders and finally equity holders
are paid last.
57.
They can only lose what they initially invested; they cannot lose any more than that.
1-249
Accuracy checked
58.
Primary market.
59.
Shares can bought in small amounts, a marketable parcel of shares can cost as little as
$1,000. In contrast, a tradeable debt security typically has a minimum price of around
$100,000. Thus, shares can be easily bought by individual investors, as the minimum
purchase price is low. In contrast, debt securities are typically only traded by institutional
investors, as the minimum price is high.
60.
An increase in the share price, which is a capital gain and through dividend payments.
61.
There is no specific promise of future cash flows with a share investment.
62.
The discounted cash flow approach and the relative valuation approach.
63.
The value of the company today is the present value of the future cash flows that the investor
will receive.
64.
(a)
P0 = D1/(k g)
P0 = 1.8(0.11 0.03)
P0 = $22.50
(b)
65.
Overvalued.
(a)
P0 = D1/(k g)
P0 = 0.3(0.09 0.045)
P0 = $6.67
(b)
Gargoyles shares are undervalued.
66.
Negative. A decreasing EPS implies that the company is generating less earnings for each
share on issue, which is a negative signal.
67.
Company X. Company X is expected to perform better in the future because investors are
prepared to pay more for each dollar of earnings than for company Y.
68.
(a)
P0 = P/E x EPS
P0 = 35 x 0.8
P0 = $28
(b)
69.
Undervalued.
(a)
P0 = P/E x EPS
P0 = 14 x 4.3
P0 = $60.20
1-250
Accuracy checked
(b)
Bonbon is undervalued.
70.
Rt = (Pt Pt-1)/Pt-1
Rt = (43 37)/37
Rt = 0.1622 = 16.22% p.a.
71.
Rt = (Pt Pt-1)/Pt-1
Rt = (13 16)/16
Rt = -0.1875 = -18.75% p.a.
72.
A value-weighted portfolio will provide a more realistic measure of the change in wealth of the
market as a whole, as it will weight larger companies more heavily and smaller companies
less.
73.
The ASX200 and the All Ordinaries. The ASX200 effectively comprises the largest 200
companies on the ASX whereas the All Ords effectively comprises the largest 500 companies
on the ASX.
74.
RABC = (Pt Pt-1)/Pt-1

RABC = (5.4 5)/5
RABC = 0.08
RDEF = (63 78)/78
RDEF = -0.1923
RGHI = (22 23)/23
RGHI = -0.0435
Rportfolio = 1/3(0.08 - 0.1923 - 0.0435)
Rportfolio = -0.0519 = -5.19% p.a.
75.
(a)
RXXX = (Pt Pt-1)/Pt-1

RXXX = (138 121.1)/121.1
RXXX = 0.1396
RYYY = (1.03 0.87)/0.87
RYYY = 0.1839
RZZZ = (113.98 96.8)/96.8
RZZZ = 0.1775
Rportfolio = 1/3(0.1396 + 0.1839 + 0.1775)
Rportfolio = 0.167 = 16.70% p.a.
(b)
RXXX = (Pt Pt-1)/Pt-1
1-251
Accuracy checked
RXXX = (138 121.1)/121.1

RXXX = 0.1396
RYYY = (1.03 0.87)/0.87
RYYY = 0.1839
Rportfolio = 1/2(0.1396 + 0.1839)
Rportfolio = 0.1618 = 16.18% p.a.
76.
The percentage gain or loss of an investment over a period.
77.
No. You can just observe the change in value of your investment over time.
78.
A realised return is the actual return on an investment over a prior period. An expected return
is the return expected on an investment over a future period.
79.
Because the future value of an investment is always uncertain, there will always be risk
associated with any investment.
80.
The key advantage of the second definition is that it can be applied to both realised returns
and to an expectation of future returns. In contrast, the first definition can only be applied to
an expectation of future returns.
81.
Historical risk is risk measured over a prior period whereas expected risk is an expectation of
risk in the future.
82.
No. We need to know the variability in the returns of both investments to assess the risk of
both investments. We cannot do this with just the beginning and end price of both
investments.
83.
Because you expect that the return on the riskier asset will be higher.
84.
A risk-averse investor is an investor who will only accept a higher level of risk if they expect to
be compensated with a higher return. Thus, if investors are risk-averse, there will be a
positive relationship between risk and expected return.
85.
Market risk is the variability in returns that arises from fluctuations in the return of the
overall share market.
Interest rate risk is the variability in a securitys returns that results from changes in the level
of interest rates.
Business risk is the risk associated with the unique circumstances of a particular company.
Financial risk is risk associated with a companys use of debt financing.
Default risk is the risk of an entity defaulting on its debt payments and ultimately going
bankrupt.
Liquidity risk is the risk associated with trading a security in a secondary market.
1-252
Accuracy checked
86.
Small stocks are riskier than large stocks. The main reason is that small stocks will have
greater variability in their cash flows than large stocks, which will give rise to greater
variability in their returns and hence, higher risk. In addition, small stocks are more likely to
have higher levels of business risk, default risk and liquidity risk than big stocks, which will
give rise to greater total risk than big stocks.
87.
Because equity-holders are the residual claimants of the firm, which means they are the last
to be paid when a company winds up and can only receive dividends after all other financial
obligations are met. Further, because they are the last to be paid, there is much more
variability in the cash flows to equity-holders and this induces greater variability in returns.
88.
The chance of the US government going bankrupt is lower than the chance of a large
company going bankrupt. Thus, the default risk of a government bond is lower than a
corporate bond. Over time, the higher risk of corporate bonds is rewarded with a higher
return.
89.
Long-term government bonds. There is greater interest rate risk with long-term government
bonds than with Treasury bills. The reason for this is that there is a greater chance that
interest rates will fluctuate with the longer term to maturity of government bonds. Over time,
the higher level of risk is rewarded with a higher return.
90.
1) In the long-term, investing will almost certainly increase your wealth. 2) In the long-term, a
higher level of risk will almost certainly be rewarded with a higher return.
1-253
Accuracy checked

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Chapter 1

Accounting is the process of identifying, recording, and communicating the

Bookkeeping usually involves only the recording of economic events and

Principles of Accounting and Finance

in accounting standards now allow us an alternative to cost to show the lands

One of the advantages Teresa Bono would enjoy is that ownership of a

The basic accounting equation is Assets = Liabilities + Owners Equity.

Assets are resources controlled by an entity. Liabilities are claims

Business transactions are the economic events of the entity recorded by

The death of the owner of the company is not a business transaction as it

Principles of Accounting and Finance

A withdrawal of cash from the business is a business transaction as it

Corporate governance is the system in which entities are directed or controlled,

Principles of Accounting and Finance

The principles of corporate governance still apply to small business. Those

ASXCGC principles and recommendations capitulate best business practice.

Corporate social responsibility reporting can lead to increased capital

The three components of triple bottom line reporting are:

Social bottom line

Information on environmental and social matters is considered important to

Generally accepted accounting principles (GAAP) are a set of

The framework consists of the following:

Objectives of financial reporting.

Principles of Accounting and Finance

Qualitative characteristics of accounting information.

Income should generally be recognised in the accounting period in which it is

Initially, the subscription received in advance should be recognized as a liability

Accounting standards are not uniform throughout the world although

Comparability is an enhancing qualitative characteristic of financial

Principles of Accounting and Finance

the assumption that consistent and comparable accounting principles are

Impact of ones values and upbringing

Controlled by the entity

Can be measured reliably

Yes: If like material has been

SOLUTIONS TO BRIEF EXERCISES

$90 000 $50 000 = $40 000 (Owners Equity).

BRIEF EXERCISE 1-2

$100 000 + $232 000 = $332 000 (Total assets).

Principles of Accounting and Finance

BRIEF EXERCISE 1-3

BRIEF EXERCISE 1-4

BRIEF EXERCISE 1-5

BRIEF EXERCISE 1-6

BRIEF EXERCISE 1-7

BRIEF EXERCISE 1-8

BRIEF EXERCISE 1-9

BRIEF EXERCISE 1-10

Principles of Accounting and Finance

For information to be recorded, it must first meet the definition and

Controlled by the entity

Probable future economic

Principles of Accounting and Finance

BRIEF EXERCISE 1-12

Meets element definition

Insurance revenue is increased as it represents an increase in an economic benefit

Meets recognition criteria

Probable Once contract is signed revenue is guaranteed but commission to