CHAPTER 3

THE ACCOUNTING CYCLE:

CAPTURING ECONOMIC EVENTS

OVERVIEW OF EXERCISES, PROBLEMS, CASES,

AND INTERNET ASSIGNMENT
Learning
Exercises Topic Objectives Characteristics
3–1 Accounting terminology 1 – 10 Conceptual
3–2 The accounting cycle 1, 2, 5, 9, 10 Conceptual
3–3 The matching principle 6, 7 Personal, conceptual
3–4 Recording transactions 3, 4, 5 Mechanical
3–5 Journal and ledger relationships 2, 3, 4, 5 Mechanical, conceptual
3–6 Preparing a trial balance 9 Mechanical
3–7 Net income and owners’ equity 6, 8 Analytical, mechanical
3–8 Accounting equation 2, 3, 4, 5, 6 Conceptual, analytical
relationships
3–9 Accounting equation 2, 3, 4, 5, 6 Conceptual, analytical
relationships
3–10 Revenue realization 6, 7 Mechanical, conceptual
3–11 Recognizing expenses 6, 7 Mechanical, conceptual
3–12 Analyzing and recording 4, 6, 7, 8 Mechanical, conceptual
transactions
3–13 Short comprehensive exercise 3, 4, 5 Mechanical, conceptual
3-14 Short comprehensive exercise 3, 4, 5 Mechanical, conceptual
3-15 Using an annual report 1, 2, 3, 7, 10 Mechanical, conceptual, real—
Tootsie Roll

Problems
3–1 Recording journal entries and 3, 4, 5 Conceptual, mechanical
identifying their effects on the
accounting equation
3–2 Recording journal entries and 3, 4, 5, 6, 7, Conceptual, mechanical
identifying their effects on the 8
accounting equation
3–3 Recording journal entries and 3, 4, 5, 6, 7, Conceptual, mechanical
identifying their effects on the 8
accounting equation
3–4 The accounting cycle 1 – 10 Conceptual, mechanical
3–5 The accounting cycle 1 – 10 Conceptual, mechanical

Cases
3–1 Revenue recognition 7, 10 Group assignment, conceptual,
communication
3–2 Income measurement 6, 7, 10 Ethics, group assignment,
communication, conceptual

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Business Week Learning
Assignment Topic Objectives Characteristics
3–3 Business Week assignment 10 Conceptual, group, real—PepsiCo,
Inc.

Internet
Assignment
3–1 Source of revenue 6 Internet, communication

DESCRIPTIONS OF PROBLEMS, CASES,

AND THE INTERNET ASSIGNMENT
Below are brief descriptions of each problem, case, and Internet assignment. These descriptions are
accompanied by the estimated time (in minutes) required for completion and by a difficulty rating. The time
estimates assume use of the partially filled-in working papers.

Problems
3–1 Heartland Construction 30 Medium
A company engages in numerous transactions during its first month of
operations. Students are required to journalize each transaction and analyze the
effect of each transaction on the accounting equation.

3–2 Environmental Services, Inc. 30 Medium

Calls for a detailed analysis of numerous transactions, journalizing, and the
application of the realization and matching principles.

3–3 Weida Surveying, Inc. 35 Medium

Requires students to journalize transactions and to understand the relationship
between the income statement and the balance sheet.

3–4 Aerial Views 50 Strong

Requires students to journalize and post transactions, prepare a trial balance,
and understand the relationships between the income statement and balance
sheet.

3–5 Dr. Schekter, DVM 60 Strong

Requires students to journalize and post transactions, prepare a trial balance,
and understand the relationships between the income statement and balance
sheet.

56 © The McGraw-Hill Companies, Inc., 2005

Cases
3–1 Revenue Recognition 15 Medium
Requires students to draw conclusions concerning the point at which various
companies should recognize revenue.

3–2 Measuring Income 30 Strong

Students are to determine whether a company’s methods of measuring income
are fair and reasonable. Also requires students to distinguish between net
income and cash flow.

Business Week Assignment

3–3 Business Week Assignment 15 Easy
Students are asked to consider types of information PepsiCo would track for
its soft drink operations.

Internet Assignment
3–1 PC Connection 10 Easy
Using the company’s 10-K report, students are asked to identify revenue from
various sources.

SUGGESTED ANSWERS TO DISCUSSION QUESTIONS

1. Although it has no obligation to issue financial statements to creditors or investors, Baker Construction
still should maintain an accounting system. For a start, the company probably has numerous reporting
obligations other than financial statements. These include income tax returns, payroll tax returns,
(including workers’ compensation insurance) and payroll data, which must be reported to individual
employees.
Even though the company is not required by law to issue financial statements, Tom Baker should find
such statements useful in managing the business and also in arranging financing should the business
ever need additional capital.
In addition, an accounting system provides managers and employees with a wealth of information vital
to daily business operations. For example, the system keeps track of the amounts due from customers
and amounts payable to employees, tax authorities, and suppliers. It also provides information about
the company’s cash position and the performance of different departments within the organization.
Another important use of an accounting system is establishing the accountability of specific employees
for the assets and operations under their direct control.
2. The three basic parts of an account are (1) its title, (2) a left side called the debit side, and (3) a right
side called the credit side.
3. There was a $112,100 debit balance ($126,900 beginning debit balance, plus $23,400 in debit entries,
minus $38,200 in credit entries).
4. Assets are located on the left side of the balance sheet; an increase in an asset account is recorded by an
entry on the left (or debit) side of the account. Liabilities and owners’ equity are located on the right
side of the balance sheet; an increase in a liability account or an owners’ equity account is recorded by
an entry on the right (or credit) side of the account.

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 5. Asset accounts:
a. Increases are recorded by debits.
b. Decreases are recorded by credits.
Liability and owners’ equity accounts:
a. Increases are recorded by credits.
b. Decreases are recorded by debits.
6. No, the term debit means an entry on the left-hand side of an account; the term credit simply means an
entry on the right-hand side of an account. Consequently, the term debit means increase when applied
to an asset account, but it signifies a decrease when applied to a liability or owners’ equity account.
The term credit means decrease when applied to an asset account, but it signifies an increase when
applied to a liability or owners’ equity account.
7. The double-entry system requires that equal dollar amounts of debit and credit entries be made for
every business transaction recorded.
8. a. “A debit of $200 to the Cash account” means that the amount of $200 was entered on the left side
of the Cash account, indicating a $200 increase in the asset Cash.
b. “A debit of $600 to Accounts Payable” means an entry of $600 on the left side of the ledger
account for Accounts Payable and indicates a decrease of $600 in this liability.
c. “A credit of $50 to Accounts Receivable” means an entry on the right side of the Accounts
Receivable account and indicates a reduction of $50 in this asset.
d. “A debit to the Land account” means that an entry was made on the left side of the ledger account
for Land and indicates an increase in this asset account.
e. “Credit balance” means that the total amount of the credits in a given ledger account exceeds the
total amount of the debits in that account.
f. “Credit side of an account” means the right-hand side.
9. a. Credit Cash. Cash is an asset account and was decreased by this transaction. Decreases in assets are
recorded by credits.
b. Credit Office Equipment. Office Equipment is an asset account and was decreased by this
transaction. Decreases in assets are recorded by credits.
c. Debit Cash. Cash is an asset account and was increased by this transaction. Increases in assets are
recorded by debits.
d. Credit Accounts Payable. Accounts Payable is a liability account and was increased by this
transaction. Increases in liabilities are recorded by credits.
e. Credit Capital Stock. Capital Stock is an owners’ equity account and was increased by this
transaction. Increases in owners’ equity are recorded by credits.
10. Operating profitably causes an increase in owners’ equity. Usually, this increase in equity is
accompanied by an increase in total assets. However, the increase in equity might be offset in part or in
whole by a decrease in total liabilities.
11. No, net income does not represent an amount of cash. The entire amount of cash owned by a business
appears on the asset side of the balance sheet and is entitled Cash. Net income is an increase in owners’
equity and implies nothing about the form in which the company’s assets are held.

58 © The McGraw-Hill Companies, Inc., 2005

 12. Revenue represents the price of goods sold and of services rendered to customers during the period. It
is an increase in owners’ equity accompanied either by an increase in assets or a reduction in liabilities.
Not every receipt of cash represents the earning of revenue. The borrowing of money from a bank
causes cash to be received but does not increase the owners’ equity and does not represent revenue.
Collection of an account receivable is merely the exchange of one asset (the receivable) for another
asset (cash) and does not constitute revenue.
13. The term expenses means the cost of the goods and services used up or consumed in the process of
obtaining revenue. Expenses cause a decrease in owners’ equity. To determine the net income for a
given accounting period, it is necessary that all expenses of that period be deducted from the revenue
earned in that period. In deciding whether a given transaction represents an expense of the current
period, two questions are pertinent: (1) Was the alleged expense incurred primarily to generate revenue
during the current period? (2) Does the item in question reduce the owners’ equity?
Not all cash payments represent expense. Examples of cash payments that are not expenses include
purchase of an asset such as a building or supplies, payment of an existing liability, and dividends.
14. The revenue is recognized in May. The journal entry in May consists of a $500 debit to Accounts
Receivable and a $500 credit to a revenue account such as Commissions Earned or Fees Earned. The
entry in June consists of a $500 debit to Cash and a $500 credit to Accounts Receivable.
15. Revenue is considered realized at the time that services are rendered to customers or goods sold are
delivered to customers. The realization principle answers the question of when revenue should be
recognized in accounting records.
16. Classic Auto Painters should recognize the paint as expense in the month of April—the month in which
the paint was used in the effort to generate revenue. This answer demonstrates the matching
principle—the idea that revenue should be offset by all the expenses incurred in the effort of producing
that revenue.
17. The matching principle indicates that expenses should be recognized in the period (or periods) that the
expenditure helps to produce revenue.
18. Revenue increases owners’ equity; therefore revenue is recorded by a credit. Expenses decrease
owners’ equity; therefore expenses are recorded by debits.
19. The trial balance provides proof that the ledger is in balance. A trial balance does not, however, prove
that transactions have been analyzed and recorded in the proper accounts and/or for the proper
amounts. Furthermore, if a transaction were completely omitted from the ledger, the error would not be
disclosed by the trial balance.
20. A dividend is a distribution of assets (usually cash) by a corporation to its stockholders. Dividends
reduce both assets and owners’ equity (specifically, the Retained Earnings account). Dividends are not
an expense deducted from revenue in the computation of net income. Rather than being reported in the
income statement as a component of net income, dividends are reported in the statement of retained
earnings as a component of the Retained Earnings balance reported in the balance sheet.
21. The accrual basis of accounting calls for recording revenue in the period in which it is earned and
recording expenses in the period in which they are incurred. The cash basis of accounting calls for
recording revenue when it is received in cash and for recording expenses when they are paid. The
accrual basis of accounting gives a more accurate picture of the profitability of a business because it
matches revenue with the related expenses incurred in producing that revenue. Net income can be
determined accurately only if we recognize all the revenue earned and all the related expenses incurred
in a given time period.

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 SOLUTIONS TO EXERCISES

Ex. 3–1 a. Accounting period

b. Accounting cycle
c. None (This statement describes the accounting convention of conservatism.)
d. Net income
e. Realization principle
f. Credit
g. Matching principle
h. Expenses

Ex. 3–2 a. 1. Journalize transactions.

2. Post transaction data to the ledger.
3. Prepare a trial balance.
4. Make end-of-period adjustments.
5. Prepare an adjusted trial balance.
6. Prepare financial statements.
7. Journalize and post closing entries.
8. Prepare an after-closing trial balance.

b. 1. Evaluate the efficiency of operations.

2. Establish accountability for assets and transactions.
3. Maintain a documentary record of business activities.
4. Help make business decisions.

60 © The McGraw-Hill Companies, Inc., 2005

Ex. 3–3 a. Costs of owning and operating an automobile (estimates will vary; the following list is only
an example):
Insurance .................................................................................................................. $ 1,000
Gasoline (15,000 miles at 30 mpg. × $1.80/gal.) ..................................................... 900
Registration and license ........................................................................................... 100
Repairs and maintenance.......................................................................................... 200
Depreciation ............................................................................................................. 1,200
Interest on car loan* ................................................................................................. 500
Annual total.............................................................................................................. $ 3,900
Average cost per mile ($3,900 ÷ 15,000 miles) ....................................................... $ 0.26
*Note to instructor: It is worth noting that including both depreciation and the “principal” portion of the car
loan would be “double-counting” the purchase price of the car. Depreciation issues are introduced in
Chapter 4.
b. Although you spent no money during this trip, you incurred significant costs. For example,
you have used much of the gasoline in your tank. Also, the more miles you drive, the higher
your repair and maintenance costs, depreciation, and insurance. Assuming that it cost you
about 26 cents per mile to own and operate your vehicle, about $26 would be a reasonable
estimate of your “driving expenses.”
Note to instructor: Most employers do base their reimbursement of driving expenses on an average cost per
mile. In a sophisticated class, you may want to point out that the incremental costs of this trip are much less
than the average cost. Thus, employees usually benefit somewhat in the short-term when they are
reimbursed for using their own cars.

Ex. 3–4 Oct. 1 Cash........................................................................................... 200,000

Capital Stock ................................................................. 200,000
Issued capital stock at $50 per share.
4 Diagnostic Equipment ............................................................... 75,000
Cash ............................................................................... 25,000
Notes Payable ................................................................ 50,000
Purchased equipment, paying part in cash and signing a note
payable for the balance.
12 Accounts Payable ...................................................................... 9,000
Cash ............................................................................... 9,000
Paid account payable to Zeller Laboratories
19 Surgical Supplies....................................................................... 2,600
Accounts Payable .......................................................... 2,600
Purchased surgical supplies on account.
25 Cash........................................................................................... 24,000
Accounts Receivable ..................................................... 24,000
Collected amount owed from Health One Insurance.
30 Dividends .................................................................................. 300,000
Cash ............................................................................... 300,000
Paid cash dividend.

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Ex. 3–5 Nov. 1 Cash........................................................................................... 120,000
Capital Stock ................................................................. 120,000
Issued stock in exchange for cash.
8 Land........................................................................................... 70,000
Building..................................................................................... 58,600
Cash ............................................................................... 33,600
Notes Payable ................................................................ 95,000
Purchased land and building, by paying $33,600 cash and
issuing a note payable for the remaining balance.
15 Office Equipment ...................................................................... 3,200
Accounts Payable .......................................................... 3,200
Purchased office equipment on account.
21 Accounts Payable ...................................................................... 480
Office Equipment .......................................................... 480
Returned some of the office equipment purchased on
November 15.
25 Notes Payable............................................................................ 12,000
Cash ............................................................................... 12,000
Paid note payable.
30 Vehicles..................................................................................... 9,400
Cash ............................................................................... 1,400
Notes Payable ................................................................ 8,000
Purchased vehicles by paying $1,400 cash and issuing a note
payable for the remaining balance.

Ex. 3–6 AVENSON INSURANCE COMPANY

Trial Balance
November 30, 20__
Cash ............................................................................................................ $ 73,000
Land ............................................................................................................ 70,000
Building ...................................................................................................... 58,600
Office equipment ........................................................................................ 2,720
Vehicles ...................................................................................................... 9,400
Notes payable.............................................................................................. $ 91,000
Accounts payable........................................................................................ 2,720
Capital stock ............................................................................................... 120,000
$ 213,720 $ 213,720

62 © The McGraw-Hill Companies, Inc., 2005

Ex. 3–7 a. Liabilities at the beginning of the year: $6.0 billion – $3.9 billion = $2.1 billion

b. Owners’ equity at the end of the year: $6.3 billion – $2.2 billion = $4.1 billion

c. Ending owners’ equity (from part b)................. $4,100,000,000

Less: Beginning owners’ equity........................ (3,900,000,000)
Increase in owners’ equity ................................ $ 200,000,000
Less: Increase in capital stock ........................... (135,000,000)
Net income ........................................................ $ 65,000,000

Ex. 3–8
Income Statement Balance Sheet
Trans- Net Owners’
action Revenue − Expenses = Income Assets = Liabilities + Equity
1. I NE I I NE I
2. NE NE NE D D NE
3. NE NE NE NE NE NE
4. NE I D NE I D
5. NE NE NE I I NE
6. NE NE NE D NE D

Ex. 3–9
a.
Income Statement Balance Sheet
Trans- Net Owners’
action Revenue − Expenses = Income Assets = Liabilities + Equity
1. NE I D NE I D
2. I NE I I NE I
3. NE NE NE D NE D
4. NE NE NE I I NE
5. NE I D D NE D
6. NE NE NE NE NE NE
7. NE NE NE I I NE
8. NE NE NE D D NE

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 b. 1. Incurred wages expense to be paid at a later date.
2. Earned revenue to be collected at a later date.
3. Declared and paid a cash dividend.
4. Purchased office supplies on account.
5. Incurred and paid repairs expense.
6. Collected cash from a customer for revenue earned previously on account.
7. Purchased tools and equipment by paying part in cash and issuing a note payable for the
remaining balance.
8. Paid an outstanding account payable.

Ex. 3–10 a. An investment by stockholders does not constitute revenue. Although this investment causes
an increase in owners’ equity, this increase was not earned. It did not result from the
rendering of services or sale of merchandise to outsiders.

b. The collection of an account receivable does not increase owners’ equity and does not
represent revenue.

c. The borrowing of money from a bank creates a liability; it does not increase the owners’
equity and does not represent revenue.

d. The interest was earned in May and represents revenue of that month, despite the fact that no
withdrawals were made from the bank.

e. This fee was earned in May and represents revenue of that month, despite the fact that
collection will not be made until June.

Ex. 3–11 a. Purchase of a copying machine does not represent expense. The asset Cash is exchanged for
the asset Office Equipment, without any change in owners’ equity. The purpose of the
transaction was to obtain the use of the copier over a number of years, rather than to generate
revenue only during the current period. (Evergreen will recognize depreciation expense on
this asset throughout its useful life, but the purchase does not represent an expense in March.
Depreciation issues are introduced in Chapter 4.)

b. Gasoline purchased is an expense because it is ordinarily used up in the current period. These
purchases decrease the owners’ equity and are for the purpose of generating revenue.

c. Payment to an employee for services rendered in March is a March expense. Such a payment
is made to generate revenue and decreases owners’ equity.

d. The payment to the attorney for services rendered in a prior period reduced an existing
liability but did not affect the owners’ equity. The payment was not an expense.

e. The dividend does not constitute an expense. Unlike payments for advertising, rent, and
supplies, dividends do not generate revenue. Dividends constitute a return to stockholders of
a portion of their equity in the business.

64 © The McGraw-Hill Companies, Inc., 2005

Ex. 3–12 a. Apr. 5 Accounts Receivable........................................................... 900
Drafting Fees Earned .............................................. 900
Prepared plans for Spangler Construction; payment due in
30 days.
May 17 Dividends............................................................................ 5,000
Dividends Payable .................................................. 5,000
Declared cash dividend; payment due June 25.
May 29 Professional Expenses......................................................... 2,000
Accounts Payable.................................................... 2,000
Received accounting bill from Bob Needham due on June
10.
June 4 Cash .................................................................................... 900
Accounts Receivable............................................... 900
Received full payment from Spangler Construction for
bill sent April 5.
June 10 Accounts Payable................................................................ 2,000
Cash ........................................................................ 2,000
Paid amount owed to Bob Needham, CPA.
June 25 Dividends Payable .............................................................. 5,000
Cash ........................................................................ 5,000
Paid cash dividend declared May 17.

b. The following transactions will not cause a change in net income.

May 17: Declaration of a cash dividend.

June 4: Collection of an account receivable.
June 10: Payment of an account payable.
June 25: Payment of a dividend payable.

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Ex. 3–13 a. July 18 Cash .................................................................................... 1,500
Capital Stock........................................................... 1,500
Issued 500 shares of capital stock to Patrick Donegan at
$3 per share.
July 22 Office Supplies .................................................................... 100
Accounts Payable.................................................... 100
Purchased office supplies on account.
July 23 Mowing Equipment ............................................................. 2,000
Cash ........................................................................ 400
Notes Payable ......................................................... 1,600
Purchased mowing equipment paying $400 cash and
issuing a $1,600 note payable for the balance.
July 24 Fuel Expense........................................................................ 25
Cash ........................................................................ 25
Paid for gasoline to be used in July.
July 25 Accounts Receivable............................................................ 150
Cash ........................................................................ 150
Billed Lost Creek Cemetery for mowing services.
Payment is due July 30.
July 26 Accounts Receivable............................................................ 200
Mowing Revenue.................................................... 200
Billed Golf View Condominiums for mowing services.
Payment is due August 1.
July 30 Cash ..................................................................................... 150
Accounts Receivable............................................... 150
Collected amount due from Lost Creek Cemetery for
mowing services provided July 25.
July 31 Salaries Expense .................................................................. 80
Cash ........................................................................ 80
Paid salary to Teddy Grimm for work performed in July.

66 © The McGraw-Hill Companies, Inc., 2005

b.
Cash Accounts Receivable
July 18 1,500 July 23 400 July 25 150 July 30 150
July 30 150 July 24 25 July 26 200
July 31 80

July 31 Bal. 1,145 July 31 Bal. 200

Office Supplies Mowing Equipment

July 22 100 July 23 2,000

July 31 Bal. 100 July 31 Bal. 2,000

Accounts Payable Notes Payable

July 22 100 July 23 1,600

July 31 Bal. 100 July 31 Bal. 1,600

Capital Stock Retained Earnings

July 18 1,500

July 31 Bal. 1,500 July 31 Bal. 0

Mowing Revenue Salaries Expense

July 25 150 July 31 80
July 26 200

July 31 Bal. 350 July 31 Bal. 80

Fuel Expense
July 24 25

July 31 Bal. 25

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c. DONEGAN'S LAWN CARE SERVICE
Trial Balance
July 31, 2005
Cash $ 1,145
Accounts receivable 200
Office supplies 100
Mowing equipment 2,000
Accounts payable $ 100
Notes payable 1,600
Capital stock 1,500
Retained earnings -
Mowing revenue 350
Salaries expense 80
Fuel expense 25
$ 3,550 $ 3,550

d. Donegan’s Retained Earnings balance is zero because the company has been in business for only two
weeks and has not yet updated the Retained Earnings account for any revenue or expense activities. The
procedure to update the Retained Earnings account is discussed in Chapter 5.

68 © The McGraw-Hill Companies, Inc., 2005

Ex. 3–14 a. Feb. 2 Accounts Payable................................................................ 750
Cash ........................................................................ 750
Paid $750 in partial settlement of outstanding accounts
payable.
Feb. 6 Cash ..................................................................................... 900
Accounts Receivable............................................... 900
Collected $900 in full settlement of outstanding accounts
receivable.
Feb. 18 Accounts Receivable............................................................ 175
Party Revenue ......................................................... 175
Billed Sunflower Child Care for clown services.
The entire amount is due March 15.
Feb. 26 Cash ..................................................................................... 480
Party Revenue ......................................................... 480
Billed and collected cash for performing at several
birthday parties.
Feb. 28 Salaries Expense .................................................................. 260
Cash ........................................................................ 260
Paid clown salaries for work performed in February.
Feb. 28 Travel Expense .................................................................... 40
Cash ........................................................................ 40
Paid travel expenses incurred in February.
Feb. 28 Dividends............................................................................. 100
Cash ........................................................................ 100
Declared and distributed dividend to Ralph Jaschob.

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 Cash Accounts Receivable
Feb. 1 Bal. 2,850 Feb. 2 750 Feb. 1 Bal. 900 Feb. 6 900
Feb. 6 900 Feb. 28 260 Feb. 18 175
Feb. 26 480 Feb. 28 40
Feb. 28 100

Feb. 28 Bal. 3,080 Feb. 28 Bal. 175

Accounts Payable Capital Stock

Feb. 2 750 Feb. 1 Bal. 800 Feb. 1 Bal. 2,000

Feb. 28 Bal. 50 Feb. 28 Bal. 2,000

Retained Earnings Dividends

Feb. 1 Bal. 750 Feb. 1 Bal. 0
Feb. 28 100

Feb. 28 Bal. 750 Feb. 28 100

Party Revenue Salaries Expense

Feb. 1 Bal. 1,350 Feb. 1 Bal. 830
Feb. 18 175 Feb. 28 260
Feb. 26 480

Feb. 28 2,005 Feb. 28 1,090

Bal. Bal.

Party Food Expense Travel Expense

Feb. 1 Bal. 240 Feb 1 Bal. 80
Feb. 28 40

Feb. 28 Bal. 240 Feb. 28 120

Bal.

70 © The McGraw-Hill Companies, Inc., 2005

c. CLOWN AROUND, INC.
Trial Balance
February 28, 2005
Cash $ 3,080
Accounts receivable 175
Accounts payable $ 50
Capital stock 2,000
Retained earnings 750
Dividends 100
Party revenue 2,005
Salaries expense 1,090
Party food expense 240
Travel expense 120
$ 4,805 $ 4,805

d. Dividends are not an expense. Thus, they are not deducted from revenue in the income statement. The
reason dividends are not viewed as expenses is that these payments do not serve to generate revenue.
Rather, they are a distribution of profits to the owners of the business.

Ex. 3–15 a. The company’s balance sheet is dated December 31. Thus, it is apparent that its financial year
coincides with the calendar year.
b. 2001: $618,676 = $110,215 + $508,461

2002: $646,080 = $119,340 + $526,740

c. The company’s cash (and cash equivalents) decreased from $106,532 at the beginning of the
year, to $105,507 at the end of the year. Thus, it had to have posted more credits than debits
to cash (and cash equivalents). Note that these figures are stated in thousands of dollars.

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 SOLUTIONS TO PROBLEMS
30 Minutes, Medium PROBLEM 3–1
HEARTLAND CONSTRUCTION
a.
General Journal

20__
Feb. 1 Cash 5 0 0 0 0 0
Capital Stock 5 0 0 0 0 0
Issued 25,000 shares of Capital Stock.

10 Land 1 0 0 0 0 0
Office Building 2 0 0 0 0 0
Cash 6 0 0 0 0
Notes Payable 2 4 0 0 0 0
Purchased land and office building.

16 Computer Systems 1 2 0 0 0
Cash 1 2 0 0 0
Purchased computer system.

18 Office Furnishings 9 0 0 0
Cash 1 0 0 0
Accounts Payable 8 0 0 0
Purchased office furnishings.

22 Office Supplies 3 0 0
Cash 3 0 0
Purchased office supplies.

23 Accounts Receivable 3 6
Computer Systems 3 6
Purchased computer system.

27 Accounts Payable 4 0 0 0
Cash 4 0 0 0
Made payment on an account payable.

28 Cash 3 6
Accounts Receivable 3 6
Collected cash refunded by PC World.

72 © The McGraw-Hill Companies, Inc., 2005

 PROBLEM 3–1
HEARTLAND CONSTRUCTION (concluded)
b.
Transaction Assets = Liabilities + Owners’ Equity

Feb. 1 + $500,000 (Cash) $0 + $500,000 (Capital

Stock)

Feb. 10 + $100,000 (Land) + $240,000 (Notes Payable) $0

+ $200,000 (Office Building)
– $60,000 (Cash)

Feb. 16 + $12,000 (Computer Systems) $0 $0

– $12,000 (Cash)

Feb. 18 + $9,000 (Office Furnishings) + $8,000 (Accounts Payable) $0

– $1,000 (Cash)

Feb. 22 + $300 (Office Supplies) $0 $0

– $300 (Cash)

Feb. 23 + $36 (Accounts Receivable) $0 $0

– $36 (Computer Systems)

Feb. 27 – $4,000 (Cash) - $4,000 (Accounts Payable) $0

Feb. 28 + $36 (Cash) $0 $0

– $36 (Accounts Receivable)

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30 Minutes, Medium PROBLEM 3–2
ENVIRONMENTAL SERVICES, INC.

a. (1) (a) The asset Accounts Receivable was increased. Increases in assets are recorded by debits. Debit
Accounts Receivable, $2,500.
(b) Revenue has been earned. Revenue increases owners’ equity. Increases in owners’ equity are
recorded by credits. Credit Testing Service Revenue, $2,500.
(2) (a) The asset Testing Supplies was increased. Increases in assets are recorded by debits. Debit
Testing Supplies, $3,800.
(b) The asset Cash was decreased. Decreases in assets are recorded by credits. Credit Cash, $800.
(c) The liability Accounts Payable was increased. Increases in liabilities are recorded by credits.
Credit Accounts Payable, $3,000.
(3) (a) The liability Accounts Payable was decreased. Decreases in liabilities are recorded by debits.
Debit Accounts Payable, $100.
(b) The asset Testing Supplies was decreased. Decreases in assets are recorded by credits. Credit
Testing Supplies, $100.
(4) (a) The asset Cash was increased. Increases in assets are recorded by debits. Debit Cash, $20,000.
(b) The owners’ equity account Capital Stock was increased. Increases in owners’ equity are
recorded by credits. Credit Capital Stock, $20,000.
(5) (a) The asset Cash was increased. Increases in assets are recorded by debits. Debit Cash, $600.
(b) The asset Accounts Receivable was decreased. Decreases in assets are recorded by credits.
Credit Accounts Receivable, $600.
(6) (a) The liability Accounts Payable was decreased. Decreases in liabilities are recorded by debits.
Debit Accounts Payable, $2,900 ($3,800 - $800 - $100).
(b) The asset Cash was decreased. Decreases in assets are recorded by credits. Credit Cash, $2,900.
(7) (a) The Dividends account was increased. Dividends decrease the owners’ equity account Retained
Earnings. Decreases in owners’ equity are recorded by debits. Debit Dividends, $6,800.
(b) The asset Cash was decreased. Decreases in assets are recorded by credits. Credit Cash, $6,800.

74 © The McGraw-Hill Companies, Inc., 2005

 PROBLEM 3–2
ENVIRONMENTAL SERVICES, INC. (continued)
b.
General Journal

20__ (1)
Aug. 1 Accounts Receivable 2 5 0 0
Testing Service Revenue 2 5 0 0
Billed customers for services rendered.

(2)
3 Testing Supplies 3 8 0 0
Cash 8 0 0
Accounts Payable 3 0 0 0
Purchased testing supplies.

(3)
5 Accounts Payable 1 0 0
Testing Supplies 1 0 0
Returned portion of testing supplies puchased on Aug. 3.

(4)
17 Cash 2 0 0 0 0
Capital Stock 2 0 0 0 0
Issued 2,500 shares of capital stock at $8 per share.

(5)
22 Cash 6 0 0
Accounts Receivable 6 0 0
Received partial payment for services billed on Aug. 1.

(6)
29 Accounts Payable 2 9 0 0
Cash 2 9 0 0
Paid outstanding balance owed for testing supplies
purchased on Aug. 3.

(7)
30 Dividends 6 8 0 0
Cash 6 8 0 0
Declared and paid a cash dividend.

Solutions Manual Vol. I, Financial and Managerial Accounting 13/e, Williams et al 75

 PROBLEM 3–2
ENVIRONMENTAL SERVICES, INC. (concluded)

c. The realization principle requires that revenue be recorded when it is earned, even if cash for the goods
or services provided has not been received.
d. The matching principle requires that revenue earned during an accounting period be matched (offset)
with expenses incurred in generating this revenue. Testing supplies are recorded as an asset when they
are first purchased. As these supplies are used in a particular accounting period, their cost will be
matched against the revenue earned in that period.

76 © The McGraw-Hill Companies, Inc., 2005

35 Minutes, Medium PROBLEM 3–3
WEIDA SURVEYING, INC.
a.
Income Statement Balance Sheet
Net Owners’
Transaction Revenue − Expenses = Income Assets = Liabilities + Equity
Sept. 1 NE I D D NE D
Sept. 3 I NE I I NE I
Sept. 9 I NE I I NE I
Sept. 14 NE I D NE I D
Sept. 25 NE NE NE NE NE NE
Sept. 26 I NE I I NE I
Sept. 29 NE NE NE D D NE
Sept. 30 NE NE NE D NE D

Solutions Manual Vol. I, Financial and Managerial Accounting 13/e, Williams et al 77

 PROBLEM 3–3
WEIDA SURVEYING, INC. (concluded)
b.
General Journal

Sept. 1 Rent Expense 4400

Cash 4400
Paid September rent.

3 Accounts Receivable 5620

Surveying Revenue 5620
Billed Fine Line Homes for surveying services.

9 Cash 2830
Surveying Revenue 2830
Collected cash from Sunset Ridge Development for
services provided.

14 Advertising Expense 165

Accounts Payable 165
Placed ad in the newspaper to be published on Sept. 20.
Total amount due in 30 days.

25 Cash 5620
Accounts Receivable 5620
Received payment from Fine Line Homes for services
billed on Sept. 3.

26 Cash 400
Accounts Receivable 1490
Surveying Revenue 1890
Collected partial payment from Thompson and billed
remainder.

29 Accounts Payable 165

Cash 165
Paid newspaper for advertisement published on Sept. 20.

30 Dividends 7600
Cash 7600
Declared and paid a cash dividend.

c. Three situations in which a cash payment does not involve an expense include: (1) the payment of a
cash dividend, (2) the payment of a liability for a previously recorded expense, and (3) the purchase of
an asset, including expenses paid in advance such as insurance, rent, and advertising.

78 © The McGraw-Hill Companies, Inc., 2005

50 Minutes, Strong PROBLEM 3–4
AERIAL VIEWS
a.
Income Statement Balance Sheet
Net Owners’
Transaction Revenue − Expenses = Income Assets = Liabilities + Equity
June 1 NE NE NE I NE I
June 2 NE NE NE I I NE
June 4 NE I D D NE D
June 15 I NE I I NE I
June 15 NE I D D NE D
June 18 NE I D D NE D
June 25 NE NE NE NE NE NE
June 30 I NE I I NE I
June 30 NE I D D NE D
June 30 NE I D NE I D
June 30 NE NE NE NE I D

Solutions Manual Vol. I, Financial and Managerial Accounting 13/e, Williams et al 79

 PROBLEM 3–4
AERIAL VIEWS (continued)
b.
General Journal

2005
June 1 Cash 6 0 0 0 0
Capital Stock 6 0 0 0 0
Issued stock to Wendy Winger.

2 Aircraft 2 2 0 0 0 0
Cash 4 0 0 0 0
Notes Payable 1 8 0 0 0 0
Purchased plane from Utility Aircraft.

4 Rent Expense 2 5 0 0
Cash 2 5 0 0
Paid office and hangar rent for June.

15 Accounts Receivable 8 3 2 0
Aerial Photography Revenue 8 3 2 0
Billed customers for first half of June.

15 Salaries Expense 5 8 8 0
Cash 5 8 8 0
Paid salaries for first half of June.

18 Maintenance Expense 1 8 9 0
Cash 1 8 9 0
Paid Hannigan's Hangar for repair services.

25 Cash 4 9 1 0
Accounts Receivable 4 9 1 0
Collected portion of amount billed to customers.

30 Accounts Receivable 1 6 4 5 0
Aerial Photography Revenue 1 6 4 5 0
Billed customers for services rendered through month-end.

30 Salaries Expense 6 0 0 0
Cash 6 0 0 0
Paid salaries through month-end.

30 Fuel Expense 2 5 1 0
Accounts Payable 2 5 1 0
Received bill for fuel used during June.

30 Dividends 2 0 0 0
Dividends Payable 2 0 0 0
Declared dividend payable July 15.

80 © The McGraw-Hill Companies, Inc., 2005

 PROBLEM 3–4
AERIAL VIEWS (continued)
c. Cash
Date Explanation Debit Credit Balance
2005
June 1 6 0 0 0 0 6 0 0 0 0
2 4 0 0 0 0 2 0 0 0 0
4 2 5 0 0 1 7 5 0 0
15 5 8 8 0 1 1 6 2 0
18 1 8 9 0 9 7 3 0
25 4 9 1 0 1 4 6 4 0
30 6 0 0 0 8 6 4 0

Accounts Receivable
Date Explanation Debit Credit Balance
2005
June 15 8 3 2 0 8 3 2 0
25 4 9 1 0 3 4 1 0
30 1 6 4 5 0 1 9 8 6 0

Aircraft
Date Explanation Debit Credit Balance
2005
June 2 2 2 0 0 0 0 2 2 0 0 0 0

Notes Payable
Date Explanation Debit Credit Balance
2005
June 2 1 8 0 0 0 0 1 8 0 0 0 0

Accounts Payable
Date Explanation Debit Credit Balance
2005
June 30 2 5 1 0 2 5 1 0

Solutions Manual Vol. I, Financial and Managerial Accounting 13/e, Williams et al 81

 PROBLEM 3–4
AERIAL VIEWS (continued)
Dividends Payable
Date Explanation Debit Credit Balance
2005
June 30 2 0 0 0 2 0 0 0

Capital Stock
Date Explanation Debit Credit Balance
2005
June 1 6 0 0 0 0 6 0 0 0 0

Dividends
Date Explanation Debit Credit Balance
2005
June 30 2 0 0 0 2 0 0 0

Aerial Photography Revenue

Date Explanation Debit Credit Balance
2005
June 15 8 3 2 0 8 3 2 0
30 1 6 4 5 0 2 4 7 7 0

Maintenance Expense
Date Explanation Debit Credit Balance
2005
June 18 1 8 9 0 1 8 9 0

82 © The McGraw-Hill Companies, Inc., 2005

 PROBLEM 3–4
AERIAL VIEWS (continued)
Fuel Expense
Date Explanation Debit Credit Balance
2005
June 30 2 5 1 0 2 5 1 0

Salaries Expense
Date Explanation Debit Credit Balance
2005
June 15 5 8 8 0 5 8 8 0
30 6 0 0 0 1 1 8 8 0

Rent Expense
Date Explanation Debit Credit Balance
2005
June 4 2 5 0 0 2 5 0 0

Solutions Manual Vol. I, Financial and Managerial Accounting 13/e, Williams et al 83

 PROBLEM 3–4
AERIAL VIEWS (continued)
d. AERIAL VIEWS
Trial Balance
June 30, 2005
Cash $ 86 40
Accounts receivable 1 98 60
Aircraft 22 00 00
Notes payable $1 80 0 0 0
Accounts payable 2 5 1 0
Dividends payable 2 0 0 0
Capital stock 60 0 0 0
Retained earnings 0
Dividends 20 00
Aerial photography revenue 247 70
Maintenance expense 1 8 9 0
Fuel expense 2 5 1 0
Salaries expense 1 1 8 8 0
Rent expense 2 5 0 0
$26 9 2 8 0 $2 692 80

84 © The McGraw-Hill Companies, Inc., 2005

 PROBLEM 3–4
AERIAL VIEWS (concluded)
e.

Total assets:
Cash $ 8 6 4 0
Accounts receivable 1 9 8 6 0
Aircraft 2 2 0 0 0 0
Total assets $2 4 8 5 0 0

Total liabilities:
Notes payable $1 8 0 0 0 0
Accounts payable 2 5 1 0
Dividends payable 2 0 0 0
Total liabilities $1 8 4 5 1 0

Total stockholders’ equity:

Total assets - total liabilities ($248,500 - $184,510) $ 6 3 9 9 0

(Alternate computation—net all owners’ equity accounts, permanent

and temporary:
$60,000 − $2,000 + $24,770 − $1,890 − $2,510 − $11,880 − $2,500)

The above figures are most likely not the amounts to be reported
in the balance sheet dated June 30. The accounting cycle includes
adjustments that must be made to the trial balance figures before
financial statements are prepared. The adjusting process is
covered in Chapter 4.

Solutions Manual Vol. I, Financial and Managerial Accounting 13/e, Williams et al 85

60 Minutes, Strong PROBLEM 3–5
DR. SCHEKTER, DVM
a.
Income Statement Balance Sheet
Net Owners’
Transaction Revenue − Expenses = Income Assets = Liabilities + Equity
May 1 NE NE NE I NE I
May 4 NE NE NE I I NE
May 9 NE NE NE NE NE NE
May 16 NE NE NE I I NE
May 21 NE NE NE NE NE NE
May 24 I NE I I NE I
May 27 NE I D NE I D
May 28 NE NE NE NE NE NE
May 31 NE I D D NE D

86 © The McGraw-Hill Companies, Inc., 2005

 PROBLEM 3–5
DR. SCHEKTER, DVM (continued)
b.
General Journal

2005
May 1 Cash 4 0 0 0 0 0
Capital Stock 4 0 0 0 0 0
Issued 5,000 shares of capital stock.

4 Land 7 0 0 0 0
Building 1 8 0 0 0 0
Cash 1 0 0 0 0 0
Notes Payable 1 5 0 0 0 0
Purchased land and building.

9 Medical Instruments 1 3 0 0 0 0
Cash 1 3 0 0 0 0
Purchased medical instruments.

16 Office Fixtures & Equipment 5 0 0 0 0

Cash 2 0 0 0 0
Accounts Payable 3 0 0 0 0
Purchased fixtures and equipment.

21 Office Supplies 5 0 0 0
Cash 5 0 0 0
Purchased office supplies.

24 Cash 1 9 0 0
Accounts Receivable 3 0 0
Veterinary Service Revenue 2 2 0 0
Recorded veterinary service revenue earned.

27 Advertising Expense 4 0 0
Accounts Payable 4 0 0
Recorded advertising expense incurred in May.

28 Cash 1 0 0
Accounts Receivable 1 0 0
Collected cash for May 24 services.

31 Salary Expense 2 8 0 0
Cash 2 8 0 0
Paid May salary expense.

Solutions Manual Vol. I, Financial and Managerial Accounting 13/e, Williams et al 87

 PROBLEM 3–5
DR. SCHEKTER, DVM (continued)
c.
Cash Notes Payable
May 1 400,000 May 4 100,000 May 4 150,000
May 24 1,900 May 9 130,000
May 28 100 May 16 20,000 May 31 Bal. 150,000
May 21 5,000
May 31 2,800
May31 Bal. 144,200

Accounts Receivable Accounts Payable

May 24 300 May 28 100 May 16 30,000
May 27 400
May 31 Bal. 200 May 31 Bal. 30,400

Office Supplies Capital Stock

May 21 5,000 May 1 400,000

May 31 Bal. 5,000 May 31 Bal. 400,000

Medical Instruments Veterinary Service Revenue

May 9 130,000 May 24 2,200

May 31 Bal. 130,000 May 31 Bal. 2,200

Office Fixtures & Equipment Advertising Expense

May 16 50,000 May 27 400

May 31 Bal. 50,000 May 31 Bal. 400

Land Salary Expense

May 4 70,000 May 31 2,800

May 31 Bal. 70,000 May 31 Bal. 2,800

Building
May 4 180,000

May 31 Bal. 180,000

88 © The McGraw-Hill Companies, Inc., 2005

 PROBLEM 3–5
DR. SCHEKTER, DVM (continued)
d. DR. SCHEKTER, DVM
Trial Balance
May 31, 2005
Cash $14 42 0 0
Accounts receivable 2 0 0
Office supplies 50 0 0
Medical instruments 13 00 0 0
Office fixtures & equipment 5 00 0 0
Land 7 00 0 0
Building 18 00 0 0
Notes payable $1 500 00
Accounts payable 304 00
Capital stock 4 000 00
Retained earnings 0
Veterinary service revenue 22 00
Advertising expense 4 00
Salary expense 28 00
$58 26 00 $5 826 00

Solutions Manual Vol. I, Financial and Managerial Accounting 13/e, Williams et al 89

 PROBLEM 3–5
DR. SCHEKTER, DMV (concluded)
e.

Total assets:
Cash $ 1 4 4 2 0 0
Accounts receivable 2 0 0
Office supplies 5 0 0 0
Medical instruments 1 3 0 0 0 0
Office fixtures & equipment 5 0 0 0 0
Land 7 0 0 0 0
Building 1 8 0 0 0 0
Total assets $ 5 7 9 4 0 0

Total liabilities:
Notes payable $ 1 5 0 0 0 0
Accounts payable 3 0 4 0 0
Total liabilities $ 1 8 0 4 0 0

Total owners' (stockholders’) equity:

Total assets − total liabilities ($579,400 − $180,400) $ 3 9 9 0 0 0

As shown below, the business was not profitable in its first month
of operations:

Veterinary service revenue $ 2 2 0 0

Less: Advertising expense $ 4 0 0

Salary expense 2 8 0 0 3 2 0 0
Net loss $ ( 1 0 0 0 )

Note to Instructor: It is not uncommon for new small businesses

to initially report a net loss from operations. In this particular
situation, there were so few revenue and expense transactions in
May that it is difficult, if not impossible, to draw any conclusions
about the expected performance of the veterinary clinic in the future.

90 © The McGraw-Hill Companies, Inc., 2005

 SOLUTIONS TO CASES
15 Minutes, Medium CASE 3–1
REVENUE RECOGNITION

Revenue is realized in the period that services are rendered to customers or goods are delivered to customers.
Using this principle as a guide, the three independent situations are analyzed below:
a. Period of flight. Airlines earn revenue by rendering a service—transportation—to their customers.
Therefore, revenue should be recognized in the accounting period in which this service is rendered.
(Selling a ticket does not qualify as “delivering goods” to the customer. The ticket is not a “product”—it
is merely a receipt showing that the customer has already made payment for services to be rendered in
the future.)

b. Period furniture sold. In this case the furniture store delivers goods to its customers and acquires an
account receivable at the date of sale. This is the period in which revenue should be recognized, even
though the account receivable may not be collected for many months. Collection of an account
receivable does not produce revenue; this action merely converts one asset (receivable) into another
(cash).

c. Periods that magazines are mailed to customers. The “goods” that a magazine publisher delivers to its
customers are magazines. Thus, the publisher does not earn its revenue until the magazines are delivered
to the customers. (For practical purposes, the act of mailing the magazine may be viewed as “delivery.”)

Solutions Manual Vol. I, Financial and Managerial Accounting 13/e, Williams et al 91

30 Minutes, Strong CASE 3–2
40% OF THIS, NOT THAT!

a. Discussion of “fairness and reasonableness” of income measurement policies:

(1) Given that most revenue is received in cash and that credit terms are constant, recognizing revenue
on a cash basis will cause little distortion in annual results. Thus, it appears “fair and reasonable”—
at least for the first two years. But we should consider that in the last (third) year of the agreement,
this policy will exclude from net income credit sales in December. Stanley may expect some
adjustment for this.
(2) Charging weekly expenditures for business supplies directly to expense is reasonable, but
considering the Morris family’s grocery and dry cleaning bills as expenses of the business is neither
fair nor reasonable (nor legal).
(3) Morris’s salary of $60,000 is “fair and reasonable” because it has been agreed upon by both parties.
But to make additional salary payments of $90,000 per year to Morris family members who worked
only on a part-time basis does not seem to meet the “fair and reasonable” criteria.
(4) Income taxes on the Morris family’s salaries are personal expenses, not expenses of the business. It
is neither fair nor reasonable to deduct these taxes in computing the income of the corporation.
(5) It is not reasonable to report the entire $150,000 value of the equipment as an expense in the first-
year income statement. This equipment will be used by the company for many years to generate
revenue. By assigning the entire cost of the equipment to the first year of operations, Morris has
violated the matching principle. In Chapter 4, we will see how the process of depreciation should be
used to spread the cost of the printing equipment over its estimated useful life.
b. The state-of-the-art printing equipment valued at $150,000 is an asset, not an expense. By reporting the
equipment’s entire $150,000 value as an expense in the company’s first-year income statement, the net
income computed by Morris was probably significantly lower than the net cash flow generated by the
business.

92 © The McGraw-Hill Companies, Inc., 2005

15 Minutes, Easy CASE 3–3
BUSINESS WEEK ASSIGNMENT

In addition to tracking revenue data for each of its soft drink brands, the company also tracks data related to:
• Sales performance by geographic area (both nationally and internationally).
• Market share information.
• Demographic data (e.g., information about soft drink consumption trends by various age groups).
• Information about product cannibalization (when one of the company’s products takes market share
away from another one of its products).
• Distributor information.
• Brand marketing costs (e.g., advertising and other promotional activities).
• Ingredient costs and contracts with the suppliers of ingredients.
• Detailed information about accounts payable to specific suppliers.
• Labor and overhead cost information.
• Inventory locations and the amount of product at each location.
• Shipping and logistics data.
• Customer lists and detailed information about customer accounts receivable.
• Major institutional customers.
• Endorsement contracts (when the company pays a famous figure to promote its products).
• Actual sales performance relative to each brand’s budgeted target performance.
• Quality assurance information.
• Customer feedback and survey information.
• Research and development information.

Solutions Manual Vol. I, Financial and Managerial Accounting 13/e, Williams et al 93

 SOLUTION TO INTERNET ASSIGNMENT
10 Minutes, Easy INTERNET 3–1
REVENUE FROM VARIOUS SOURCES

A recent 10-K report reveals that sales of Macintosh computers represented only 10% of the company’s total
sales, down from nearly 15% just two years prior. The company distributes approximately 42 million
catalogs to potential customers each year.

94 © The McGraw-Hill Companies, Inc., 2005