Chapter 4 - Accural accounting concepts PDF

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Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley

Financial Accounting, Seventh Canadian Edition

CHAPTER 4 Accrual Accounting Concepts LEARNING OBJECTIVES 1. 2. 3. 4. 5.

Explain the accrual basis of accounting and the reasons for adjusting entries. Prepare adjusting entries for prepayments. Prepare adjusting entries for accruals. Prepare an adjusted trial balance and financial statements. Prepare closing entries and a post-closing trial balance.

SUMMARY OF QUESTIONS BY LEARNING OBJECTIVES AND BLOOM’S TAXONOMY Item LO

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Item LO

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Item LO BT Item LO Questions

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1.

1

C

6.

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11.

2,3

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16.

4,5

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21.

5

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1

AP

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12.

2,3

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17.

4,5

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22.

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5.

2

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10.

2,3

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15.

2,3,4

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2,3

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2,3,4

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2,3 2,3

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Brief Exercises

Exercises

Problems: Set A and B

Accounting Cycle Review 1. 2,3,4,5

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2. 2,3,4,5

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Cases 1.

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Solutions Manual 4-1 Chapter 4 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley

Financial Accounting, Seventh Canadian Edition

Legend: The following abbreviations will appear throughout the solutions manual file. LO

Learning objective

BT

Bloom's Taxonomy K Knowledge C Comprehension AP Application AN Analysis S Synthesis E Evaluation Level of difficulty S Simple M Moderate C Complex Estimated time to prepare in minutes Association to Advance Collegiate Schools of Business Communication Communication Ethics Ethics Analytic Analytic Technology Tech. Diversity Diversity Reflective Thinking Reflec. Thinking CPA Canada Competency Ethics Professional and Ethical Behaviour PS and DM Problem-Solving and Decision-Making Comm. Communication Self-Mgt. Self-Management Team & Lead Teamwork and Leadership Reporting Financial Reporting Stat. & Gov. Strategy and Governance Mgt. Accounting Management Accounting Audit Audit and Assurance Finance Finance Tax Taxation

Difficulty:

Time: AACSB

CPA CM cpa-e001 cpa-e002 cpa-e003 cpa-e004 cpa-e005 cpa-t001 cpa-t002 cpa-t003 cpa-t004 cpa-t005 cpa-t006

Solutions Manual 4-2 Chapter 4 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley

Financial Accounting, Seventh Canadian Edition

ANSWERS TO QUESTIONS 1.

Adjusting entries are made to adjust the accounts at the end of the period to ensure revenues and expenses are recorded when they are earned or incurred. When revenues and expenses should be recognized in the accounting records is dictated by recognition criteria. Revenue is recognized or recorded when an increase in future economic benefits arising from an increase in an asset or a decrease in a liability has occurred in the course of ordinary activities. In general, revenue recognition occurs when or as the performance obligation has been satisfied. In a service company, revenue is considered to be earned when the service is provided. In a merchandising company, revenue is considered to be earned when the merchandise is sold (normally at the point of sale). Expenses are recognized in the accounting records when there is a decrease in future economic benefits related to a decrease in an asset or an increase in a liability in the course of ordinary activities. Expense recognition is linked to revenue recognition in that expenses are recognized, wherever possible, in the period in which a company makes efforts to generate revenues. This gives rise to adjusting entries so that revenues and expenses can be recorded in the proper period.

LO 1 BT: C Difficulty: S Time: 10 min. AACSB: None CPA: cpa-t001 CM: Reporting

Solutions Manual 4-3 Chapter 4 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley

2.

(a)

Financial Accounting, Seventh Canadian Edition

The five-step process to use to measure and report revenue is: 1. 2. 3. 4.

(b)

Identify the contract with the client or customer. Identify the performance obligations in the contract. Determine the transaction price. Allocate the transaction price to the performance obligations in the contract. 5. Recognize revenue when (or as) the company satisfies the performance obligations. For the law firm: 1. The contract was created in March between the law firm and the client when the engagement was accepted by the law firm. 2. The performance obligation in the contract is to provide legal services. 3. The transaction price is $8,000. 4. There is a single task and so there are no other obligations in the contract that need to be allocated. 5. The revenue is recognized by the law firm once it satisfies the obligation under the engagement and performs the work for the client in April.

LO 1 BT: AP Difficulty: M Time: 5 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

3.

Expenses of $4,500 should be deducted from the revenues in April because that is when the expenses were incurred and the revenues earned.

LO 1 BT: C Difficulty: S Time: 2 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

Solutions Manual 4-4 Chapter 4 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley

4.

Financial Accounting, Seventh Canadian Edition

(a)

The accrual-basis financial statements provide reporting of assets, liabilities, and shareholders’ equity as well as revenues and expenses. They include receivables and payables to ensure that revenues are recorded when earned and expenses recorded when incurred in the period revenue is generated. Receivables and payables do not exist under the cash basis of accounting. (b) The cash-basis financial statements provide reliable reporting of cash receipts and cash disbursements. No estimates are required, as is the case with accrual-basis financial statements. (c) Companies using IFRS or ASPE cannot choose between the cash and accrual basis of accounting for financial reporting purposes because generally accepted accounting principles require the accrual basis. In addition, the cash basis could allow for the manipulation of income by delaying or speeding up the timing of cash flow.

LO 1 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

5.

(a)

Prepaid expenses are assets because they have a future benefit since they were paid for before they are used or consumed. (b) As the benefit of the prepayment expires, (often with the passage of time) the asset must be reduced and an expense recognized. This requires an adjustment at the end of each accounting period, to expense the portion of the prepaid that has expired (been used up) during the period.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

6.

(a)

Unearned revenue arises when cash is received for goods or services to be provided in the future. It represents a liability because the cash has not yet been earned—the company has a future obligation to provide the goods or services. (b) Unearned revenues must be adjusted at the end of an accounting period to reflect any revenues that have been earned.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Solutions Manual 4-5 Chapter 4 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley

7.

Financial Accounting, Seventh Canadian Edition

No. Depreciation is the process of allocating the cost of a long-lived asset to expense over its useful life. Depreciation results in the presentation of the carrying amount (cost less accumulated depreciation) of the asset, not its current value.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

8.

(a)

Depreciation expense is an expense account with a normal debit balance and is reported on the income statement as part of the operating expenses. This account shows the portion of the cost of a long-lived asset that has expired during the current accounting period. Accumulated depreciation is a contra asset account with a normal credit balance that is reported on the statement of financial position as a reduction of a depreciable asset (such as building and equipment). The balance in the accumulated depreciation account is the total depreciation that has been recognized from the date of acquisition of the depreciable asset to the statement of financial position date.

(b)

Cost is the original cost of the asset when purchased. The carrying amount is the original cost of the asset less its related accumulated depreciation, and represents the portion of the asset that has not yet been depreciated.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

9.

A contra asset account is an account with a credit balance that is deducted from the related asset account on the statement of financial position. Using a contra asset account, such as Accumulated Depreciation, enables disclosure of both the original cost of the asset and the total estimated cost that has expired or been used up to date. This information is useful to the financial statement user who can determine how long until the asset is fully depreciated.

LO 2 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Solutions Manual 4-6 Chapter 4 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley

10.

Financial Accounting, Seventh Canadian Edition

Yes, I agree. A “simple” adjusting entry affects one statement of financial position account and one income statement account. An adjusting entry reallocates amounts between a statement of financial position account and an income statement account. For example: to record the expiration of insurance the following entry would be recorded; a debit to Insurance Expense (an income statement account) and a credit to Prepaid Insurance (a statement of financial position account). Compound adjusting journal entries are also possible which would affect more accounts, but at least one statement of financial position account and one income statement account are always affected whether a simple adjusting entry or a compound adjusting entry is made.

LO 2,3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

11.

Disagree. Adjusting entries never involve the Cash account. In making adjusting entries for prepayments, the cash has already been paid or received and recorded. The adjusting journal entry is prepared to reflect the fact that a portion of the unearned revenue or prepaid expense arising in the past when the cash flow occurred is now earned or incurred. In making adjusting entries for accruals, we record the fact that, although the cash has not been paid or received, revenue has been earned or an expense has been incurred. Again, there is no impact on the Cash account because cash has not yet been received or paid but is expected to be subsequently.

LO 2,3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

12.

To ensure that the adjusting entry is properly calculated and prepared, the preparer of the adjusting entry must first properly understand the original cash payment transaction that lead to the recording of the prepayment. For example, if you are preparing an adjusting entry to record the supplies on hand, you must know first how much is already recorded. On the other hand, in the case of an accrual, there is no cash payment to look up in the accounts. Consequently, there is no original entry to examine in the process of preparing an adjusting entry related to an accrual.

LO 2,3 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

13.

(a)

Yes, it does matter whether the adjusting entry is made on December 31. If the interest is not accrued on December 31, then expenses (interest expense) and liabilities (interest payable) will both be understated in that year’s financial statements. In addition, expenses (interest expense) will be overstated in the subsequent year, when the expense is recorded (incorrectly) when paid on January 1. By not making this journal entry, expenses will not be matched with the period in which the loan was available for use.

(b)

The correct journal entries are as follows:

Solutions Manual 4-7 Chapter 4 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley

Financial Accounting, Seventh Canadian Edition

Dec. 31 Interest Expense .............................. Interest Payable.........................

100

Jan. 1

100

Interest Payable .............................. Cash ..........................................

100 100

If no entry is made on Dec. 31, and interest expense is recorded on January 1 when paid, interest expense will be understated by $100 and interest payable will be understated by the same amount for the year ended December 31, 2018. LO 3 BT: AN Difficulty: C Time: 10 min. AACSB: Analytic CPA: cpa-t001 CM: Reporting

14.

Financial statements 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. An unadjusted trial balance is not up to date for prepayments and accruals.

LO 4 BT: C Difficulty: S Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

Solutions Manual 4-8 Chapter 4 Copyright © 2017 John Wiley & Sons Canada, Ltd. Unauthorized copying, distribution, or transmission of this page is strictly prohibited.

Kimmel, Weygandt, Kieso, Trenholm, Irvine, Burnley

15.

Financial Accounting, Seventh Canadian Edition

(a)

Original transaction entries are made throughout the accounting period when transactions arise. Adjusting entries are only recorded at the end of the accounting period, prior to the preparation of the financial statements. As well, adjusting entries never affect the Cash account and always result in an adjustment to a statement of financial position account and an income statement account. Transaction entries often result in a debit or credit to Cash and can affect any account on the statement of financial position or the income statement (or both). (b) Closing entries are required to reset the revenue and expense (income statement) and dividend declared accounts to zero and to update the balance in Retained Earnings to the ending balance as shown in the statement of changes in equity. Unlike adjusting entries, which are prepared before the financial statements are prepared and could be prepared more than once per year (for example, monthly, quarterly), closing entries are only prepared and posted after the year-end financial statements have been completed.

LO 2,3,4 BT: C Difficulty: M Time: 5 min. AACSB: None CPA: cpa-t001 CM: Reporting

16.

The unadjusted, adjusted, and post-closing trial balances are similar in that they prove the equality of the total debit and total credit balances. Another similarity between the unadjusted and adjusted trial balances is that they are prepared at the end of an accounting period. Where trial balances differ is that the unadjusted trial balance is prepared before any adjusting entries have been recorded or posted. An adjusted trial balance is prepared after the adjusting entries have been posted to the accounts. The financial statements are prepared from the adjusted trial balance. After the financial statements have been prepared, closing entries are prepared and posted. The post-closing trial balance is then prepared and used to form the basis of the opening balances for the next accounting period. Unlike the adjusted trial balance which will list temporary (revenue, expense, dividend declared) account balances prior to recording t...