FINANCIAL ACCOUNTING-II

BBA-FA/ SECOND SEMESTER

Instructor: MR. LALIT MAN SHRESTHA
Lumbini Banijya Campus
Mobile No. : 9857028774
Syllabus
FINANCIAL ACCOUNTING-II
[ACC-202]
Credit Hours: 3 LH: 48

Course Objectives:

The main objective of this course is to provide in-depth knowledge and understanding about current assets,
long-term assets, current liabilities and stockholders' equity in order to enable them to record, analyze and report
information for decision making.

Course Description

This course contains accounting for inventory and cost of goods sold, accounting for cash and internal control,
accounting for receivable, accounting for current liabilities, accounting for long term liabilities and accounting
for stockholders' equity.

Course Contents

Unit 1: Accounting for Inventories and Cost of Goods Sold LH 5

Concept, forms and cost of inventory; Cost of goods sold model; Inventory record system: Periodic and
perpetual system; Inventory costing method with a periodic and perpetual system; inventory valuation and
income measurement; Inventory errors; Inventory estimation: Retail inventory method and gross profit method;
Analyzing the management of inventory: Inventory turnover ratio and number of days' sales in inventory.
Unit 2: Accounting for Cash and Internal Control LH 3

Concept of cash and cash equivalent; Cash book and bank statement; Preparation of bank reconciliation
statement in financial institutions using NFRS; adjusting entries; petty cash fund; introduction to internal
control; internal control procedures.

Unit 3: Accounting for receivables LH 8

Concept of accounts receivable; two methods to accounts for bad debts: direct write off method and allowance
method; Accounting entries for bad debts related transactions; Balance sheet presentation of accounts
receivable; concept of notes receivable; accounting entries for interest bearing and non-interest bearing notes
receivable; Balance sheet presentation of notes receivable; Analyzing the management of accounts receivable:
Accounts receivable turnover ratio and Days' sales outstanding.

Unit 4: Accounting for Operating Assets LH 10

Concept and types of operating assets; Acquisition cost of property, plant and equipment; Depreciation of
property, plant and equipment: Straight-Line Method, Diminishing Balance Method, Units-of-Production
Method, and Double Declining Balance Method; Choice of depreciation method; Disposal of property, plant
and equipment; Change in depreciation estimate; Capital versus Revenue expenditure; Balance sheet
presentation of property, plant and equipment; Analyzing the management of property, plant and equipment:

Unit 5: Accounting for Current Liabilities and Contingencies LH 7

Concept of current liabilities; types of current liabilities: Notes payable, current maturity of long-term debt,
taxes payable and other accrued liabilities; Accounting entries of interest bearing and non-interest bearing notes
payable; Balance sheet presentation of notes payable; Concept of contingent liabilities; Accounting entries of
product warranty and guarantees; Analyzing the management of current liabilities:

Unit 6: Accounting for Long Term Liabilities LH 7

Concept of long term liabilities; Concept and characteristics of bonds payable; Accounting entries for issuance,
amortization and redemption of bonds payable; Balance sheet presentation of bonds payable; Concept and types
of leases; Acquisition of capital lease; depreciation of leased asset; Amortization of lease obligation; Balance
sheet presentation of lease obligation; Analyzing the management of long-term debt.

Unit 7: Accounting for Stockholders' Equity LH 8

Concept of stockholders' equity; Components of stockholders' equity: Common stock, preferred stock,
additional paid-in capital, and retained earnings; Balance sheet presentation of stockholders' equity; Accounting
entries for issuance of stock; Accounting entries for treasury stock; Distribution of cash dividend to preferred
and common stock; Accounting entries for cash and Stock dividend; stock split and its effect on stockholders'
equity; Book value per share; Analyzing the management of stockholders' equity.
Suggested Readings
Kimmel, P., Weygandt, J., &Kieso, D. (2011).Financial Accounting: Tools for Business Decision Making(5 th
Edition).
Narayanaswamy, R. (2011). Financial Accounting: A Managerial Perspective (Fourth Edition). New Delhi:
PHI Learning Private Limited.
Porter, G. A., & Norton, C. L. (2013).Introduction to Financial Accounting (8th Edition).

Chapter

Accounting for Inventory

and Cost of Goods Sold

Inventory:
Inventory can be defined as tangible property held for sale in the ordinary course of business or in the process of production for such
sale, or for consumption the production of goods or services for sale. Inventory encompasses goods purchased and held for resale.
Retailers and wholesalers purchase inventory in finished form and hold it for resale. In contrast, manufacturer transforms raw
materials into a finished product prior to sale. Whether a company is a wholesaler, retailer, or manufacturer, its inventory is an asset
that is held for resale in the normal course of business. Therefore, inventories include finished goods, work in progress, and raw
materials. However inventories do not include an operating asset.
Three Types of Inventory Cost and Three Forms of Inventory:
The cost of inventory to a merchandiser (wholesaler and retailer) is limited to the product’s purchase price. On the balance sheet
they use a single account for inventory, titled merchandise inventory.
Three distinct types of costs are incurred by a manufacturer. They are direct material, direct labour, and manufacturing overhead. In
addition the three types of cost incurred in production process, the inventory of manufacturer takes distinct forms. The three forms
or stages in the development of inventory are raw materials, work in process and finished goods.
The Cost of Goods Sold:
Cost of goods sold is the cost to the seller of goods sold to customers and it is the largest item of expense for merchandising and
manufacturing companies. The recognition of cost of goods sold as an expense is an excellent example of the matching principle. The
company needs to match the revenue of the period with one of the most important costs necessary to generate the revenue, the
cost of goods sold. The cost of goods sold is calculated as follows:
Beginning Inventory *****
Add: Cost of goods purchased *****
Cost of goods available for sales *****
Less: Ending inventory *****
Cost of goods sold *****
Cost of Goods Purchased:
Purchase ****
Less: Purchase return and allowance ****
Less: Purchase discount ****
Net Purchase ****
Add: Transportation-in ****
Cost of goods purchased ****
Notes:
Certain cost may also be included in the price paid:
 Any freight costs incurred by the buyer.
 Insurance cost during the time that inventory is in transit
 Various types of taxes paid, such as excise and sales taxes.
 The cost of storing inventory before the time it is ready to be sold.
 Other cost necessary to put the inventory into position to be able to sell it.
Inventory Record System
There are two principal system of determining the physical quantities and monetary value of inventories sold and in hand. They are:
1. Periodic inventory system: Periodic inventory system is a method of ascertaining inventory by taking an actual physical count of
all the inventory items on hand at a particular date on which inventory is required. This system is based on actual physical
count. So, it is also updated only at the end of the period. The cost of goods sold is determined as shown below:
Opening inventory (Known) ****
Add: Purchase (Known ****
Cost of goods available for sales ****
Less: Ending inventories (Physical Counted) ****
Cost of goods sold ****
Limitations:
 Physical stock taking is required more than once a year for preparation of quarterly or half yearly financial statement there
by making this system more expensive.
 Physical count of goods requires closure of normal operation of business.
 As cost of goods sold is taken as residual figure, it includes loss of goods during the year.
 Inventory control is not possible under this system.
2. Perpetual Inventory System: Under perpetual system, the inventory account is updated perpetually or after each sale or purchase
of merchandise. In a perpetual system, every time goods are purchased, the inventory account is increased. When goods are sold,
the accountant also records an entry to recognize the cost of goods sold and the decrease in the cost of inventory on hand.
Not long ago, only companies that sold a limited range of product with high value used the perpetual inventory system because the
cost and effort of maintaining the system were too high for most types of business. However, with the availability of computers at
relatively low costs, many firms are switching from periodic to perpetual inventory system.
Distinction between Periodic and Perpetual Inventory System.
S.N. Perpetual system S.N. Periodic system
1. The inventory account is updated 1. The inventory account is updated only
perpetually or after each sales or purchase periodically after a physical count has been
of goods. made.
2. Sales revenue and cost of goods sold 2. Sales revenue is booked when a sale is
recorded simultaneously when a sale is made but not cost of goods sold.
made.
3. Perpetual inventory system does not 3. Periodic system requires a purchase
require a purchase account or a purchase account or a purchase return and
return and allowances account. allowance account.
4. Under the perpetual inventory system, 4. Under the perpetual inventory system, one
there is no entry to record the ending must record the ending inventory and
inventory since a continuous record of transfer account related to inventory, such
inventory is available. The closing entries as merchandise inventory (Beginning),
simply transfer the balance in the COGS purchase and purchase return and
account to profit and loss account. allowance to profit and loss account.
5. Key advantage is information availability. 5. Key advantage is low cost.
6. Key disadvantage is costly. 6. Key disadvantage is lack of readily available
inventory.
Accounting Entries under Periodic and Perpetual Inventory System:
S.N. Periodic System S.N. Perpetual System
1 For purchase of merchandise: 1 For purchase of merchandise:
. Purchase a/c Dr. . Inventory a/c Dr
To account payable or Cash a/c To Accounts payable or Cash a/c
2 For Purchase return: 3 For Purchase return:
. Account payable a/c Dr Account Payable a/c Dr
To purchase return and all. a/c To Inventory a/c
3 For payment of transportation-in 3 For payment of transportation-in
. Transportation-in Dr . Inventory Dr
To Cash To Cash
4 For paid to supplier: 4 For paid to supplier:
Account Payable a/c Dr Account Payable a/c Dr
To Cash a/c To Cash a/c
To Purchase discount To Inventory
5 For sales of merchandise: 2 For sales of merchandise:
. Cash or account receivable a/c Dr .  Cash/ acc. Receivable a/c Dr
To Sales a/c
To Sales a/c
  Cost of goods sold a/c Dr
To Inventory a/c
6 For Sales return and allowance 6 For sales return and allowance
. Sales return and allowance Dr  Sales return and allowance Dr
To cash or a/c receivable
To Cash or accounts receivable

 Inventory Dr
To Cost of goods sold

Inventory costing methods:

1. Specific Identification Method:
This method assigns specific cost to each unit sold and each unit on hand. This method may be used if the units in the
ending inventory can be identified as coming from specific purchases. This method is based on actual physical flow of
goods. The specific identification method is based on actual physical flow of goods. The specific identification method is
particularly suited to inventories of high-value, low volume items such as jewelers, automobile, appliance, furniture etc. the
specific identification method does not involve any assumption about cost flow. It matches the cost to the physical flow of
the inventory and eliminates the effect of cost flow assumption on reported net profit. The method is costly to implement.
Beside it is unlikely to produce better information when the inventory consists of homogenous or high-volume items.
2. First-in, First-out (FIFO): This method assumes that the first units acquired are the first unit sold. Therefore, the cost of the
units in the ending inventory is that of the most recent purchases.
A major criticism of FIFO is that it leads to an improper matching of cost with revenues since the cost of goods sold is
computed on the basis of old prices that are possibly unrealistic.
3. Last-in, First-out (LIFO):
This method assumes that the last units acquired are the first unit sold. Therefore, the cost of the units in the ending
inventory is that of the earliest purchases.
The LIFO cost of goods sold will be a good approximation of the current cost of the units sold. The chief disadvantage of
LIFO is that the balance sheet value of inventory may be outdated and unrealistic.
4. Weighted-Average Cost (WAC):
This method assumes that the goods available for sale are homogeneous. The average cost is computed by dividing the cost
of goods available for sale, which consists of the cost of the beginning inventory and all purchases, by the number of units
available for sale. The weighted-average unit cost that results from this computation is applied to find out the value of
ending inventory and cost of goods sold.
WAC is appropriate when the inventory units involved are homogeneous or when it is difficult to make a cost flow
assumption. The major criticism of WAC is that it assigns no more importance to current prices than to past prices paid
several months ago.
Cost of goods available for sales
WAC =
Units available for sales
Now,
Cost of goods sold = Units Sold × WAC
 Ending Inventory = Units Unsold × WAC
Comparing Alternative Inventory Costing System
Of the above four most common methods for costing inventory, the specific identification method is based on actual costs, whereas
the other three methods are based on cost flow assumption. We can summarize the effects of FIFO, LIFO and WAC on ending
inventory, cost of goods sold and gross profit.
Direction of price change Ending Inventory Cost of Goods Sold Gross Profit
Increasing FIFO>WAC>LIFO LIFO>WAC>FIFO FIFO>WAC>LIFO
Constant FIFO=WAC=LIFO FIFO=WAC=LIFO FIFO=WAC=LIFO
Decreasing LIFO>WAC>FIFO FIFO>WAC>LIFO LIFO>WAC>FIFO
Inventory valuation and Income Measurement:
We obtain the cost of goods sold by deducting ending inventory form the cost of goods available for sale. The cost assigned to the
ending inventory directly affects the determination of cost of goods sold. Thus, if we assign a higher value to the ending inventory,
the cost of goods sold will decrease and the gross profit will increase. In contrast, if we assign a lower value to the ending inventory,
the cost of goods sold will increase and the gross profit will decrease. Clearly, inventory valuation affects both the profit and loss
account and the balance sheet.
Selecting an Inventory Costing Method
Which method should a business select? The answer depends on many factors, such as the effect of each method on balance sheet,
profit and loss account and income tax. Here is a summary of the method:
 FIFO inventory value is more realistic since it is closer to current cost, but it produces a net profit unrelated to current input
cost.
 LIFO does a fair job of matching current selling prices and cost of goods sold, which is closer to current replacement cost,
but often produces an outdated inventory value.
 Both LIFO and WAC allow a business to manipulate net profit by changing the timing of additional purchases.
Method of Inventory Estimation:
In a periodic inventory system, a physical inventory must be taken to determine the ending inventory value. Since frequent
inventory taking disrupt normal operations and involves considerable expense, a physical inventory is usually taken at the end of the
accounting period; however, management needs to prepare interim financial statements (quarterly or half-yearly) to report to the
shareholders and to monitor the performance of the company. Besides, there are occasions when physical inventory cannot be
taken and must be estimated, such as when the inventory has been destroyed by fire or flood, in such cases, estimates are needed
for insurance claims. Estimation procedures, if they are reasonable, are also useful to test the accuracy of a perpetual inventory,
taken by an enterprise’s employees. The commonly used estimation techniques are:
1. Retail Inventory Method: We estimate the ending inventory as follows:
 Compute the amount of goods available for sales both at cost and at retail.
 Divide the goods available for sale at cost by the goods available at retail to obtain the ratio of cost to retail.
 Deduct sales form goods available for sale at retail to determine the ending inventory at retail.
 Multiply the ending inventory at retail by the ratio of cost at retail to convert the inventory into cost.
2. Gross Profit Method:
Under the gross profit method, we estimate the amount of ending inventory as follows:
 Compute the cost of goods available for sale.
 Estimate the cost of goods sold by deducting the gross profit from sales.
  Deduct the estimated cost of goods sold from the cost of goods available for sale to arrive at the estimated ending
inventory.
Ratio Relating to Inventory
Inventory (Stock) Turnover Ratio: Inventory turnover ratio indicates the number of times the inventory is replaced during the year.
The ratio shows, how rapidly the inventory is turning into receivables through sales. Inventory turnover measures the relationship
between the costs of goods sold and the inventory level. The ratio shows the efficiency of inventory management. It can be compared
either with the level of the other firm in the same industry or over a period of time on the basis of trend analysis. A higher the ratio
indicates the better efficiency of the inventory management of the firm.
Inventory turnover ratio =
In the absence of the cost of goods sold and Average inventory the following formula can be used for calculation of inventory
turnover ratio.
Inventory turnover ratio =
Average holding period/ Inventory holding period/ Days in inventory: Average holding period is used to determine how quickly a
company is converting their inventory into sales. The formula to calculate days in inventory is the number of days in the period
divided by the inventory turnover ratio. A slower turnaround on sales may be a warning sign that there are problems internally, such
as brand image or the product, or externally, such as an industry downturn or the overall economy.

Days∈a year
Average holding period =
Inventory Turnover Ratio

 Practical Problems with Solution

Problem 1: Cost of goods sold
The following amounts are taken from White Wholesalers’ records. (All amounts are for 2010.)
Inventory, January 1 $14,200
Inventory, December 31 10,300
Purchases 87,500
Purchase discounts 4,200
Purchase returns and allowances 1,800
Transportation-in 4,500
Required: Prepare the Cost of Goods Sold section of White’s 2010 income statement.
Solution:
Cost of Goods Sold
Inventory, January 1 14,200
Add: Cost of goods purchased (WN) 77,000
Total cost of goods available for sales 91,200
Less: Inventory, December 31 10,300
Cost of goods sold 80,900
Cost of goods purchased
Purchase 87,500
Less: Purchase return and allowance 1,800
Less: Purchase discount 4,200
Net purchase 81,500
Add: Transportation-in 4,500
Cost of goods purchased 77,000
Problem 2: Missing Amounts in Cost of Goods Sold Model
For each of the following independent cases, fill in the missing amounts.
Case 1 Case 2 Case 3
Beginning inventory ? $2,350 $1,890
Purchases (Gross) 6,230 5,720 ?
Purchase return and allowance 470 800 550
Purchase discount 200 ? 310
Transportation-in 150 500 420
cost of goods available for sale 7,110 ? 8,790
Ending inventory ? 1,750 1,200
Cost of goods sold 5,220 5,570 ?
Problem 3: Periodic System
Journalize each of the following transactions of Buckeye Corporation. (All purchases on credit are made with terms of
1/10, n/30, and Buckeye uses the periodic system of inventory.)
July 3 : Purchased merchandise on credit from Wildcat Corp. for $3,500.
July 6 : Purchased merchandise on credit from Cyclone Company for $7,000.
July 12 : Paid amount owed to Wildcat Corp.
August 5 : Paid amount owed to Cyclone Company.
Solution
Journal Entries
Date Particulars LF Debit Rs. Credit Rs.
July 3 Purchase Dr 3,500
To Accounts payable 3,500
(To record purchase of merchandise)
July 6 Purchase Dr 7,000
To Accounts payable 7,000
(To record purchase of merchandise)
July 12 Accounts payable Dr 3,500
To Cash 3465
To Purchase discount 35
(To record amount paid to Wildcat Corp.)
August 5 Accounts payable Dr 7,000
To Cash 7,000
(To record amount paid to Cyclone Company)
Problem 4: Periodic System
Identify and analyze each of the following transactions of Wolverine Corporation. The company uses the periodic
system.
March 3 : Purchased merchandise from Spartan Corp. for $2,500 with terms of 2/10, n/30.
Shipping costs of $250 were paid to Neverlate Transit Company.
March 7 : Purchased merchandise from Boilermaker Company for $1,400 with terms of n/30.
March 12 : Paid amount owed to Spartan Corp.
March 15 : Received a credit of $500 on defective merchandise purchased from Boilermaker
Company. The merchandise was kept.
March 18 : Purchased merchandise from Gopher Corp. for $1,600 with terms of 2/10, n/30.
March 22 : Received a credit of $400 from Gopher Corp. for spoiled merchandise returned to
Gopher. This is the amount of credit exclusive of any discount.
April 6 : Paid amount owed to Boilermaker Company.
April 18 : Paid amount owed to Gopher Corp.
Solution
Journal Entries
Date Particulars LF Debit Rs. Credit Rs.
March 3 Purchase Dr 2,500
Transportation-in Dr 250
To Accounts payable 2,500
To Cash 250
(To record purchase of merchandise from Spartan Corp.)
March 7 Purchase Dr 1,400
To Accounts payable 1,400
(To record purchase of goods from Boilermaker Co,)
 March 12 Account payable Dr 2,500
To Purchase discount 50
To Cash 2,450
(To record amount paid to Spartan Corp.)
March 15 Accounts payable Dr 500
To Purchase return and allowance 500
(To record credit received on defective items from Boilermaker)
March 18 Purchase Dr 1,600
To Account payable 1,600
(To record purchase of goods from Gopher Corp.)
March 22 Account payable Dr 400
To Purchase return and allowance 400
(To record goods returned to Gopher Corp.)
April 6 Accounts payable Dr 900
To Cash 900
(To record payment made to Boilermaker Co.)
April 18 Accounts payable Dr 1,200
To Cash 1,200
(To record amount paid to Gopher Corp.)

Problem 5: Inventory Costing Methods-Periodic

VanderMeer Inc. reported the following information for the month of February:
Inventory, February 1 65 units @ $20
Purchases:
February 7 50 units @ $22
February 18 60 units @ $23
February 27 45 units @ $24
During February, VanderMeer sold 140 units. The company uses a periodic inventory system.
Required:
What is the value of ending inventory and cost of goods sold for February under the following assumptions:
1. Specific identification method (Of the 140 units sold, 55 cost $20, 35 cost $22, 45 cost $23, and 5 cost $24.)
2. FIFO
3. LIFO
4. Weighted average
Solution
Details Units Units Cost Amount
Feb 1 Beginning inventory 65 20 1,300
Feb 7 Purchase 50 22 1,100
Feb 18 Purchase 60 23 1,380
Feb 27 Purchase 45 24 1,080
Total Goods Available for Sales 220 4,860
Less: Sold 140 ?
Ending inventory 80 ?
Required 1: Specific Identification Method
Cost of Goods Sold
55 units @$20 1,100
35 units @$22 770
45 units @$23 1,035
5 units @$24 120
Cost of goods sold 3,025

Ending Inventory
Cost of goods available for sales 4,860
Less: Cost of goods sold 3,025
Ending Inventory 1,835
Required 2: FIFO
Cost of Goods Sold
65 units @$20 1,300
 50 units @$22 1,100
25 units @$23 575
Cost of goods sold 2,975

Ending Inventory
Cost of goods available for sales 4,860
Less: Cost of goods sold 2,975
Ending Inventory 1,885
Required 3: LIFO
Cost of Goods Sold
45 units @$24 1,080
60 units @$23 1,380
35 units @$22 770
Cost of goods sold 3,230

Ending Inventory
Cost of goods available for sales 4,860
Less: Cost of goods sold 3,230
Ending Inventory 1,630
Required 4: Weighted Average
Cost of goods available for sales 4,860
WAC = = =22.09
total units available for sales 220
Cost of goods sold = Units sold × WAC = 140 × 22.09 = 3,093
Ending Inventory = Units unsold × WAC = 80 × 22.09 =1,767
Problem 6: Inventory Costing Method-Periodic
Stewart Distributing Company sells a single product for $2 per unit and uses a periodic inventory system. The
following data are available for the year:
Date Transactions No. of units Unit cost Total
1/1 Beginning inventory 500 $1.00 $500.00
2/5 Purchase 350 1.10 385.00
4/12 Sale (550)
7/17 Sale (200)
9/23 Purchase 400 1.30 520.00
11/5 Sale (300)
Required:
1. Compute cost of goods sold and ending inventory assuming the company uses:
a. FIFO b. LIFO c. Weighted average cost
2. Compute gross profit under each of the three methods.
3. Assume a 40% tax rate. Compute the amount of taxes saved if Stewart uses the LIFO method rather than the FIFO
method.
Solution:
Required 1
Details Units Units Amount
Cost
1/1 Beginning inventory 500 1.00 500.00
2/5 Purchase 350 1.10 385.00
9/23 Purchase 400 1.30 520.00
Goods available for sales 1,250 1,405
Less: Sold 1,050 ?
200 ?

a) FIFO
 Cost of Goods Sold
500 units @$1.00 500
350 units @$1.10 385
200 units @$1.30 260
Cost of goods sold 1,145

Ending Inventory
Cost of goods available for sales 1,405
Less: Cost of goods sold 1,145
Ending Inventory 260
b) LIFO

Cost of Goods Sold

400 units @$ 1.30 520
350 units@$ 1.10 385
300 units @$ 1.00 300
Cost of goods sold 1,205

Ending Inventory
Cost of goods available for sales 1,405
Less: Cost of goods sold 1,205
Ending Inventory 200
c) Weighted average cost
Cost of goods available for sales 1405
WAC = = =1.124
total units available for sales 1250
Cost of goods sold = Units sold × WAC = 1050 × 1.124 = 1,180.20
Ending Inventory = Units unsold × WAC = 200 × 1.124 =224.80
Required 2
Income Statement
FIFO WAC LIFO
Sales Revenue (1,050 * 2) 2,100 2,100 2,100
Less: Cost of goods sold 1,145 1,180.20 1,205
Gross profit 955 919.80 895
Less: Operating expense Nil Nil Nil
Net income before tax 955 919.80 895
Less: Tax @ 40% 398 368 358
Net income after tax 557 551.80 537
Required 3: The amount of tax saved is $40 if Stewart uses the LIFO method rather than the FIFO method.
Problem 7: Inventory Costing Methods—Periodic System
Following is an inventory acquisition schedule for Weaver Corp. for 2010:
Units Unit Cost
Beginning inventory 5,000 $10
Purchases:
February 4 3,000 9
April 12 4,000 8
September 10 2,000 7
December 5 1,000 6
During the year, Weaver sold 12,500 units at $12 each. All expenses except cost of goods sold and taxes amounted to
$20,000. The tax rate is 30%.
Required:
1. Compute cost of goods sold and ending inventory under each of the following three methods assuming a periodic
inventory system: (a) weighted average, (b) FIFO, and (c) LIFO.
 2. Prepare income statements under each of the three methods.
3. Which method do you recommend so that Weaver pays the least amount of taxes during 2010? Explain your answer.
Solution:
Details Units Units Cost Amount
Beginning inventory 5000 10 50000
Feb 4 Purchase 3000 9 27000
April 12 Purchase 4000 8 32000
Sept 10 Purchase 2000 7 14000
Dec 5 Purchase 1000 6 6000
Goods available for sales 15000 129000
Less: Sold 12500 ?
Ending inventory 2500 ?
Required 1
a) Weighted Average
Cost of goods available for sales 129000
WAC = = =8.60
total units available for sales 15000
Cost of goods sold = Units sold × WAC = 12500 × 8.60 = 107500
Ending Inventory = Units unsold × WAC = 2500 × 8.60 = 21500
b) FIFO
Cost of Goods Sold
5000 units @$10 50,000
3000 units @$9 27,000
4,000 units @$8 32,000
500 units @$7 3,500
Cost of goods sold 112,500

Ending Inventory
Cost of goods available for sales 129,000
Less: Cost of goods sold 112,500
Ending Inventory 16,500
c) LIFO
Cost of Goods Sold
1000 units @$6 6,000
2000 units @$7 14,000
4000 units @$8 32,000
3,000 units @$9 27,000
2500 units @$10 2,500
Cost of goods sold 104,000

Ending Inventory
Cost of goods available for sales 129,000
Less: Cost of goods sold 104,000
Ending Inventory 25,000
Required 2
Income Statement
FIFO WAC LIFO
Sales Revenue (12,500*12) 150000 15000 150000
0
Less: Cost of goods sold 112500 10750 104000
0
Gross profit 37500 42500 46000
Less: Operating expense 20000 20000 20000
Net income before tax 17500 22500 26000
 Less: Tax @ 30% 5250 6750 7800
Net income after tax 12250 15750 18200
Required 3: Cost of goods sold of Weaver Co. is more under FIFO method, which result less net income before tax.
therefore, Weaver pays the least amount of taxes during 2010 under FIFO method by $2550.
Problem 8: Inventory Costing Methods—Periodic System
Following is an inventory acquisition schedule for Fees Corp. for 2010:
Units Unit Cost
Beginning inventory 4,000 $20
Purchases:
February 4 2,000 18
April 12 3,000 16
September 10 1,000 14
December 5 2,500 12
During the year, Fees sold 11,000 units at $30 each. All expenses except cost of goods sold and taxes amounted to
$60,000. The tax rate is 30%.
Required:
1. Compute cost of goods sold and ending inventory under each of the following three methods assuming a periodic
inventory system: (a) weighted average, (b) FIFO, and (c) LIFO.
2. Prepare income statements under each of the three methods.
3. Which method do you recommend so that Fees pays the least amount of taxes during 2010? Explain your answer.
Solution

Details Units Units Cost Amount

Beginning inventory 4000 20 80,000
Purchase, Feb 4 2000 18 36,000
Purchase, April 12 3000 16 48,000
Purchase, Sept 10 1000 14 14,000
Purchase, Dec 5 2500 12 30,000
Goods available for sales 12500 208,000
Less: Sold 11,000 ?
Ending inventory 1,500 ?
Required 1
a) Weighted Average
Cost of goods available for sales 208000
WAC = = =16.64 per unit
total units available for sales 12500
Cost of goods sold = Units sold × WAC = 11,000 × 16.64 = 183,040
Ending Inventory = Units unsold × WAC = 1,500 × 16.64 = 24,960
b) FIFO
Cost of Goods Sold
4000 Units @$20 80,000
2000 units @$18 36,000
3000 units @$16 48,000
1000 units @$ 14 14,000
1000 units @$ 12 12,000
Cost of goods sold 190,000

Ending Inventory
Cost of goods available for sales 208,000
190,000
Ending Inventory 18,000
c) LIFO
Cost of Goods Sold
2500 units @$12 30,000
 1000 units @$ 14 14,000
3000 units @$ 16 48,000
2000 units @$ 18 36,000
2500 units @$ 20 50,000
Cost of goods sold 178,000

Ending Inventory
Cost of goods available for sales 208,000
Less: Cost of goods sold 178,000
Ending Inventory 30,000
Required 2
Income Statement
FIFO WAC LIFO
Sales Revenue (11,000*30) 330,00 330,000 330,000
0
Less: Cost of goods sold 190,00 183,040 178,000
0
Gross profit 140,00 146,960 152,000
0
Less: Operating expense 60,000 60,000 60,000
Net income before tax 80,000 86,960 92,000
Less: Tax @ 30% 24,000 26,088 27,600
Net income after tax 56,000 60,872 64,400
Required 3: Cost of goods sold of Fees Corp. is more under FIFO method, which result less net income before tax.
Therefore, Fees Corp. pays the least amount of taxes during 2010 under FIFO method by $3,600.

Problem 9: Inventory Costing Methods-Periodic System

The following information is available concerning the inventory of Carter Inc.:
Units Unit Cost
Beginning inventory 200 $10
Purchases:
March 5 300 11
June 12 400 12
August 23 250 13
October 2 150 15
During the year, Carter sold 1,000 units. It uses a periodic inventory system.
Required
1. Calculate ending inventory and cost of goods sold for each of the following three methods:
a. Weighted average
b. FIFO
c. LIFO
2. Assume an estimated tax rate of 30%. How much more or less (indicate which) will Carter pay in taxes by using
FIFO instead of LIFO? Explain your answer.

Solution:

Details Units Units Cost Amount

Beginning inventory 200 10 2000
Purchase, March 5 300 11 3300
Purchase, June 12 400 12 4800
 Purchase, August 23 250 13 3250
Purchase, October 2 150 15 2250
Goods available for sales 1300 15,600
Less: Sold 1000 ?
Ending inventory 300 ?
Required 1
d) Weighted Average
Cost of goods available for sales 15600
WAC = = =12 per unit
total units available for sales 1300
Cost of goods sold = Units sold × WAC = 1000 × 12 = 12,000
Ending Inventory = Units unsold × WAC = 300 × 12 = 3,600
e) FIFO
Cost of Goods Sold
200 units @$10 2000
300 units @$11 3300
400 units @$12 4800
100 units @$13 1300
Cost of goods sold 11,400

Ending Inventory
Cost of goods available for sales 15600
Less: Cost of goods sold 11400
Ending Inventory 4200
f) LIFO
Cost of Goods Sold
150 units @$15 2250
250 units @$ 13 3250
400 units @$ 12 4800
200 units @$11 2200
Cost of goods sold 12500

Ending Inventory
Cost of goods available for sales 15600
Less: Cost of goods sold 12500
Ending Inventory 3100
Required 2
COGS under FIFO 11400
COGS under LIFO 12500
Less expense under FIFO 1100
(×) Tax Rate 30%
More tax payable under FIFO than LIFO 330

Problem 10: Inventory Costing Methods—Periodic System

Bitten Company’s inventory records show 600 units on hand on October 1 with a unit cost of $5 each. The following
transactions occurred during the month of October:
Date Unit Purchases Unit Sales
October 4 500 @ $10.00
8 800 @ $5.40
9 700 @ $10.00
18 700 @ $5.76
20 800 @ $11.00
29 800 @ $5.90
All expenses other than cost of goods sold amount to $3,000 for the month. The company uses an estimated tax rate of
30% to accrue monthly income taxes.
Required:
1. Prepare a chart comparing cost of goods sold and ending inventory using the periodic system and the following
costing methods:
Cost of Goods Sold Ending Inventory Total
Weighted average
FIFO
LIFO
2. What does the Total column represent?
3. Prepare income statements for each of the three methods.
4. Will the company pay more or less tax if it uses FIFO rather than LIFO? How much more or less?
Solution:

Details Units Units Cost Amount

Beginning inventory, Oct 1 600 5 3000
Purchase, Oct 8 800 5.40 4,320
Purchase, Oct 18 700 5.76 4,032
Purchase, Oct 29 800 5.90 4,720
Goods available for sales 2,900 16,072
Less: Sold 2,000 ?
Ending inventory 900 ?
Required 1
a) Weighted Average
Cost of goods available for sales 16,072
WAC = = =5.5420 per unit
total units available for sales 2900
Cost of goods sold = Units sold × WAC = 2000 × 5.5420 = 11,084
Ending Inventory = Units unsold × WAC = 900 × 5.5420 = 4,988
b) FIFO
Cost of Goods Sold
600 units @$5.00 3000
800 units @$5.40 4320
600 units @$5.76 3456
Cost of goods sold 10,776

Ending Inventory
Cost of goods available for sales 16072
Less: Cost of goods sold 10776
Ending Inventory 5,296
c) LIFO
Cost of Goods Sold
800 units @$ 5.90 4,720
700 units @$ 5.76 4,032
500 units @$ 5.40 2,700
Cost of goods sold 11,452

Ending Inventory
Cost of goods available for sales 16,07
2
Less: Cost of goods sold 11,45
2
Ending Inventory 4,620
Cost of goods sold Ending Inventory Total
 Weighted avverage 11,084 4,988 16,072
FIFO 10,776 5,296 16,072
LIFO 11,452 4,620 16,072
Required 2: Total column represents cost of goods available for sales.
Required 3:

Income Statement
FIFO WAC LIFO
Sales Revenue 20800 20800 20800
Less: Cost of goods sold 10776 11084 11452
Gross profit 10024 9716 9348
Less: Operating expense 3000 3000 3000
Net income before tax 7024 6716 6348
Less: Tax @ 30% 2107 2015 1904
Net income after tax 4,917 4701 4444
Required 4: The company will pay more tax of $ 203 (2107 – 1904) if it uses FIFO rather than LIFO.
Problem 11: Inventory Costing Methods—Periodic System
Stellar Inc.’s inventory records show 300 units on hand on November 1 with a unit cost of $4 each. The following
transactions occurred during the month of November:
Date Unit Unit Sales
Purchases
November 4 200 @ $9.00
8 500 @ $4.50
9 500 @ $9.00
18 700 @ $4.75
20 400 @ $9.50
29 600 @ $5.00
All expenses other than cost of goods sold amount to $2,000 for the month. The company uses an estimated tax rate of
25% to accrue monthly income taxes.
Required:
1. Prepare a chart comparing cost of goods sold and ending inventory using the periodic system and the following
costing methods:
Cost of Goods Sold Ending Inventory Total
Weighted average
FIFO
LIFO
2. What does the Total column represent?
3. Prepare income statements for each of the three methods.
4. Will the company pay more or less tax if it uses FIFO rather than LIFO? How much more or less?
Solution
Details Units Units Cost Amount
Beginning inventory, Nov 1 300 4 1200
Purchase, Nov 8 500 4.50 2250
Purchase, Nov 18 700 4.75 3325
Purchase, 29 600 5 3000
Goods available for sales 2100 9,775
Less: Sold 1100 ?
Ending inventory 1000 ?
Required 1
a) Weighted Average
Cost of goods available for sales 9775
WAC = = =4.6547 per unit
total units available for sales 2100
Cost of goods sold = Units sold × WAC = 1100 × 4.6547 = 5120
 Ending Inventory = Units unsold × WAC = 1000 × 4.6547 = 4655
b) FIFO
Cost of Goods Sold
300 units @$ 4.00 1200
500 units @$ 4.50 2250
300 units @$ 4.75 1425
Cost of goods sold 4875

Ending Inventory
Cost of goods available for sales 9775
Less: Cost of goods sold 4875
Ending Inventory 4900
c) LIFO
Cost of Goods Sold
600 units @$ 5.00 3000
500 units @$ 4.75 2375
Cost of goods sold 5375

Ending Inventory
Cost of goods available for sales 9775
Less: Cost of goods sold 5375
Ending Inventory 4400

Cost of goods sold Ending Inventory Total

Weighted average 5120 4655 9775
FIFO 4875 4900 9775
LIFO 5375 4400 9775

Required 2: Total column represents cost of goods available for sales.

Required 3:

Income Statement
FIFO WAC LIFO
Sales Revenue 10,100 10,100 10,100
Less: Cost of goods sold 4875 5120 5375
Gross profit 5225 4,980 4725
Less: Operating expense 2000 2000 2000
Net income before tax 3225 2980 2725
Less: Tax @ 25% 806 745 681
Net income after tax 2419 2235 2044
Required 4: The company will pay more tax of $ 375 (2419 – 2044) if it uses FIFO rather than LIFO.

Problem 12: Inventory Costing Methods—Periodic System

Oxendine Company’s inventory records for the month of November reveal the following:
Inventory, November 1 200 units @ $18.00
November 4, purchase 250 units @ $18.50
November 7, sale 300 units @ $42.00
November 13, purchase 220 units @ $18.90
November 18, purchase 150 units @ $19.00
November 22, sale 380 units @ $42.50
November 24, purchase 200 units @ $19.20
November 28, sale 110 units @ $43.00
Selling and administrative expenses for the month were $10,800. Depreciation expense was $4,000. Oxendine’s tax
rate is 35%.
Required
1. Calculate the cost of goods sold and ending inventory under each of the following three methods assuming a
periodic inventory system: (a) FIFO, (b) LIFO, and (c) weighted average.
2. Calculate the gross profit and net income under each costing assumption.
3. Under which costing method will Oxendine pay the least taxes? Explain your answer.
Solution
Calculation Table
Date Particulars Unit Unit cost Amount
1-Nov Beginning inventory 200 18 3600
4-Nov Purchase 250 18.5 4625
13-Nov Purchase 220 18.9 4158
18-Nov Purchase 150 19 2850
24-Nov Purchase 200 19.2 3840
Goods available for sales 1020 19073
Less: Sold (300+380+110) 790 ?
Ending inventory 230 ?
Required 1
a) FIFO
Cost of goods sold
200 units @$18 3600
250 units @18.50 4625
220 units @$18.90 4158
120 units @$19 2280
Cost of goods sold 14663

Enging Inventory
30 units @$19 570
200 units @$19.2 3840
Ending inventory 4410

b) LIFO
Cost of goods sold
200 units @$19.2 3840
150 units @$19 2850
220 units @$18.90 4158
220 units @$18.50 4070
Cost of goods sold 14918

Enging Inventory
200 units @$18 3600
30 units @$18.50 555
 Ending inventory 4155

c) WAC
WAC = Cost of goods available for sales / Units available for sales
WAC = 19073/1020 = 18.7
Now,
Cost of goods sold= Units sold * WAC
Cost of goods sold = 790*1870= 14773
Ending Inventory
cost of goods available for
sales 19073
Less: Cost of goods sold 14773
Value of ending inventory 4300

Required 2
Income statement
Particulars FIFO WAC LIFO Sales Revenue
Sales revenue 33480 33480 33480 12600
Less: Cost of goods sold 14663 14773 14918 16150
Gross Profit 18817 18707 18562 4730
Less: Operating expense 33480
Selling and distribution 10800 10800 10800
Depreciation 4000 4000 4000
net income before tax 4017 3907 3762
Less: Tax (35%) 1406 1367 1317
Net income after tax 2611 2540 2445

Required 3
LIFO methods will pay less amount of tax $89.

Problem 13: Inventory Costing Methods—Periodic System

Story Company’s inventory records for the month of November reveal the following:
Inventory, November 1 300 units @ $27.00
November 4, purchase 375 units @ $26.50
November 7, sale 450 units @ $63.00
November 13, purchase 330 units @ $26.00
November 18, purchase 225 units @ $25.40
November 22, sale 570 units @ $63.75
November 24, purchase 300 units @ $25.00
November 28, sale 165 units @ $64.50
Selling and administrative expenses for the month were $16,200. Depreciation expense was $6,000. Story’s tax rate is
35%.
Required:
1. Calculate the cost of goods sold and ending inventory under each of the following three methods assuming a
periodic inventory system: (a) FIFO, (b) LIFO, and (c) weighted average.
2. Calculate the gross profi t and net income under each costing assumption.
3. Under which costing method will Story pay the least taxes? Explain your answer.
Solution
Details Units Units Cost Amount
Inventory, Nov 1 300 27.00 8100.00
Purchase, Nov 4 375 26.50 9937.50
Purchase, Nov 13 330 26.00 8580.00
Purchase, Nov 18 225 25.40 5715.00
Purchase, Nov 24 300 25.00 7500.00
Goods available for sales 1530 39832.50
Less: Sold 1185 ?
Ending inventory 345 ?
Required 1
a) Weighted Average
Cost of goods available for sales 39832.50
WAC = = =26.0343 per unit
total units available for sales 1530
Cost of goods sold = Units sold × WAC = 1185 × 26.0343 = 30,851
Ending Inventory = Units unsold × WAC = 345 × 26.0343 = 8981.50
b) FIFO
Cost of Goods Sold
300 units @$ 27.00 8100.00
375 units @$ 26.50 9937.50
330 units @$ 26.00 8580.00
180 units @$ 25.40 4572.00
Cost of goods sold 31189.50

Ending Inventory
Cost of goods available for sales 39832.50
Less: Cost of goods sold 31189.50
Ending Inventory 8643.00
c) LIFO
Cost of Goods Sold
300 units @$ 25.00 7500
225 units @$ 25.40 5715
330 units @$ 26.00 8580
330 units @$ 26.50 8745
Cost of goods sold 30540

Ending Inventory
Cost of goods available for sales 39832.50
Less: Cost of goods sold 30540.00
Ending Inventory 9292.50
Required 2:

Income Statement
FIFO WAC LIFO
Sales Revenue 75330.0 75330.00 75330.00
0
Less: Cost of goods sold 31189.5 30,851 30540.00
 0
Gross profit 44140.5 44479.00 44790.00
0
Less: Selling and administration expense 16200.0 16200.00 16200.00
0
Depreciation expense 6000.00 6000.00 6000.00
Net income before tax 21940.5 22279.00 22590.00
0
Less: Tax @ 35% 7679.00 7798.00 7906.50
Net income after tax 14261.5 14481.00 14683.50
0
Required 3: Cost of goods sold under FIFO is greater than LIFO. Which result lower net income before tax under FIFO.
Thus, FIFO method will pay the least taxes by $227.50.

Problem 14: Inventory Costing Methods-Perpetual System

The following information is available concerning Stillwater Inc.:
Units Unit Cost
Beginning inventory 200 $10
Purchases:
March 5 300 11
June 12 400 12
August 23 250 13
October 2 150 15
Stillwater, which uses a perpetual system, sold 1,000 units for $22 each during the year. Sales occurred on the
following dates:
Units
February 12 150
April 30 200
July 7 200
September 6 300
December 3 150
Required
1. Calculate ending inventory and cost of goods sold for each of the following three methods:
a. Moving average
b. FIFO
c. LIFO
2. Assume the use of the perpetual system and an estimated tax rate of 30%. How much more or less
(indicate which) will Stillwater pay in taxes by using LIFO instead of FIFO? Explain your answer.
Solution
Required 1
Store Ledger under FIFO
Purchases Sales Balance
Unit Unit Unit
Date Particulars Units Cost Amount Unit Cost Amount Units cost Amount

1-Jan Beginning Inventory 200 10 2,000

12-Feb Sales 150 10 1500 50 10 500

5-Mar Purchase 300 11 3300 50 10 500

300 11 3300

30-Apr Sales 50 10 500

150 11 1650 150 11 1650

 12-Jun Purchase 400 12 4800 150 11 1650

400 12 4800

7-Jul Sales 150 11 1650

50 12 600 350 12 4200

23-Aug Purchase 250 13 3250 350 12 4200

250 13 3250

Setp 6 sales 300 12 3600 50 12 600

250 13 3250

2-Oct Purchase 150 15 2250 50 12 600

250 13 3250

150 15 2250

3-Dec Sales 50 12 600 150 13 1950

100 13 1300 150 15 2250

Cost of goods Sold = 11400
Ending Inventory = 4200

Store Ledger under LIFO

Purchases Sales Balance
Unit Unit
Date Particulars Units Cost Amount Unit Unit Cost Amount Units cost Amount

1-Jan Beginning inventory 200 10 2,000

12-Feb Sales 150 10 1500 50 10 500

5-Mar Purchase 300 11 3300 50 10 500

300 11 3300

30-Apr Sales 200 11 2200 50 10 500

100 11 1100

12-Jun Purchase 400 12 4800 50 10 500

100 11 1100

400 12 4800

7-Jul Sales 200 12 2400 50 10 500

100 11 1100

200 12 2400

23-Aug Purchase 250 13 3250 50 10 500

100 11 1100

200 12 2400

250 13 3250

6-Sep Sales 250 13 3250 50 10 500

50 12 600 100 11 1100

 150 12 1800

2-Oct Purchase 150 15 2250 50 10 500

100 11 1100

150 12 1800

150 15 2250

3-Dec sales 150 15 2250 50 10 500

100 11 1100

150 12 1800
Cost of goods sold = 12200
Ending Inventory = 3400

Store ledger under Moving Average

Purchases Sales Balance
Unit Unit Unit
Date Particulars Units Cost Amount Unit Cost Amount Units cost Amount
Beginning
1-Jan inventory 200 10 2,000

12-Feb Sales 150 10 1500 50 10 500

5-Mar Purchase 300 11 3300 350 10.86 3,800

30-Apr sales 200 10.86 2172 150 10.86 1,628

12-Jun Purchase 400 12 4800 550 11.69 6428

7-Jul Sales 200 11.69 2338 350 11.69 4090

23-Aug Purchase 250 13 3250 600 12.23 7340

6-Sep Sales 300 12.23 3669 300 12.23 3671

2-Oct Purchase 150 15 2250 450 13.16 5921

3-Dec Sales 150 13.16 1974 300 13.16 3947

Cost of goods sold = 11653
Ending inventory = 3947

Required 2

COGS under LIFO 12200

COGS under FIFO 11400

Over expense under LIFO 800

(*) Tax Rate 30%

Less tax payable under LIFO 240

Income Statement
LIFO FIFO
Sales (1000*22) 22000 22000
Less: Cost of goods sold 12200 11400
 Gross profit 9800 10600
Less: Operating expense 0 0
net income before tax 9800 10600
Less: Tax (30%) 2940 3180
Net income after tax 6860 7420
LIFO method pays less amount of tax by $240 than FIFO method.

Problem 15: Inventory Costing Method-Perpetual System

Bitten Company’s inventory records show 600 units on hand on October 1 with a unit cost of $5 each. The following
transactions occurred during the month of October:
Date Unit Purchases Unit Sales
October 4 500 @ $10.00
8 800 @ $5.40
9 700 @ $10.00
18 700 @ $5.76
20 800 @ $11.00
29 800 @ $5.90
All expenses other than cost of goods sold amount to $3,000 for the month. The company uses an estimated tax rate of
30% to accrue monthly income taxes.
Required:
1. Prepare a chart comparing cost of goods sold and ending inventory using the periodic system and the following
costing methods:
Cost of Goods Sold Ending Inventory Total
Moving average
FIFO
LIFO
2. What does the Total column represent?
3. Prepare income statements for each of the three methods.
4. Will the company pay more or less tax if it uses FIFO rather than LIFO? How much more or less?
Solution:
Required 1

Store ledger under LIFO

Purchases Sales Balance
Unit Amoun Unit Unit
Date Particulars Units Cost t Unit Cost Amount Units cost Amount
1-Oct Balance 600 5 3000
4-Oct Sales 500 5 2500 100 5 500
8-Oct Purchase 800 5.4 4320 100 5 500
800 5.4 4320
9-Oct Sales 700 5.4 3780 100 5 500
100 5.4 540
18-Oct Purchase 700 5.76 4032 100 5 500
100 5.4 540
700 5.76 4032
20-Oct Sales 700 5.76 4032
 100 5.4 540 100 5 500
29-Oct Purchase 800 5.9 4720 100 5 500
800 5.9 4720
Cost of goods sold = 10853
Ending Inventory = 5220

Store ledger under FIFO

Purchases Sales Balance

Unit Unit
Date Particulars Units Cost Amount Unit Unit Cost Amount Units cost Amount
1-Oct Beginning inventory 600 5 3,000
4-Oct Sales 500 5 2,500 100 5 500
8-Oct Purchase 800 5.4 4320 100 5 500
800 5.4 4320
9-Oct Sales 100 5 500
600 5.4 3240 200 5.4 1080
18-Oct Purchase 700 5.76 4032 200 5.4 1080
700 5.76 4032
20-Oct Sales 200 5.4 1080
600 5.76 3456 100 5.76 576
29-Oct Purchase 800 5.9 4720 100 5.76 576
800 5.9 4720
Cost of goods sold= 10776
Ending inventory =5296

Store ledger under Moving Average Cost Method (WAC)

Purchases Sales Balance
Unit Unit Unit
Date Particulars Units Cost Amount Unit Cost Amount Units cost Amount
Beginning
1-Oct Balance 600 5 3,000
4-Oct Sales 500 5 2500 100 5 500
5.355
8-Oct Purchas 800 5.4 4320 900 5 4,820
5.355
9-Oct Sales 700 5.3555 3749 200 5 1071
18-Oct Purchase 700 5.76 4032 900 5.67 5103
20-Oct Sales 800 5.67 4536 100 5.67 567
29-Oct Purchase 800 5.9 4720 900 5.87 5287
Cost of goods sold = 10785
Ending inventory = 5287
 Cost of goods sold Ending Inventory Total
Moving Average 10785 5287 16072
FIFO 10776 5296 16072
LIFO 10852 5220 16072
Required 2
Total Column represents cost of goods available for sales.
Required 3
Income Statement
FIFO Moving Avg. LIFO

Sales Revenue 20800 20800 20800

Less: Cost of goods sold 10776 10785 10852

Gross Profit 10024 10015 9948

Less: Operating expenses 3000 3000 3000

income before tax 7024 7015 6948

Less: Tax (30%) 2107 2104 2084

Net income after tax 4917 4911 4864

Required 4
Tax under FIFO 2107

Tax under LIFO 2084

Excess tax payable under FIFO 23

Or

COGS under FIFO 10776

COGS under LIFO 10852
Less expense under FIFO 76
(*) Tax rate 30%
Excess tax payable under FIFO 23

Problem 16: Inventory Costing Methods—Perpetual System

Stellar Inc.’s inventory records show 300 units on hand on November 1 with a unit cost of $4 each. The following
transactions occurred during the month of November:
Date Unit Unit Sales
Purchases
November 4 200 @ $9.00
8 500 @ $4.50
9 500 @ $9.00
18 700 @ $4.75
20 400 @ $9.50
29 600 @ $5.00
All expenses other than cost of goods sold amount to $2,000 for the month. The company uses an estimated tax rate of
25% to accrue monthly income taxes.
Required:
1. Prepare a chart comparing cost of goods sold and ending inventory using the periodic system and the following
costing methods:
Cost of Goods Sold Ending Inventory Total
Weighted average
 FIFO
LIFO
2. What does the Total column represent?
3. Prepare income statements for each of the three methods.
4. Will the company pay more or less tax if it uses FIFO rather than LIFO? How much more or less?
Solution
Required 1
Store Ledger under FIFO
Date Particulars Purchases Sales Balance
Unit Unit Unit
Units cost Amount Units cost Amount Units cost Amount
Beginning
1-Nov Inventory 300 4 1200
4-Nov Sales 200 4 800 100 4 400
8-Nov Purchase 500 4.5 2250 100 4 400
500 4.5 2250
9-Nov Sales 100 4 400
400 4.5 1800 100 4.5 450
18-Nov Purchase 700 4.75 3325 100 4.5 450
700 4.75 3325
20-Nov Sales 100 4.5 450
300 4.75 1425 400 4.75 1900
29-Nov Purchase 600 5 3000 400 4.75 1900
600 5 3000
Cost of goods sold = 4875
Ending inventory = 4900

Store Ledger under LIFO

Date Particulars Purchases Sales Balance
Unit Unit Unit
Units cost Amount Units cost Amount Units cost Amount
Beginning
1-Nov inventory 300 4 1200
4-Nov Sales 200 4 800 100 4 400
8-Nov Purchase 500 4.5 2250 100 4 400
500 4.5 2250
9-Nov Sales 500 4.5 2250 100 4 400
18-Nov Purhase 700 4.75 3325 100 4 400
700 4.75 3325
20-Nov Sales 400 4.75 1900 100 4 400
300 4.75 1425
29-Nov Purchase 600 5 3000 100 4 400
300 4.47 1425
600 5 3000
Cost of goods sold = 4950
Ending inventory = 4825

Store Ledger under Moving Average

Date Particulars Purchases Sales Balance
Unit Unit Unit
Units cost Amount Units cost Amount Units cost Amount
Beginning
1-Nov inventory 300 4 1200
4-Nov Sales 200 4 800 100 4 400
8-Nov Purchase 500 4.5 2250 600 4.42 2650
9-Nov Sales 500 4.42 2210 100 4.42 440
18-Nov Purchase 700 4.75 3325 800 4.71 3765
20-Nov sales 400 4.71 1884 400 4.71 1881
29-Nov Purchase 600 5 3000 1000 4.881 4881
Cost of goods sold = 4894
Ending inventory = 4881

Cost of goods sold Ending inventory Total

Moving Average 4894 4881 9775
FIFO 4875 4900 9775
LIFO 4950 4825 9775

Required 2
Total column represents cost of goods
available for sales.
Required 3: Income Statement
FIFO LIFO Moving Average
Sales Revenue 10100 10100 10100
Less: Cost of goods sold 4875 4950 4894
Gross profit 5225 5150 5206
less: Operating expense 2000 2000 2000
Net income before tax 3225 3150 3206
Less: Tax (25%) 806 788 802
Net income after tax 2419 2362 2404

Required: 4
FIFO method pays more tax $18 than LIFO method.
Or
COGS under FIFO 4875
COGS underLIFO 4950
Less expense under FIFO 75
(*) Tax rate 25%
FIFO pays less tax than LIFO 18

Problem 17: Inventory Error

The following highly condensed income statements and balance sheets are available for Budget Stores for a two-year
period. (All amounts are stated in thousands of dollars.)
Income Statements
2010 2009
Revenues $20,000 $15,000
Cost of goods sold 13,000 10,000
 Gross profit $ 7,000 $ 5,000
Operating expenses 3,000 2,000
Net income $ 4,000 $ 3,000
Balance Sheets
Decembe December
r 31, 2010 31, 2009
Cash $ 1,700 $ 1,500
Inventory 4,200 3,500
Other current assets 2,500 2,000
Long-term assets 15,000 14,000
Total assets $23,400 $21,000
Liabilities $ 8,500 $ 7,000
Capital stock 5,000 5,000
Retained earnings 9,900 9,000
Total liabilities and stockholders’ equity $23,400 $21,000
Before releasing the 2010 annual report, Budget’s controller learns that the inventory of one of the stores (amounting
to $600,000) was inadvertently omitted from the count on December 31, 2009. The inventory of the store was correctly
included in the December 31, 2010, count.
Required:
Prepare revised income statements and balance sheets for Budget Stores for each of the two years. Ignore the effect of
income taxes.
Solution:

Income Statement
2010 2009
Reported Corrected Reported Corrected
Revenues $20,000 20000 $15,000 15000
Cost of goods sold 13,000 13600 10,000 9400
Gross profit $ 7,000 6400 $ 5,000 5600
Operating expenses 3,000 3000 2,000 2000
Net income $ 4,000 3400 $ 3,000 3600
Balance Sheets
December 31, 2009 December 31, 2009
Reported Corrected Reported Corrected
Cash $ 1,700 $ 1,700 $ 1,500 1500
Inventory 4,200 4,200 3,500 4100
Other current assets 2,500 2,500 2,000 2000
Long-term assets 15,000 15,000 14,000 14000
Total assets $23,400 $23,400 $21,000 21600
Liabilities $ 8,500 $ 8,500 $ 7,000 7000
Capital stock 5,000 5,000 5,000 5000
Retained earnings 9,900 9,900 9,000 9600
Total liabilities and stockholders’ equity $23,400 $23,400 $21,000 21600

Problem 18: Inventory Error

The following condensed income statements and balance sheets are available for Planter Stores for a two-year period.
(All amounts are stated in thousands of dollars.)
Income Statements
2010 2009
Revenues $35,982 $26,890
Cost of goods sold 12,594 9,912
Gross profit $23,388 $16,978
Operating expenses 13,488 10,578
 Net income $ 9,900 $ 6,400

Balance Sheets December December

31, 2010 31, 2009
Cash $ 9,400 $ 4,100
Inventory 4,500 5,400
Other current assets 1,600 1,250
Long-term assets, net 24,500 24,600
Total assets $40,000 $35,350
Current liabilities $ 9,380 $10,600
Capital stock 18,000 18,000
Retained earnings 12,620 6,750
Total liabilities and stockholders’ $40,000 $35,350
equity
Before releasing the 2010 annual report, Planter’s controller learns that the inventory of one of the stores (amounting to
$500,000) was counted twice in the December 31, 2009, inventory. The inventory was correctly counted in the
December 31, 2010, inventory.
Required
Prepare revised income statements and balance sheets for Planter Stores for each of the two years. Ignore the effect of
income taxes.
Solution:
Income Statements
Particulars 2010 2009
Reported Corrected Reported Corrected
Revenues $35,982 35982 $26,890 26890
Cost of goods sold 12,594 12,094 9,912 10,412
Gross profit $23,388 23,888 $16,978 16,478
Operating expenses 13,488 13,488 10,578 10,578
Net income $ 9,900 10,400 $ 6,400 5,900

Balance Sheets December 31, 2010 December 31, 2009

Reported Corrected Reported Corrected
Cash $ 9,400 $ 9,400 $ 4,100 $ 4,100
Inventory 4,500 4,500 5,400 4,900
Other current assets 1,600 1,600 1,250 1,250
Long-term assets, net 24,500 24,500 24,600 24,600
Total assets $40,000 $40,000 $35,350 $34,850
Current liabilities $ 9,380 $ 9,380 $10,600 $10,600
Capital stock 18,000 18,000 18,000 18,000
Retained earnings 12,620 12,620 6,750 6,250
Total liabilities and stockholders’ equity $40,000 $40,000 $35,350 $34,850
Problem 19: Inventory estimation-Gross profit method
The following information was available from the records of XYZ Co.
Beginning inventory Rs. 70000
Net purchase 65000
Net Sales 150000
Gross profit Margin 60%
Required:
Estimate the company’s ending inventory using the gross profit method.
Solution
Estimation of Ending Inventory under Gross Profit Method
Beginning inventory 70,000
Add: Net Purchase 65,000
Total Cost of Goods Available for Sales 135000
Less: Estimated Cost of goods sold (150,000 *40%) 60,000
Estimated ending inventory 75,000
 Problem 20: Inventory Estimation-Retail Method
The following information was available from the record of ABC Co.
At cost At Retail
Beginning Inventory Rs. 2500 Rs. 3000
Net Purchase Rs. 11500 Rs. 14500
Net Sales Rs. 13000
Estimate the company’s ending inventory at cost using the retail inventory method.

Solution:
:

Schedule Showing Inventory Estimation

Under Retail Inventory Method
At Cost At Retail
Beginning Inventory 2500 3000
Add: Purchase of goods 11500 14500
Goods available for sales 14000 17500
Less: Sales 13000
Ending inventory at retail 4500
(×) cost to retail ratio 80%
Estimated cost of ending inventory 3600
Working Note
Goods available for sales at cost 14000
cost to retail ratio = = =80 %
Goods available for sales at retail 17500

Problem 21: Inventory Estimation-Retail Method

The following information was available from the record of Joseph Co.
At cost At Retail
Beginning Inventory Rs. 700 Rs. 900
Purchase Rs. 3400 Rs. 5300
Purchase return and allowance Rs. 100 Rs. 200
Sales Rs. 4700
Sales return and allowance Rs. 500
Estimate the company’s ending inventory at cost using the retail inventory method. Suppose during the year the
physical year-end inventory at retail was 1620. What is the estimated cost of the inventory lost through shoplifting and
other causes?
Solution
Required a)

Schedule Showing Inventory Estimation

Under Retail Inventory Method
At Cost At Retail
 Beginning Inventory 700 900
Add: Purchase of goods (purchase less return) 3300 5100
Goods available for sales 4000 6000
Less: Sales (Sales less return) 4200
Ending inventory at retail 1800
(×) cost to retail ratio 66.67%
Estimated cost of ending inventory 1200
Working Note
Goods available for sales at cost 4000
Cost to retail ratio = = =66.67 %
Goods available for sales at retail 6000
Required b
Estimated ending inventory at retail 1800
Less: Physical inventory at retail 1620
Inventory lost at retail 180
(*) cost to retail ratio 66.67%
Inventory lost at cost 120
Problem 22: Gross Profit Method
On August 1, an office supply store was destroyed by an explosion in its basement. A small amount of inventory valued at
$4,500 was saved. An estimate of the amount of inventory lost is needed for insurance purposes. The following
information is available:
Inventory, January 1 $3,200
Purchases, January – July 164,000
Sales, January – July 113,500
The normal gross profit ratio is 40%. The insurance company will pay the store $65,000.
Required:
a. Using the gross profit method, estimate the amount of inventory lost in the explosion.
b. Prepare the appropriate journal entry to recognize the inventory loss and the insurance reimbursement.
Solution:
Amount
Beginning invntory (known) 3200
Add: Purchase of inventory (known) 164,000
Cost of goods available for sales (Known) 167,200
Less: Estimated Cost of goods sold (Working note) 68100
Estimated Cost of Ending inventory 99,100
Less: Inventory saved 4500
Loss of inventory due to fire 94,600
Less: Insurance settlement 65000
Actual loss 29,600

Journal Entry
Cash (Insurance Co.) Dr 65,000
Loss from insurance settlement Dr 29,600
 To Inventory 94600

working Note
Where,
Estimated Cost of goods sold
Net Slaes 113500
Less: Estimated gross profit 45400
Estimated Cost of goods sold 68100

Problem 23: Gross Profit Method

On February 12 a hurricane destroys the entire inventory of Suncoast Corporation. An estimate of the amount of inventory
lost is needed for insurance purposes. The following information is available:
Inventory on January 1 $15,400
Net sales from January 1 to February 12 105,300
Purchase from January 1 to February 12 84,230
Suncoast estimates its gross profit ratio as 25% of net sales. The insurance company has agreed to pay Suncoast $10,000
as a settlement for the inventory destroyed.
Required:
a. Estimate the company's ending inventory using the gross profit method.
b. Prepare journal entry to recognize the inventory lost and the insurance reimbursement.
Solution
Inventory Estimation under Gross Profit Method
Beginning Inventory 15400
Add: Purchase 84230
Cost of goods available for sales 99630
Less: Estimated cost of goods sold
(105300 * 75%) 78975
Estimated Ending Inventory 20655
Less: Inventory saved Nil
Inventory lost due to hurricane 20655
Less: Claim received from insurance co. 10000
Actual loss for insurance settlement 10655
a. Journal Entry
Date Particulars LF Debit Credit
Feb 12 Cash (insurance Co.) Dr 10,000
Loss from insurance settlement Dr 10655
To Inventory 20655
(To record claim received from
insurance co.)

c) Determine the effect on the accounting equation of the adjustment to recognize the inventory lost and the insurance
reimbursement.
Assets = Liability + owners equity
(20655) INVENTORY LOSS (10655)
10000 CASH
Problem 24: Inventory estimation-Gross profit method
The following information was available from the records of XYZ Co.
 Beginning inventory Rs. 70000
Net purchase 65000
Net Sales 150000
Gross profit Margin 60%
Required:
Estimate the company’s ending inventory using the gross profit method.
Solution
Estimation of Ending Inventory under Gross Profit Method
Beginning inventory 70,000
Add: Net Purchase 65,000
Total Cost of Goods Available for Sales 135000
Less: Estimated Cost of goods sold (150,000 *40%) 60,000
Estimated ending inventory 75,000

Problem 25: Ratio

Sidney began the year with $130,000 in merchandise inventory and ended the year with $190,000. Sales and cost of
goods sold for the year were $900,000 and $640,000, respectively.
Required:
1. Compute Sidney’s inventory turnover ratio.
2. Compute the number of days’ sales in inventory.
Solution:
Beginning inventory + Ending inventory 130,000+190,000
Average Inventory = = =160,000
2 2
Cost of goods sold 640,000
Inventory Turnover Ratio = = =4×.
Average inventory 160,000
Days∈a year 365
Days' Sales in Inventory = = =91.25 Days
Inventory turnover ratio 4
Problem 26: Ratio
The following amounts are available from the 2008 annual report of Caterpillar, the maker of machinery and engines
for the construction, mining, and forestry industries. (All amounts are in millions of dollars.)
Cost of goods sold $38,415
Inventories, December 31, 2008 8,781
Inventories, December 31, 2007 7,204
Required
1. Compute Caterpillar’s inventory turnover ratio for 2008.
2. What is the average length of time it takes to sell an item of inventory?
Solution:
Beginning inventory + Ending inventory 7204+ 8781
Average Inventory = = =7992.5
2 2
Cost of goods sold 38415
Inventory Turnover Ratio = = =4.81׿
Average inventory 7992.5
Days∈a year 365
Days' Sales in Inventory = = =75.88 Days
Inventory turnover ratio 4.81
Problem 27:Ratio
The following is the given information:
Beginning inventory Rs.40,000
Ending inventory Rs.20,000
Purchase Rs.100,000
Carriage inward Rs.10,000
Sales Rs.200,000
Required: Inventory turnover ratio and inventory holding period.
Solution:
COGS = Beginning inventory + Purchase + Carriage inward – Ending inventory
 COGS = 40000 +100000+10000-20000 = 130,000
Now,
Cost of goods sold 130,000
Inventory Turnover Ratio = = =4.33׿
Average inventory 30,000
Days∈a year 365
Days' Sales in Inventory = = =84.30 Days
Inventory turnover ratio 4.33

Problem 28: Ratio

Sales Rs.2,00,000
Closing inventory Rs.40,000
Required: Inventory turnover ratio and inventory holding period.
solution:
Inventory turnover ratio = cost of goods sold / Average inventory
Or
Inventory turnover ratio = Sales / Closing inventory
Inventory turnover ratio = 200,000/ 40,000 = 5 times.
Days∈a year 365
Inventory holding period = = =73 Days
Inventory turnover ratio 5

Chapter

Accounting for Cash and Cash

Equivalent

Cash:
Cash consists of coins and currency, cheques, money on deposit in bank, including deposits in current or saving accounts and time
deposit. Cash includes any item that will accept for immediate deposit. Thus, post-dated cheques are not cash. Cash is the most liquid
asset. Every business must own some cash, so that bills for purchase and operating expenses can be paid on time and emergency needs
can be met.
Cash Equivalents:
Cash equivalents are highly liquid investment that can be easily converted into cash, with little or no delay and with maturity of about
three months or less. Examples of cash equivalents are commercial paper, money market funds, certificate of deposits and treasury
bills. Thus, cash equivalent are short-term investment, which can be converted into known amounts of cash and there is hardly any
risk of change in there values because of fluctuations. Note that according to definition a six month bank deposit and marketable
securities such as investments in share, debenture and bonds of other firms are not included in cash equivalent.
Cash Equivalent and the statement of Cash Flow:
Cash provided by operating activities ****
Cash provided by investing activities ****
Cash provided by financing activities ****
Change in Cash and Cash Equivalent ****
Add: Beginning cash and cash equivalents ****
Ending cash and cash equivalents ****
Bank Statement (Pass Book)
Bank statement is a summarized statement of all deposit and withdrawals made by the depositor during a certain period which is
provided by the bank on periodical basis. It is maintained by bank. When boney is deposited into bank, the bank credits the client
account (bank statement). In the same way, when money is withdrawn from the bank, the bank debits the client account (bank
statement).
Cash Book (Bank Column)
The cash book is a complete record of all receipt and payment which are made through bank. It is maintained by the client to know the
amount of bank balance at the end of given period. All cheques received and deposited are shown on debit side. All payments made by
cheque are shown on credit side.
Bank Reconciliation Statement:
A bank reconciliation statement is the statement which is prepared to reconcile the balance shown by the cash book and pass book
(bank statement) by finding the causes of difference between the two balances.
Reasons for the Difference:
Reason Explanation Example
1. Cheque under collection Cheque sent to the bank but not collected by the The company has deposited a cheque
(deposit in transit) bank. received from a customer but the bank has
not yet collected the amount.
2. Outstanding cheque Cheques issued by the company but not presented to The company has issued a cheque to a
the bank for payment. supplier, but the supplier has not yet
presented it for payment.
3. Amounts credited by the The bank has added certain amounts to the The bank has collected a bill receivable on
bank like interest credited company’s bank account but the company has not behalf of the company and credited the
by bank, amount collected recorded the amount in its books. amount to the company’s account.
by bank from customer etc.
(Credit memoranda)
4. Amount debited by the bank The bank has deducted certain amount form the The bank has levied service charge
like NSF cheque, monthly company’s bank account but the company has not
activity fees, fees charged recorded the amount in its book
for new cheque, rental of a
lockbox etc.
 5. Errors in recording There are error in the bank’s and/ or the company’s The company has made an error in
records. calculating its month-end balance.
Specimen of Bank Reconciliation Statement
Format of Bank Reconciliation Statement
Bank Statement Cash Book
Balance as per bank *** Balance as per cash book ***
Add: Deposit in transit/ Cheque under collection *** Add: Interest earned ***
Add: Error in recording *** Add: note receivable collected by bank ***
Less: Outstanding cheque (***) Add: Customer directly deposited into the bank ***
Less: Error in recording (***) Add: Error in recording ***

Less: Interest charge (***)

Less: Bank charges/ Collection fees (***)
Less: Payment made by bank on behalf of
customer (***)
Less: Error in recording (***)
Adjusted Balance **** Adjusted Balance ***

The Bank Reconciliation and the Need for Adjustments to the Records
After preparing the bank reconciliation, companies must prepare a number of adjustments in the form of journal entries on its records.
It is logical that the additions and deductions to the cash account on the book should be the basis for the adjustments because these are
items that company’s was unaware of before receiving the bank statement. Conversely, the additions and deductions to the bank’s
balance, that is, the deposit in transit and the outstanding checks, are items that company’s has already recorded on its books. Example
of some adjustment entries are:
Date Particular LF Debit Rs. Credit Rs
1. for collection of customer’s note with interest
Cash Dr
To Note receivable
To Interest revenue
2. Interest earned on bank account
Cash Dr
To interest revenue
3. Service fees charged by the bank
…..expense Dr
To Cash
4. NSF Check
Account receivable Dr
To Cash
Note: Entry should be made for the error made in the book of company.
Petty Cash Fund
Whatever may be the size of a firm, it generally has to make a large number of small payments relating to several petty expanses like
postage and stamps, carriage and cartage, taxi/bus fare, printing and stationery etc. it is not practicable to issue cheques for such
payments on one side and not advisable to record all these transactions into the cash book as they increase the clerical load and
troublesome to the main cashier on the other. So a small fund is created for different periodic time under the responsibility of a person,
called petty cashier and he is asked to make the payment of the petty expenses from it, which is known as petty cash fund. The petty
cashier makes small payments for the petty head from the fund and record them regularly and systematically in a book called petty
cash book.
Accounting entries for petty cash fund
Date Particular LF Debit Rs. Credit Rs
For the establishment of petty cash fund
Petty cash fund Dr
To Cash
For the reimbursement of petty cash expenses
….. Expense Dr
To Cash
For closing petty cash fund
Cash Dr
To Petty cash fund
Internal Control System
Internal Control System is of policies and procedures necessary to ensure the safeguarding of an entity’s assets, the reliability of its
accounting records and the accomplishment of overall company objectives. In other words, internal control is a process effected by an
entity’s board of directors, management and other personnel, designed to provide reasonable assurance regarding the achievement of
objectives in each of the following categories:
 Effectiveness and efficiency of operation: addresses an entity’s business objectives, including performance and profitability
goals and safeguarding of resources.
 Reliability of financial reporting: Preparation of reliable published financial statements, including interim and condensed
financial statements and selected financial data derived from statements such as earning releases, reported publicly.
 Compliance with applicable laws and regulations: deals with complying with relevant laws. These categories address
different needs and provide a directed focus to meet the separate needs
Features of a Good Internal Control System
A good internal control system is essential for prevention and early detection of fraud. The following are the essential features of a
good internal control system:
 Separation of duties
 Authorizing and recording transactions
 Sound administrative practices
 Sound personnel policies
 Internal audit
 Code of conduct and ethics policy.
Internal control for Cash
Most organizations pay a great deal of attention to control of cash. The reason is that, cash is the most liquid asset and is more prone to
embezzlement, theft, fraud and defalcation than other assets. The organization should maintain strict control over cash receipts and
payments. A system of internal control for cash should provide for protection of both cash receipts and cash disbursements. Wherever
possible, duties involving the control of cash should be separated so that cash cannot be stolen without the collusion of two or more
employees.
Cash Receipts control
Cash receipts consist of cash over-the-counter for sales and cash in the form of cheques, bank drafts and money orders received
through the mail. All cash receipts should be recorded immediately upon receipt to prevent errors and frauds. An official receipt is
issued for every remittance received by a business.
Cash disbursement control:
Organization makes cash payments for a variety of purposes: to purchase merchandise, supplies, plant, and equipment; to pay
operating expenditure; and to cover payroll expenses. The following system should be followed to control over cash disbursements:
 Establishment of petty cash fund
 Voucher system control
 Use of bank
  Electronic fund transfer system

 Practical Problems with Solution

Problem 1 Bank Reconciliation
You are given the following information:
a. The bank statement of Rara Crafts Co. shows a balance of Rs.9,395 an April 30, 2003. In this data the
balance as per cash book is Rs.8984. The following reconciling items are determined:
b. Deposit in transit: April 30 deposit (received by bank on May 1) Rs.1,365.
c. Outstanding cheques:
No. 23 Rs.800
No. 39 Rs.935
No. 40 Rs.500
d. NSF cheque for X Co. Rs485.50.
e. Bank charge, Rs.29.50
f. Interest paid by bank, Rs.56
Required:
You are requested to prepare bank reconciliation statement as on April 30, 2003. [Ans: 8525]
Solution

Bank Reconciliation Statement

Bank Statement Cash Book
Balance as per bank 9395 Balance as per cash book
Add: Deposit in transit 1365 Less: Bank charges
Less: Outstanding cheques -2235 Add: Interest paid by the bank
Less: NSF cheque
Adjusted Balance 8525 Adjusted Balance

Problem 2 Bank Reconciliation

The November 30 bank statement of Nepal Company disclosed a balance of Rs.6311.90. On the same day the
cash account in the company's ledger was Rs.3962.50. Your review reveals:
a. Cheque under collection on November 30, Rs.1910.80.
b. Outstanding cheques, Rs.784.20
c. The cash deposit of Rs.4780.50 on November 11 recorded by the bank as Rs.4,708.50.
d. A bill receivable of Rs.4,000 and interest of Rs.200 were collected by bank but have not been recorded
in the company's account.
e. A cheque of Rs.490 received from a customer was returned by the bank owing to lack of funds with the
bank.
f. Bank service charges, Rs.135.
g. A cheque for Rs.7,825.90 paid by the bank on November 18 was recorded as Rs.7852.90.
Required:
Prepare bank reconciliation statement. [Ans: 7,537.50]
Solution

Bank Reconciliation Statement

Bank Statement Cash Book

Balance as per bank 6311.9 Balance as per cash book 3962.5

Add: Cheque under collection/ deposit in 1910.8 Add: Bills receivable with interest collected 4200
 transit by the bank
Less: Outstanding cheque -784.2 Less: NSF cheque -490
Add: Error in recording 72 Less: Bank service charge -135
Add: Error in recording 27
Adjusted balance 7537.5 Adjusted Balance 7537.5

Problem 3 Bank Reconciliation

The following information is available for McCarthy Corp. on June 30, 2010:
a. The balance in cash as reported on the June 30, 2010, bank statement is $5,654.98.
b. McCarthy made a deposit of $865 on June 30 that is not included on the bank statement.
c. A comparison between the canceled checks returned with the bank statement and McCarthy’s records
indicated that two checks had not yet been returned to the bank for payment. The amounts of the two checks
were $236.77 and $116.80.
d. The Cash account on the company’s books reported a balance on June 30 of $4,165.66.
e. McCarthy rents some excess storage space in one of its warehouses, and the tenant pays its monthly rent
directly to the bank for deposit in McCarthy’s account. The bank statement indicates that a deposit of $1,500
was made during the month of June.
f. Interest earned on the checking account and added to McCarthy’s account during June was $11.75.
g. Bank service charges were $15 for the month of June as reported on the bank statement.
h. A comparison between the checks returned with the bank statement and the company’s records revealed that
a check written by the company in the amount of $56 was recorded by the company erroneously as a check for
$560.
Required:
Prepare a bank reconciliation for the month of June in good form. (Ans:$6,166.41)
Solution
Bank Reconciliation Statement (May 31, 2010)
Bank Statement Cash Book
Balance as per bank statement 5654.98 Balance as per cash book 4165.66
Add: Deposit in transit 865 Add: Rent deposited into the bank 1500
Less: Outstanding cheques -353.57 Add: Interest earned on checking account 11.75
Add: Error in recording Less: Bank charges -15
Add: Error in recording 504
Adjusted Balance 6166.41 Adjusted Balance 6166.41
Adjusting Entries
Date Particulars LF Debit Credit
1 Cash Dr 1500
To Rent revenue 1500
(To record rent deposited into the
bank)
2 Cash Dr 11.75
To Interest revenue 11.75
(To record interest earned on
checking account)
3 Bank charge Dr 15
To Cash 15
(To record bank charges)
4 Cash Dr 504
To Accounts payable 504
 (To record error in recording)

Problem 4 Bank Reconciliation

The following information is available to assist you in preparing a bank reconciliation for Calico Corners on
May 31, 2010:
a. The balance on the May 31, 2010, bank statement is $8,432.11.
b. Not included on the bank statement is a $1,250 deposit made by Calico Corners late on May 31.
c. A comparison between the canceled checks returned with the bank statement and the company records
indicated that the following checks are outstanding at May 31:
No. 123 $ 23.40
No. 127 145.00
No. 128 210.80
No. 130 67.32
d. The Cash account on the company’s books shows a balance of $9,965.34.
e. The bank acts as a collection agency for interest earned on some municipal bonds held by Calico Corners.
The May bank statement indicates interest of $465.00 earned during the month. f. Interest earned on the
checking account and added to Calico Corners’ account during May was $54.60. Miscellaneous bank service
charges amounted to $50.00.
g. A customer’s NSF check in the amount of $166.00 was returned with the May bank statement. h. A
comparison between the deposits listed on the bank statement and the company’s books revealed that a
customer’s check in the amount of $123.45 was recorded on the books during May but was never added to the
company’s account. The bank erroneously added the check to the account of Calico Closet, which has an
account at the same bank.
i. The comparison of deposits per the bank statement with those per the books revealed that another customer’s
check in the amount of $101.10 was correctly added to the company’s account. In recording the check on the
company’s books, however, the accountant erroneously increased the Cash account by $1,011.00.
Required:
1. Prepare a bank reconciliation in good form. (Ans: 9,359.04)
2. Pass necessary adjusting entries in the Company's book.
Solution
Bank Reconciliation Statement (May 31, 2010)
Bank Statement Cash Book
Balane as per bank statement 8432.11 Balance as per cash book 9965.34
Add: Deposit in transit 1250 Add: Interest earned (a) 465
Less: Outstanding cheques -446.52 Add: Interest earned on checking account (b) 54.6
Add: Error in recording 123.45 Less: Bank charges -50
Less: NSF cheque -166
Less: Error in recording -909.9
Adjusted Balance 9359.04 Adjusted Balance 9359.04
Adjusting Entries
Date Particulars LF Debit Credit
1 Cash Dr 520
To Interest revenue 520
(To record interest earned)
2 Bank charges Dr 50
To Cash 50
(To record bank charges)
3 Accounts receivable Dr 166
 To Cash 166
(To record NSF cheque)
4 Accounts receivable Dr 909.9
To Cash 909.9
(To record error in recording)

Problem 5 Bank Reconciliation

The following information is available to assist you in preparing a bank reconciliation for Karen’s Catering on
March 31, 2010:
a. The balance on the March 31, 2010, bank statement is $6,506.10.
b. Not included on the bank statement is a $423 deposit made by Karen’s late on March 31.
c. A comparison between the canceled checks listed on the bank statement and the company records indicated
that the following checks are outstanding at March 31:
No. 112 $ 42.92
No. 117 307.00
No. 120 10.58
No. 122 75.67
d. The bank acts as a collection agency for checks returned for insufficient funds. The March bank statement
indicates that one such check in the amount of $45.00 was collected and deposited and a collection fee of $4.50
was charged.
e. Interest earned on the checking account and added to Karen’s account during March was $4.30.
Miscellaneous bank service charges amounted to $22.
f. A comparison between the deposits listed on the bank statement and the company’s books revealed that a
customer’s check in the amount of $1,250 appears on the bank statement in March but was never added to the
customer’s account on the company’s books.
g. The comparison of checks cleared per the bank statement with those per the books revealed that the wrong
amount was charged to the company’s account for a check. The amount of the check was $990. The proof
machine encoded the check in the amount of $909, the amount charged against the company’s account.
Required:
1. Determine the balance on the books before any adjustments as well as the corrected balance to be reported on
the balance sheet. (Ans: $5,139.13; $6,411.93)
2. Pass necessary adjusting entries in the book of Company.
Solution
Bank Reconciliation Statement (May 31, 2010)
Bank Statement Cash Book
Balance as per bank statement 6506.1 Balance as per cash book 5139.13
Add: Deposit in transit 423 Add: Cheque deposited by the bank 45
Less: Outstanding cheques -436.17 Less: Collection fees -4.5
Less: Error in recording -81 Add: Interest earned on checking account 4.3
Less: Service charges -22
Add: Cheque deposited only recorded bank statement 1250
Adjusted balance 6411.93 Adjusted balance 6411.93

Adjusting Entries
Dat
e Particulars LF Debit Credit
a Cash Dr 45
To Accounts receivable 45
 b Collection fees Dr 4.5
To Cash 4.5

c Cash Dr 4.3
To Interest revenue 4.3

d Service charge Dr 22
To Cash 22

e Cash Dr 1250
To Accounts receivable 1250

Problem 6 Petty Cash Fund

On January 2, 2010, Clearer Vedio Stores decided to set up a petty cash fund. the treasurer established the fund
by writing and cashing a $300 check and placing the coin and currency in a locked petty cash drawer. Edward
Haskell was designated as the custodian for the fund. During January, the following receipts were given to
Haskell in exchange for cash from the fund:
U.S. Post Office (Stamps) $76.00
Speedy Delivery Service 45.30
Cake N Cookies (Part for retiring employee) 65.40
Office Supplies Superstore (paper, pencils) 36.00
A count of the cash in the drawer on January 31 revealed a balance of $74.10. The treasurer wrote and cashed a
check on the same day to restore the fund to its original balance of $300.
Required:
Prepare the necessary journal entries, with explanations, for January. Assume that all stamps and office supplies
were used during the month.
Solution
Adjusting Entries
Date Particulars LF Debit Credit
Jan 2 Petty Cash Dr 300
To Cash 300
(To record establishment of petty cash fund)

Jan 31 Stamps expense Dr 76.00

Delivery expense Dr 45.30
Cake N cookies expense Dr 65.40
Office supplies expense Dr 36.00
Cash short and over Dr 3.20
To Cash 225.9
(To record reimbursement of petty cash fund)

Problem 7: Bank Reconciliation Statement

The following are the extract of pass book and cash book of Gandaki Noodles Pokhara, from which you are
required to prepare Bank Reconciliation Statement stating clearly the reasons for disagreement between these
two accounts.
Current Account of Gandaki Noodles
Pass book/ Bank Statement
 Date Particulars Debit Credit Dr/Cr Balance
1999 Jan 01 Balance b/d Cr. 18,000
1999 Jan 02 Salary (cheque no…..) 15,000 Cr. 3,000
1999 Jan 05 B/R collected 9,000 Cr. 12,000
1999 Jan 10 Hari (Cheque no……) 4,000 Cr. 8,000
1999 Jan 20 Bank Charges 200 Cr. 7,800
1999 Jan 25 Cash 5,000 Cr. 12,800
1999 Jan 25 Interest on investment 2,000 Cr. 14,800
Cash Book
Bank Column Only
Dr Cr
Date Particulars Amount Date Particulars Amount
1999 Jan 1 To balance b/d 18,000 1999 Jan 02 By salaries 15,000
1999 Jan 23 To Cash 5,000 1999 Jan 07 By Hari 4,000
1999 Jan 28 To moti & sons 4,500 1999 Jan 25 By Rent 2,300
(Cheque…)
1999 Jan 31 By balance c/d 6,200
27,500 27,500

Working Note:
1. Balance as per bank statement, Rs.14,800.
2. Balance as per cash book, 6200.
3. Bank charges only recorded in bank statement, Rs.200.
4. Rent paid only recorded in cash book, Rs.2300
5. bills receivable collected only recorded in bank statement, Rs.9000
6. Interest on investment only recorded in bank statement, Rs.2000
7. Cheque received from moti is only recorded in cash book, 4500.
Solution

Bank Reconciliation Statement (May 31, 2010)

Bank Statement Cash Book
Balance as per bank statement 14800 Balance as per cash book 6200
Add: Deposit in transit (Moti & sons) 4500 Add: Bills receivable collected by the bank 9000
Less: Outstanding cheque (Rent) (2300) Add: Interest on investment 2000
Less: Bank charges (200)
Adjusted balance 17000 Adjusted balance 17000

Adjusting Entries
Date Particulars LF Debit Credit
a Cash Dr 9,000
To Bills receivable 9,000
(To record bills receivable collected by the bank)
b Cash Dr 2000
To Interest revenue 2000
(To record interest earned on investment)
c Bank charges Dr 200
To Cash 200
(To record bank charges)
 Chapter

Accounting for Receivables

Concept:
Accounts Receivable (AR) is the proceeds or payment which the company will receive from its customers who have
purchased its goods & services on credit. Usually, the credit period is short ranging from few days to months or in some
cases maybe a year.
 It arises from sale of goods and services on credit
 It is treated as current asset.
 It does not bear interest charge.
 It is based on verbal promise.
Journal Entries Relating to Accounts Receivable:
1. For Sale of goods and services on credit:
Journal Entry
Date Particulars LF Debit Rs. Credit Rs.
Accounts Receivable Dr
To Sales revenue/ Service revenue
(To record sales of goods or services on credit)
2. For sales return and allowance:
Journal Entry
Date Particulars LF Debit Rs. Credit Rs.
Sales return and allowance Dr
To Accounts receivable
(To record goods returned form customers)
3. For collection of account receivable:
Journal Entry
Date Particulars LF Debit Rs. Credit Rs.
Cash Dr
To Accounts receivable
(To record collection of accounts redceivable)

Accounting for Bad Debt/ Uncollectible Account

1. Direct Write-off Method
The direct write-off method expenses bad debt once a customer account is determined as uncollectible. Because the period
in which the loss is recorded usually varies from the period of sale, the loss may not properly match the related revenues
that were previously recognized. Thus, this method is not consistent with the Generally Accepted Accounting Principles
(GAAPs).
Accounting Entry:
 For recording bad debt expense in the period when it is determined to be uncollectible.
Date Particulars LF Debit Rs. Credit Rs.
Bad debt expense Dr
To Accounts receivable
(To record bad debt written off)
 For recovery of bad debt written off previously.
Date Particulars LF Debit Rs. Credit Rs.
Cash Dr
To Bad debt recovered

2. Allowance Method
Under the allowance method, a company records an adjusting entry at the end of each accounting period for the amount of
the losses it anticipates as the result of extending credit to its customers. The entry will involve the operating expense
account Bad Debts Expense and the contra-asset account Allowance for doubtful account. Later, when a specific account
receivable is actually written off as uncollectible, the company debits Allowance for Doubtful Accounts and credits
Accounts Receivable. The allowance method is preferred over the direct write-off method because:
 The income statement will report the bad debts expense closer to the time of the sale or service, and
 The balance sheet will report a more realistic net amount of accounts receivable that will actually be turning to
cash
Accounting Entries:
1. For estimating/ recognizing bad debt expense at the end of accounting period when sales is made
Date Particulars LF Debit Rs. Credit Rs.
Bad debt expense Dr
To Allowance for doubtful account
(To record estimated bad debt expense)
2. For recording bad debt written off in the year when it is declared as uncollectible:
Date Particulars LF Debit Rs. Credit Rs.
Allowance for doubtful account Dr
To Accounts receivable
(To record actual bad debts written off)
3. Recovery of Bad debt written off previously
 For recording reverse entry of bad debt written ff
Date Particulars LF Debit Rs. Credit Rs.
Accounts receivable Dr
To Allowance for doubtful account
(To record reverse entry for bad debt written off)
 For recording collection of bad debt written off
Date Particulars LF Debit Rs. Credit Rs.
Cash Dr
To Accounts receivable
(To record collection of bad debt written off)

Approaches of Estimating Bad Debts Expense under Allowance Method

There are two approaches of estimating bad debt expense under allowance method. They are (a) Percentage of net credit
sales approach and (b) Percentage of accounts receivable approach.
 1. Percentage of net credit sales: If a company has been in business for enough years, it may be able to use the past
relationship between bad debts and net credit sales to predict bad debt amounts. Net means that credit sales have been
adjusted for sales discounts and returns and allowances. Under this method bad debt expense is estimated as under:
Estimated bad debt expense = Net Credit Sales × Given Percent
2. Percentage of accounts receivable approach: Some companies believe that they can more accurately estimate bad
debts by relating them to the balance in the accounts receivable account at the end of the period rather than to the sales
of the period. Following formula can be used to estimate bad debt expense under this approach:
Estimated bad debt expense = (Year end account receivable × Given percent) ± Balance in allowance account
Note:
(+) Debit (Negative) balance in allowance for doubtful account.
(-) Credit (Positive) balance in allowance for doubtful account.
Net Realizable Value of Account Receivable:
The total accounts receivable minus the allowance for uncollectible accounts is called net realizable value of accounts
receivable. It also called the book value of accounts receivable. Accounts receivable is shown in the balance sheet at its
net realizable value. It is calculated as follows:
Accounts Receivable ×××
Less: Allowance for doubtful account ×××
Net Realizable Value ×××
Promissory Note
A promissory note is a written promise to repay a definite sum of money on demand or at a fixed or determinable date in
the future. Promissory notes normally require the payment of interest for the use of someone else’s money. The party that
agrees to repay money is the maker of the note, and the party that receives money in the future is the payee. A company
that holds a promissory note received from another company has an asset, called a note receivable; the company that
makes or gives a promissory note to another company has a liability, a note payable. Over the life of the note, the maker
incurs interest expense on its note payable and the payee earns interest revenue on its note receivable. The following
summarizes this relationship:

Note receivable
An asset resulting from the acceptance of a promissory note from another company.
 Note payable
A liability resulting from the signing of a promissory note.
Use of Promissory Note
 Banks normally require a company to sign a promissory note to borrow money.
 Promissory notes are often used in the sale of consumer durables with relatively high purchase prices
 Promissory note is also issued to replace an existing overdue account receivable.
Important Terms Connected with Promissory Notes
 Principal: the amount of cash received, or the fair value of the products or services received, by the maker when
a promissory note is issued.
 Maturity date: The date the promissory note is due.
 Term: The length of time a note is outstanding, that is, the period of time between the date it is issued and the
date it matures.
 Maturity value: The amount of cash the maker is to pay the payee on the maturity date of the note.
 Interest: The difference between the principal amount of the note and its maturity value.

Accounting Entries of Interest Bearing Note:

S. In the book of Maker (Note Payable) S. In the book of Payee (Note Receivable)
No No.
.
1. For issuance of promissory note 1. For Acceptance of promissory note
Purchase a/c Dr. (when goods purchased on credit) Note Receivable a/c Dr
or To Sales Revenue (When goods sold on credit)
Cash a/c Dr. (When loan taken) or
or To Cash a/c (When loan provided)
Accounts Payable Dr (When a/c payable converted into note or
payable) To Accounts Receivable (When a/c receivable converted into
To Note payable a/c note receivable)
2. For adjustment of interest expense at the end of accounting 2. For adjustment of interest revenue at the end of accounting
period: period:
Interest expense a/c Dr Interest Receivable a/c Dr
To interest payable a/c To interest revenue a/c
3. For recording payment of principal and interest at the maturity 3. For recording collection of note receivable with interest
date:
Note payable a/c Dr Cash a/c Dr
Interest payable a/c Dr To interest revenue a/c
Interest expense a/c Dr To interest receivable a/c
To Cash a/c To note receivable a/c

Accounting Entries of Non-Interest Bearing Note:

S. In the book of Maker (Note Payable) S. In the book of Payee (Note Receivable)
No. No.
1. For issuance of promissory note 1 For acceptance of promissory note
Purchase/ cash a/c Dr Note receivable a/c Dr
Discount on Note payable a/c Dr To Discount on note receivable a/c
To Note payable a/c To Sales/ cash a/c
2. For transfer of discount on note payable to interest 2 For transfer of discount on note receivable to interest revenue account
expense account at the end of accounting period: at the end of accounting period:
Interest expense Dr Discount on note receivable a/c
To Discount on note payable a/c To interest revenue a/c
4. For transfer of remaining discount on note payable to For transfer of remaining discount on note receivable to interest
interest expense at maturity date revenue account at maturity date:
Interest expense Dr Discount on note receivable a/c
To Discount on note payable a/c To interest revenue a/c
3. For retirement of note payable 3. For collection of note receivable
Note payable a/c Dr Cash a/c Dr
To cash a/c To note receivable
Balance Sheet Presentation of Promissory Note:
 Maker (Note Payable) Payee (Note Receivable)
Liabilities: Assets:
Note payable *** Note Receivable ***
Less: Discount on note payable *** *** Less: Discount on note receivable *** ***

Difference between Note Receivable and Account receivable

Basis Accounts Receivable Notes Receivable
Meaning Money owed to a company due to its A legal instrument issued to the lender
credit sales of goods or services. against money owed to him.
Finance cost No Interest charges. Interest charges.
Time period Only short term. Can be both short term or long term.
Legally binding Has no written contract or document Has a legally binding contract attached,
except the sales invoice. properly written and signed by both the
parties.
Transferability Is not a negotiable instrument and Is a negotiable instrument and can be
cannot be transferred to meet financial transferred to anyone in order to meet
obligations. financial obligations.

Difference between Note Payable and Account Payable

Basis Accounts Payable Notes Receivable
Meaning They generally do not involve any Note payable is known as written
written agreement of a payment to be promissory notes that a company receives
made within a specified period. when it borrows money from a lender.
Terms Always a short-term obligation to the Can be short-term or long-term obligation
business to the business
Conversion Accounts payables can be always Notes payables can never be converted into
converted into notes payables accounts payables
Parties The amount is generally due to the Notes payables are the amount which is
vendors and the suppliers of the due to the financial institutions and the
company credit companies
Risk It is created in the case of low-risk It is created in the case of high-risk
customers. A customer which has low customers. A high-risk customer should be
risk can be given money because of its given money only and when it fulfills
good credit history and certain obligations
creditworthiness
Financial cost There are no specific terms under There is a specific payment term such as
accounts payables and no specific maturity period, interest rate, clauses for
payment obligation to the creditors non-payment etc.
Transaction It originates from the purchase of It may also evolve in case of purchase of
tradable items or inventories long-lived assets or borrowing or to satisfy
the existing obligations
 Practical Problems with Solution
Problem 1: Estimation of Bad Debt Expense
Brown Corp. ended the year with balances in Accounts Receivable of
$60,000 and in Allowance for Doubtful Accounts of $800 (balance before
adjustment). Net sales for the year amounted to $200,000.
Required:
1. Estimated percentage of net sales uncollectible is 1% and prepares journal
entry.
2. Estimated percentage of year-end accounts receivable uncollectible is 4%
and prepare journal entry.
Solution:
Required 1:
Journal Entries
Date Particulars LF Debit Credit
Bad debt expense Dr 2,000
To Allowance for doubtful account 2,000
(To record estimation of bad debts expense)
Working Note:
Bad debt expense = 1% of sales = 200,000 ×1% = 2,000
Required 2:
Journal Entries
Date Particulars LF Debit Credit
Bad debt expense Dr 1,600
To Allowance for doubtful account 1,600
(To record estimation of bad debts expense)
Working Note:
Bad debt expense =( Year end account receivable ×4%)- Credit balance in allowance
Bad debt expense =(60,000×4%)- 800 = 1,600

Problem 2: Allowance Method of Accounting for Bad Debts

Kandel Company had the following data available for 2010 (before making any
adjustments):
Accounts receivable, 12/31/10 $320,100
Allowance for doubtful accounts 2,600
Net credit sales, 2010 834,000
Required
 1. Prepare the journal entry to recognize bad debts under the following
assumptions: (a) bad debts expense is expected to be 2% of net credit sales for the
year and (b) Kandel expects it will not be able to collect 6% of the balance in
accounts receivable at year-end.
2. Assume instead that the balance in the allowance account is a negative $2,600.
How will this affect your answers to (1)?
Solution:
Required 1 (a)
Journal Entries
Date Particulars LF Debit Credit
Bad debt expense Dr 16,680
To Allowance for doubtful account 16,680
(To record estimation of bad debts expense)

(b)
Journal Entries
Date Particulars LF Debit Credit
Bad debt expense Dr 16,606
To Allowance for doubtful account 16,606
(To record estimation of bad debts expense)

Working Note:
(a) Bad debt expense = 1% of sales = 834,000 ×2% = 16,680
(b) Bad debt expense =( Year end account receivable ×4%)- Credit balance in allowance
Bad debt expense = ( 320,100 ×6%)- 2,600 = 16,606
Required 2:(a)
Journal Entries
Date Particulars LF Debit Credit
Bad debt expense Dr 16,680
To Allowance for doubtful account 16,680
(To record estimation of bad debts expense)

(b)
Journal Entries
Date Particulars LF Debit Credit
Bad debt expense Dr 21,806
To Allowance for doubtful account 21,806
(To record estimation of bad debts expense)

Working Note:
(a) Bad debt expense = 1% of sales = 834,000 ×2% = 16,680
(b) Bad debt expense =( Year end account receivable ×4%) + Debit balance in allowance
Bad debt expense = ( 320,100 ×6%) + 2,600 = 21,806
 Problem 3: Allowance Method for Accounting for Bad Debts
At the beginning of 2010, EZ Tech Company’s accounts receivable balance was $140,000 and the balance in
Allowance for Doubtful Accounts was $2,350. EZ Tech’s sales in 2010 were $1,050,000, 80% of which were on credit.
Collections on account during the year were $670,000. The company wrote off $4,000 of uncollectible accounts during
the year.
Required
1. Prepare summary journal entries related to the sale, collections, and write-offs of accounts receivable during 2010.
2. Prepare journal entries to recognize bad debts assuming that (a) bad debts expense is 3% of credit sales and (b)
amounts expected to be uncollectible are 6% of the year-end accounts receivable.
3. What is the net realizable value of accounts receivable on December 31, 2010, under each assumption in (2)?
4. What effect does the recognition of bad debts expense have on the net realizable value? What effect does the write-
off of accounts have on the net realizable value?
Solution:
Required 1:
Journal Entries
Date Particulars LF Debit Credit
a. Cash Dr 210,000
Accounts receivable Dr 840,000
To Sales revenue 1,050,000
(To record sales made during the year)

b. Cash Dr 670,000
To Accounts receivable 670,000
(To record collection of accounts receivable)

c. Allowance for doubtful account Dr 4,000

To Accounts receivable 4,000
(To record actual bad debts written off)
Required 2 (a)
Journal Entries
Date Particulars LF Debit Credit
Bad debts expense Dr 25,200
To Allowance for doubtful account 25,200
(To record estimation of bad debts expense)
(b)
Journal Entries
Date Particulars LF Debit Credit
Bad debts expense Dr 20,010
To Allowance for doubtful account 20,010
(To record estimation of bad debts expense)

Working Note:
 (a) Bad debt expense = 3% of credit sales = 840,000×3% = 25,200
(b) Bad debt expense =( Year end account receivable ×4%) + Debit balance in allowance
Where,
Year end receivable Amount Dr/Cr
Beginning balance 140,000 Dr
Credit sales 840,000 Dr
Collection (670,000) Cr
Bad debts written off (4,000) Cr
Balance 306,000 Dr

Year end allowance Amount Dr/Cr

Beginning balance 2,350 Cr
Bad debts written off (4,000) Dr
Balance 1,650 Dr
Now, Bad debts expense = (306,000 ×6%) + 1,650 = 20,010
Required 2
Calculation of Net Realizable Value of Accounts Receivable under each assumption in required 2.
Assumption a Assumption b
Year end accounts receivable 306,000 year end receivable 306,000
Less: Allowance for doubtful 23,550 Less: Allowance for doubtful 18,360
account account
Net Realizable Value 282,450 Net Realizable Value 287,640

Working Note:
Assumption a
Year end allowance Amount Dr/Cr
Beginning balance 2,350 Cr
Bad debts written off (4,000) Dr
Bad debts estimation 25,200 Cr
Balance 23,550 Cr
Assumption b
Year end allowance Amount Dr/Cr
Beginning balance 2,350 Cr
Bad debts written off (4,000) Dr
Bad debts estimation 20,010 Cr
Balance 18,360 Cr
Required 4:
Recognition of bad debts expense reduces the net realizable value of account receivable whereas write-off of accounts
have no any effect on the net realizable value of accounts receivable.
Problem 4: Allowance Method for Accounting for Bad Debts
At the beginning of 2010, Miyazaki Company’s accounts receivable balance was $105,000, and the balance in
Allowance for Doubtful Accounts was $1,950. Miyazaki’s sales in 2010 were $787,500, 80% of which were on credit.
Collections on account during the year were $502,500. The company wrote off $3,000 of uncollectible accounts during
the year.
Required
 1. Prepare summary journal entries related to the sales, collections, and write-offs of accounts receivable during 2010.
2. Prepare journal entries to recognize bad debts assuming that (a) bad debts expense is 3% of credit sales and (b)
amounts expected to be uncollectible are 6% of the year-end accounts receivable.
3. What is the net realizable value of accounts receivable on December 31, 2010, under each assumption in (2)?
4. What effect does the recognition of bad debts expense have on the net realizable value? What effect does the write-
off of accounts have on the net realizable value?
Solution
Required 1:
Journal Entries
Date Particulars LF Debit Credit
a. Cash Dr 157,500
Accounts receivable Dr 630,000
To Sales revenue 787,500
(To record sales made during the year)

b. Cash Dr 502,500
To Accounts receivable 502,500
(To record collection of accounts receivable)

c. Allowance for doubtful account Dr 3,000

To Accounts receivable 3,000
(To record actual bad debts written off)
Required 2 (a)
Journal Entries
Date Particulars LF Debit Credit
Bad debts expense Dr 18,900
To Allowance for doubtful account 18,900
(To record estimation of bad debts expense)
(b)
Journal Entries
Date Particulars LF Debit Credit
Bad debts expense Dr 14,820
To Allowance for doubtful account 14,820
(To record estimation of bad debts expense)

Working Note:
(a) Bad debt expense = 3% of credit sales = 630,000×3% = 18,900
(b) Bad debt expense =( Year end account receivable ×4%) + Debit balance in allowance
Where,
Year end receivable Amount Dr/Cr
Beginning balance 105,000 Dr
Credit sales 630,000 Dr
Collection (502,500) Cr
Bad debts written off (3,000) Cr
Balance 229,500 Dr
 Year end allowance Amount Dr/Cr
Beginning balance 1950 Cr
Bad debts written off (3,000) Dr
Balance 1,050 Dr
Now, Bad debts expense = (229,500 ×6%) + 1,050 = 14,820
Required 2
Calculation of Net Realizable Value of Accounts Receivable under each assumption in required 2.
Assumption a Assumption b
Year end accounts receivable 229,500 year end receivable 229,500
Less: Allowance for doubtful Less: Allowance for doubtful
account 17,850 account 13,770
Net Realizable Value 211,650 Net Realizable Value 215,730

Working Note:
Assumption a
Year end allowance Amount Dr/Cr
Beginning balance 1,950 Cr
Bad debts written off (3,000) Dr
Bad debts estimation 18,900 Cr
Balance 17,850 Cr
Assumption b
Year end allowance Amount Dr/Cr
Beginning balance 1,950 Cr
Bad debts written off (3,000) Dr
Bad debts estimation 14,820 Cr
Balance 13,770 Cr
Required 4:
Recognition of bad debts expense reduces the net realizable value of account receivable whereas write-off of accounts
have no any effect on the net realizable value of accounts receivable.

Problem 5: Using an Aging Schedule to Account for Bad Debts

Sparkle Jewels distributes fi ne stones. It sells on credit to retail jewelry stores and extends terms that require the stores
to pay in 60 days. For accounts that are not overdue, Sparkle has found that there is a 95% probability of collection. For
accounts up to one month past due, the likelihood of collection decreases to 80%. If accounts are between one and two
months past due, the probability of collection is 60%, and if an account is over two months past due, Sparkle Jewels
estimates only a 40% chance of collecting the receivable. On December 31, 2010, the balance in Allowance for Doubtful
Accounts is $12,300. The amounts of gross receivables by age on this date are as follows:
Category Amount
Current $200,000
Past due:
Less than one month 45,000
One to two months 25,000
 Over two months 10000
Required
1. Prepare a schedule to estimate the amount of uncollectible accounts at December 31, 2010.
2. On the basis of the schedule in (1), prepare the journal entry on December 31, 2010, to estimate bad debts.
3. Show how accounts receivable would be presented on the December 31, 2010, balance sheet.

Solution
Required 1
Aging Schedule to Estimate Bad Debts
Category Amount Estimated Percent Estimated Amount
Uncollectible Uncollectible
Current 200,000 5% 10,000
Past due:
Less than one month 45,000 20% 9,000
One to two months 25,000 40% 10,000
Over two months 10,000 60% 6,000
Total uncollectible amounts 35,000
Less: Credit balance in allowance for doubtful account 12,300
Estimated bad debt expense 22,700
Required 2
Journal Entries
Date Particulars LF Debit Credit
Bad debts expense Dr 22,700
To Allowance for doubtful account 22,700
(To record estimation of bad debts expense)
Required 3:
Net Realizable Value of Accounts Receivable
Accounts Receivable 280,000
Less: Allowance for doubtful accounts 35,000
Net Realizable Value 245,000

Problem 6: Using an Aging Schedule to Account for Bad Debts

Rough Stuff is a distributor of large rocks. It sells on credit to commercial landscaping companies and extends terms
that require customers to pay in 60 days. For accounts that are not overdue, Rough Stuff has found that there is a 90%
probability of collection.
For accounts up to one month past due, the likelihood of collection decreases to 75%. If accounts are between one and
two months past due, the probability of collection is 65%, and if an account is over two months past due, Rough Stuff
estimates only a 25% chance of collecting the receivable. On December 31, 2010, the balance in Allowance for Doubtful
Accounts is $34,590. The amounts of gross receivables, by age, on this date are as follows:
Category Amount
Current $200,000
Past due:
 Less than one month 60,300
One to two months 35,000
Over two months 45,000
Required
1. Prepare a schedule to estimate the amount of uncollectible accounts at December 31, 2010.
2. On the basis of the schedule in (1), prepare the journal entry on December 31, 2010, to estimate bad debts.
3. Show how accounts receivable would be presented on the December 31, 2010, balance sheet.

Solution
Required 1
Aging Schedule to Estimate Bad Debts
Category Amount Estimated Percent Estimated Amount
Uncollectible Uncollectible
Current 200,000 10% 20,000
Past due:
Less than one month 60,300 25% 15,075
One to two months 35,000 35% 12,250
Over two months 45,000 75% 33,750
Total uncollectible amounts 81,075
Less: Credit balance in allowance for doubtful account 34,590
Estimated bad debt expense 46,485
Required 2
Journal Entries
Date Particulars LF Debit Credit
Bad debts expense Dr 46,485
To Allowance for doubtful account 46,485
(To record estimation of bad debts expense)
Required 3:
Net Realizable Value of Accounts Receivable
Accounts Receivable 340,300
Less: Allowance for doubtful accounts 81,075
Net Realizable Value 259,225

Problem 7: Using an Aging Schedule to Account for Bad Debts

Carter Company sells on credit with terms of n/30. For the $500,000 of accounts at the end of the year that are not
overdue, there is a 90% probability of collection. For the $200,000 of accounts that are less than a month past due, Carter
estimates the likelihood of collection going down to 70%. The probability of collecting the $100,000 of accounts more
than a month past due is estimated to be 25%.
Required
1. Prepare an aging schedule to estimate the amount of uncollectible accounts.
2. On the basis of the schedule in (1), prepare the journal entry on December 31, 2010 to estimate bad debts. Assume
that the balance in Allowance for Doubtful Accounts is $20,000.
 Solution
Required 1
Aging Schedule to Estimate Bad Debts
Category Amount Estimated Percent Estimated Amount
Uncollectible Uncollectible
Current 500,000 10% 50,000
Past due:
Less than one month 200,000 30% 60,000
More than one month 100,000 75% 75,000
Total uncollectible amounts 185,000
Less: Credit balance in allowance for doubtful account 20,000
Estimated bad debt expense 165,000
Required 2
Journal Entries
Date Particulars LF Debit Credit
Bad debts expense Dr 165,000
To Allowance for doubtful account 165,000
(To record estimation of bad debts expense)

Problem 8: Interest Bearing Notes Receivable

On September 1, 2010, Dougherty Corp. accepted a six-month, 7%, $45,000 interest- bearing note from Rozelle
Company in payment of an accounts receivable. Dougherty’s year-end is December 31. Rozelle paid the note and interest
on the due date.
Required
1. Who is the maker and who is the payee of the note?
2. What is the maturity date of the note?
3. Prepare all necessary journal entries Dougherty needs to make in connection with this note on each of the following
dates:
a. September 1, 2010
b. December 31, 2010
c. March 1, 2011
Solution:
Require 1:
Rozelle Company is the maker and Dougherty Corp. is the payee of note.
Required 2:
March 1, 2011 is the maturity date of the note.
Required 3:
Journal Entry
In the book of Dougherty Corp. (Payee of Note)
Date Particulars LF Debit Credit
Sept 1, 2010 Note receivable Dr 45,00
 0
To Accounts receivable 45,000
(To record acceptance of promissory note)

Dec. 31, 2010 Interest receivable Dr 1,050

To Interest revenue 1,050
(To record interest revenue due)
March 1, 2011 Cash Dr 46,57
5
To Note receivable 45,000
To Interest receivable 1,050
To Interest revenue 525
(To record collection of note with interest)
Problem 9: Non-Interest Bearing Note Receivable
On May 1, Ranjana Music Company sold an electronic keyboard to Fewa Music. Fewa Music made a Rs. 300 down
payment and signed 10 months note for Rs.1,625. The normal selling price of the keyboard is Rs.1,800 in cash. Ranjana's
fiscal year ends December 31. Fewa Music paid Ranjana in full on the maturity date.
Required:
1. How much total interest did Ranjana receive on this note?
2. Prepare the journal entries on Ranjana's book on May 1, December 31 and maturity date.
Solution:
Journal Entry
In the book of Ranjana Music Company (Payee of Note)
Date Particulars LF Debit Credit
May 1 Cash Dr 300
Notes Receivable Dr 1,625
To Sales revenue 1,800
To Discount on note receivable 125
(To record sales of electronic keyboard)

Dec. 31 Discount on note receivable Dr 100

To Interest revenue 100
(To record discount on note receivable
transferred to interest revenue account)

March 1 Discount on note receivable Dr 25

To Interest revenue 125
(To record discount on note receivable
transferred to interest revenue account)

March 1 Cash Dr 1,625

To Note receivable 1,625
(To record collection of notes receivable)
Problem 10: Accounts and Notes Receivable
Linus Corp. sold merchandise for $5,000 to C. Brown on May 15, 2010, with payment due in 30 days. Subsequent to this,
Brown experienced cash flow problems and was unable to pay its debt. On August 10, 2010, Linus stopped trying to
collect the outstanding receivable from Brown and wrote off the account as uncollectible. On December 1, 2010, Brown
sent Linus a check for $1,000 and offered to sign a two-month, 9%, $4,000 promissory note to satisfy the remaining
obligation. Brown paid the entire amount due Linus, with interest, on January 31, 2011. Linus ends its accounting year on
December 31 each year and uses the allowance method to account for bad debts.
Required
Prepare all of the necessary journal entries on the book of Linus Corp. form May 15, 2010 to January 31, 2011.
Solution:
Journal Entry
In the book of Dougherty Corp. (Payee of Note)
Date Particulars LF Debit Credit
May 15, 2010 Accounts receivable Dr 5,000
To Sales revenue 5,000
(To record sales of goods on credit)

Aug. 10, 2010 Allowance for doubtful debt Dr 5,000

To Accounts receivable 5,000
(To record bad debt written off)

Dec. 1, 2010 Accounts receivable Dr 5,000

To Allowance for doubtful debt account 5,000

Dec. 1, 2010 Cash Dr 1,000

Notes receivable Dr 4,000
To Accounts receivable 5,000
(To record collection of accounts receivable)

Dec. 31, 2010 Interest receivable Dr 30

To Interest revenue 30
(To record interest due for the month)

Feb 1, 20100 Cash Dr 4060

To Note receivable 4,000
To Interest receivable 30
To Interest revenue 30
(To record collection of note with interest)
Problem 11: Accounts and Notes Receivable
Tweety Inc. sold merchandise for $6,000 to P.D. Cat on July 31, 2010, with payment due in 30 days. Subsequent to
this, Cat experienced cash flow problems and was unable to pay its debt. On December 24, 2010, Tweety stopped trying
to collect the outstanding receivable from Cat and wrote off the account as uncollectible. On January 15, 2011, Cat sent
Tweety a check for $1,500 and offered to sign a two-month, 8%, $4,500 promissory note to satisfy the remaining
obligation. Cat paid the entire amount due Tweety, with interest, on March 15, 2011. Tweety ends its accounting year on
December 31 each year.
Required
Prepare all of the necessary journal entries on the books of Tweety Inc. from July 31, 2010, to March 15, 2011.
Solution:
Journal Entry
 In the book of Tweety Inc. (Payee of Note)
Date Particulars LF Debit Credit
July 31, 2010 Accounts receivable Dr 6,000
To Sales revenue 6,000
(To record sales of goods on credit)

Dec. 24, 2010 Allowance for doubtful debt Dr 6,000

To Accounts receivable 6,000
(To record bad debt written off)

Jan. 15, 2011 Accounts receivable Dr 6,000

To Allowance for doubtful debt account 6,000

Jan. 15, 2011 Cash Dr 1,500

Notes receivable Dr 4,500
To Accounts receivable 5,000
(To record collection of accounts receivable)

March 15, 2011 Cash Dr 4,560

To Note receivable 4,500
To Interest revenue 60

(To record collection of note with interest)

Problem 12: Accounts Receivable Turnover for General Mills

The 2009 annual report of General Mills (the maker of Cheerios® and Wheaties®) reported the following amounts (in
millions of dollars):
Net sales, for the year ended May 31, 2009 $14,691.3
Receivables, May 31, 2009 953.4
Receivables, May 25, 2008 1,081.6
Required
1. Compute General Mills’s accounts receivable turnover ratio for the year ended May 31, 2009. (Assume that all sales
are on credit.)
2. What is the average collection period in days for an account receivable?
Solution:
Required 1:
Beginning receivabl+ Ending receivable 1,081.60+953.4
Average receivable = = = 1,017.5
2 2
Now,
Credit Sales 14,691.3
Accounts receivable turnover ratio = = =14.44׿
Average receivable 1,017.5
Required 2:
 Days∈a year 365
Average collection period = = =25.28 days
Accounts receivale turnover 14.44

Chapter

Accounting for Operating

Assets

Concept of operating assets (Fixed assets or long term assets)

Operating assets is an asset that is held with the intention of being used for the purpose of producing or providing goods or services
and is not held for sale in the normal course of business.
Types of operating assets:
Operating assets, also referred to as long lived assets or long term assets, are often divided into several categories:
1. Tangible assets: These are fixed assets that have physical existence and can be seen and felt, and include land, building, plant,
equipment, and vehicles. Property, plant and equipment is another term for tangible assets.
2. Intangible assets: Unlike tangible assets, these hove no physical existence; rather, they represent legal rights or economic
benefits. Trademark, Patents, franchises, copy rights and goodwill are examples of intangible assets.
3. Natural resources: Natural resources are that asset which is consumed as it is used. Most natural resources can not be
replenished in the foreseeable future. Examples are oil and gas wells, mines, and forests.
Acquisition of operating assets and the capitalization process:
Assets classified as property, plant and equipment are initially recorded at acquisition cost or historical cost. Acquisition cost
should include all of the costs that are normal and necessary to acquire the asset and prepare it for its intended use. Items
included in acquisition cost would generally include the following:
 Purchase price
 Tax paid at the time of purchase (for example, sales tax)
 Transportation charges
 Installation costs
 Transit insurance, initial delivery and handling costs
 Stamp duty and registration fees for transfer of title to land or building
 Lawyer’s fees
 Commission and brokerage for purchase
 Cost of site preparation
 Professional fees, e.g. fees of architects and engineers.
Note:
 Acquisition cost should not include expenditures unrelated to the acquisition (for example, repair costs if an asset is
damaged during installation) or costs incurred after the asset was installed and use begun.
  If a company buys an asset and borrows money to finance the purchase, the interest on the borrowed money is not
considered part of the asset’s cost. There is one exception to this general guideline, however. If a company constructs an
asset over a period of time and borrows money to finance the construction, the amount of interest incurred during the
construction period is not treated as interest expense. Instead, the interest must be included as part of the acquisition cost
of the asset. This is referred to as capitalization of interest.
 The acquisition cost of land should be kept in a separate account because land has an unlimited life and is not subject to
depreciation. Other cost associated with land should be recorded in an account such as land improvements, which have a
limited life. Therefore, the acquisition costs of land improvements should be depreciated over their useful lives.
Depreciation of Property, Plant and Equipment (Tangible Operating Assets):
When the fixed type of assets, especially the physical assets are owned by a business, they are used permanently up to their useful
working life. In course of the use in business, their intrinsic value declines by any reason year by year, up to their useful life and it is
to be accounted in the books of the business firm. It is a kind of loss or writing off the expenditure on such assets. Such a loss or
expense on the intrinsic value of a fixed asset is technically termed as depreciation. Depreciation is assumed as an annual expense
written off against a large expenditure made on a fixed asset that is owned by a business firm. In simple words, deprecation is a
permanent and gradual shrinkage in the intrinsic value of a fixed asset, especially a tangible fixed asset by means of any causes like
wear and tear, passage of time, accident, obsolescence, etc.
Causes of depreciation
There are different causes of depreciation on assets. The following are some important ones.
i. Wear and tear
When assets are constantly used, they become thinner and weaker through continuous use, rubbing or friction which reduces
the original value of an asset over times gradually and permanently.
ii. Passage of time
Some assets loose their usefulness with passage of time simply because they are older whether they are being used or not. For
example, a building is subject to decay due of rainfall, heavy storms, etc. Therefore, depreciation must be provided against the
value of building.
iii. Other physical factors
Depreciation may also be caused by other physical factors like accident, fire, flood, earthquake, etc. by damaging any part of
the assets. Such factors may reduce an asset's future technical capacity to serve and thus reduce its value.
iv. Obsolescence
It is reduction of the utility of an asset that results from the development of better machine or process due to the change in
technology, change in the taste of customers, etc. which reduce its value.
v. Expiry of legal rights
Some assets are owned for a certain fixed period by means of an agreement such as lease, patents and licenses, etc. It causes
the reduction of their values gradually as the expiry of legal rights on such assets.
Factors determining depreciation
There are many factors involved in the determination of depreciation. They are:
i. Actual cost of the asset
ii. Estimated residual (salvage or scrap) value of the asset at the end of its estimated life
iii. Estimated useful life of the asset
iv. Legal provision
Journal entries
i. For purchase of asset at the time of purchase:
Date Particulars LF Debit Rs. Credit Rs.
Fixed Asset Dr. ×××
To Cash ×××
ii. For charging depreciation against the asset at the end of the year:
Date Particulars LF Debit Rs. Credit Rs.
 Depreciation Expense Dr. ×××
To Accumulated Depreciation ×××
iii. For sales/ disposal of fixed asset
Date Particulars LF Debit Rs. Credit Rs.
Cash Dr ×××
Accumulated depreciation Dr ×××
Loss on sales of asset Dr (If sold on loss) ×××
To Fixed Asset ×××
To Gain on sales of asset (If sold on gain) ×××

Calculation of Gain or Loss on sale of asset:

Asset cost ×××
Less: Accumulated depreciation ×××
Book value ×××
Sale price ×××
Gain or Loss ×××
Note:
 If sales value is greater than book value, the result is profit.(SV>BV = Profit)
 If sales value is less than book value, the result is loss. (SV<BV = Loss)

Method of Charging Depreciation:

Straight-line method
It is one of the traditional methods of depreciation widely used from the earliest times. Under this method, a fixed sum is provided
as depreciation each year up to the useful life of an asset or till the sale of an asset. The depreciation charge for each accounting
year is therefore, not affected by the extent of the age, productivity or efficiency of the asset. The amount of depreciation is
calculated in such a way that the value of the asset at the end of its life time is reduced to zero or to its estimated break up value as
the case may be. This method provides a fixed and an equal amount for depreciation each year up to its useful life. It is also called
fixed installment method. The amount of depreciation each year is ascertained at non-fluctuated level so it is also called straight-line
method. In other words depreciation is calculated at a fixed percentage on the original cost less salvage value, it is also called original cost
method.

The formula for calculating annual depreciation is:

Annual depreciation =

Diminishing balance method

The fixed percentage is applied on the written down value but not on the original cost in the subsequent years. The rate of
depreciation remains the same while the amount of depreciation goes on decreasing. The written down value at the end of the
estimated useful life of the asset should be equal to the estimated salvage value. It is also known as reducing balance method. The
rate of depreciation under diminishing balance method is determined as:
r = 1-
Where
r = rate of depreciation
n = life (in years) of the asset
s = estimated salvage value of the asset
c = cost of the asset
Double Declining Balance method:
In this method, amount of depreciation reduces year by year. The amount of depreciation becomes higher at the earlier period and
becomes gradually lower in the subsequent period. Under this method, a fixed double declining percentage calculated on reduced
balance of the asset is brought forward from the previous year. The scrap value of the asset has to be ignored for the calculation of
annual depreciation. In this method, the depreciation for the final year will be the book or written down value of final year less scrap
value, if any. The rate of depreciation is calculated in the following manner:

100
Rate of depreciation = ×2
n
Where, n= Useful life of asset
Unit of Production method:

This method of charging depreciation on the asset is based on the units produced during the year. The estimated total
production of the asset is the criteria for providing depreciation. This method is applied where the value of the asset is
more closely related to the number of units it produces. Thus, in the years when the asset is heavily used, the amount of
depreciation will be high. Assets on which this method can be applied are Plant and Machinery. As their wear and tear
will depend on how much we use them.

Formula:

Cost of asset−Salvage Value

Depreciation expense per unit = Capacity
Total Production life of asset
the

Depreciation expense per annum = Annual production units × Depreciation expense per unit

Capital versus Revenue Expenditure

Capital Expenditure
When an expenditure increases the life of the asset or its productivity, it should be treated as a capital expenditure and
added to the asset account. A capital expenditure is a cost that is added to the acquisition cost of an asset. Examples are:
 Expenditure incurred on the acquisition of fixed asset
 Expenditure which results in an increase in the earning capacity of a business.
 Money spent on the improvement of existing assets so as to increase their life or reduce the cost of production, for
example, conversion of hand driven machine to power-driven machine.
 Expenditure incurred on the extension and addition of existing fixed assets, for instance, the cost of making
additions to the building, furniture, machinery, motor vehicles etc.
Following accounting entry is passed for recording capital expenditure:
Fixed Asset Dr
To Cash
Revenue Expenditure
When an expenditure simply maintains an asset in its normal operating condition, however, it should be treated as an
expense. A revenue expenditure is not treated as part of the cost of the asset, but as an expense on the income statement.
Some of the examples of revenue expenditure are:
 Day-to-day expenses incurred by the company. For example, carriage, office, admin, and stationary expenses etc.
 Expenses incurred to maintain the fixed assets in working order.
 Depreciation on furniture, equipment, plant, machinery and other fixed assets.
 Bank charges paid by the company.
 Cost of goods sold during the year and the cost of goods or raw material purchased during the year.
 Repair and maintenance of buildings used for factory and office of the company.
Following accounting entry is passed for recording capital expenditure:
------- Expense Dr
To Cash
Difference between Capital Expenditure and Revenue Expenditure
Basis of
Capital Expenditure Revenue Expenditure
Comparison
Expenditure incurred for acquiring assets, to
The expense incurred for maintaining the day to
Definition enhance the capacity of an existing asset that
day activities of a business
results in increasing its lifespan
Term Long Term Short Term
Value addition Enhances the value of an existing asset Does not enhance the value of an existing asset
Physical Have a physical presence except for
Do not have a physical presence
Existence intangible assets
Occurrence Non-recurring in nature Recurring in nature
Capitalization Yes No
Impact on
Do not reduce business revenue Reduces business revenue
Revenue
Benefits Long-term benefits for business Short-term benefits for business
It appears as assets in the balance sheet and
Appearance It always appears in the Income statement
some portion in the income statement

 Practical Problems with Solution

Problem 1: Acquisition Cost
On January 1, 2010, Ruby Company purchased a piece of equipment with a list price of $60,000. The following
amounts were related to the equipment purchase:
 Terms of the purchase were 2/10, net 30. Ruby paid for the purchase on January 8.
 Freight costs of $1,000 were incurred.
 A state agency required that a pollution control device be installed on the equipment at a cost of $2,500. During
installation, the equipment was damaged and repair costs of $4,000 were incurred.
 Architect’s fees of $6,000 were paid to redesign the work space to accommodate the new equipment. Ruby
purchased liability insurance to cover possible damage to the asset. The three year policy cost $8,000.
 Ruby financed the purchase with a bank loan. Interest of $3,000 was paid on the loan during 2010.
Required
Determine the acquisition cost of the equipment and pass the necessary journal entry to record acquisition of
equipment.
Solution:
Acquisition cost of the equipment
Particulars Amount
Purchase price (60000-1200) 58,800
Freight cost 1000
cost of pollution control device 2,500
Architect's fees 6,000
Acquisition Cost 68,300
Note: Repair cost $4,000 and interest $3,000 are not included in the acquisition cost of the equipment because they are
not related to the acquisition of equipment.
 Journal Entry
Date Particulars LF Debit Credit
Jan 1, 2010
Equipment Dr 68,300
To Cash 68,300
(To record acquisition of equipment)
Problem 2 Straight Line Method
On July 1, 2002 Ideal Café Inc. purchased a Kitchen Oven at a cash price of Rs.110,000. Other expenses are: Value
Added Tax (VAT) Rs.11,000, transport from Birgunj to Kathmandu is Rs.5,000, installation charges is Rs.4,000, and 3-
year fire insurance policy Rs.5,000. The company follows straight line method of depreciation. The life of Oven is of 5
years with no salvage value.
Required:
1. Prepare necessary journal entry for the above transaction on July 1, 2002 for the purchase.
2. Calculate the depreciation expense, accumulated depreciation, and book value for each year of the Kitchen Oven's
life.
3. Prepare journal entries for depreciation on December 31, 2002.
4. Prepare journal entry to record sales of asset on December 31, 2004 for Rs.70,000.
5. Prepare journal entry to record sales of asset on 31st June 2004 for Rs.65,000.
Solution:
Required 1:
Journal Entry
Date Particulars LF Debit Credit
July 1, 2002Kitchen Oven Dr 130,000
To Cash 130,000
(To record acquisition of oven)
Note: Cost of 3-year fire insurance policy Rs.5000 is not included in the acquisition cost.
Required 2:
Schedule showing depreciation expense, accumulated depreciation and book value
Year Beginning book Depreciation Accumulated Ending book
value Depreciation value
2002 (6 months) 130,000 13,000 13,000 117,000
2003 117,000 26,000 39,000 91,000
2004 91,000 26,000 65,000 65,000
2005 65,000 26,000 91,000 39,000
2006 39,000 26,000 117,000 13,000
2007 (6 months) 13,000 13,000 130,000 Nil
Required 3:
Journal Entry
Date Particulars LF Debit Credit
Dec. 31, 2002 Depreciation expense Dr 13,000
To Accumulated depreciation 13,000
(To record depreciation expense for 6
months)
Required 4:
 Journal Entry
Date Particulars LF Debit Credit
Dec. 31, 2004 Cash Dr 70,00
Accumulated depreciation Dr 0
To Kitchen Oven 65,00 130,000
To Gain on sales of oven 0 5,000
(To record sale of kitchen oven at a
profit)
Required 5:
Journal Entry
Date Particulars LF Debit Credit
June 31, 2004 Cash Dr 65,00
Accumulated depreciation Dr 0
Loss on sales of oven Dr 52,00
To Kitchen Oven 0 130,000
(To record sale of kitchen oven at a 13,00
loss) 0

Problem 3 Double Declining Balance Method

On January 1, 2010 Rolex Company purchased equipment for Rs.105,000. The Company uses double declining
balance method of depreciation. The life of equipment is estimated 5 year having Rs.5,000 salvage value.
Required:
1. Prepare necessary journal entry for the acquisition of equipment.
2. Calculate the depreciation expense, accumulated depreciation, and book value for each year of the equipment's life.
3. Prepare journal entries for depreciation on December 31, 2010.
4. Prepare journal entry to record sales of asset on December 31, 2011 for Rs.60,000.
5. Prepare journal entry to record sales of asset on 31st June 2012 for Rs.25,000.
Solution
Required 1:
Journal Entry
Date Particulars LF Debit Credit
Jan 1, 2010 Equipment Dr 105,00
To Cash 0 105,000
(To record purchase of equipment)
Required 2:
100 100
Double Declining Rate = ×2= ×2=40 %
n 5
Depreciation expense = Cost/ Book value × 40%
Schedule showing depreciation expense, accumulated depreciation and book value
Year Beginning book Depreciation Accumulated Ending book
value (40%) Depreciation value
2010 105,000 42,000 42,000 63,000
2011 63,000 25,200 67,200 37,800
 2012 37,800 15,120 82,320 22,680
2013 22,680 9,072 91,392 13,608
2014 13,608 8,608* 100,000 5,000
Note: Final year depreciation = Beginning book value of final year – Salvage value
= 13,608 – 5,000 = 8,608*
Required 3:
Journal Entry
Date Particulars LF Debit Credit
Dec 31, 2010 Depreciation expense Dr 63,000
To Accumulated Depreciation 63,000
(To record depreciation expense)
Required 4:
Journal Entry
Date Particulars LF Debit Credit
Dec 31,2011 Cash Dr 60,000
Accumulated depreciation Dr 67,200
To Equipment 105,000
To Gain on sales of equipment 22,200
(To record sales of equipment)
Required 5:
Journal Entry
Date Particulars LF Debit Credit
June 31, 2012 Cash Dr 25,000
Accumulated depreciation Dr 74,760
Loss on sale of equipment Dr 5,240
To Equipment 105,000
(To record sale of equipment)

Problem 4 Units of Production Method

Cube textiles purchased machinery for Rs.170,000 on 1st January 2010. It has an estimated useful life of 5 years
and an estimated residual value of Rs.20000. The machine has an expected production of 15000 units during its
useful life. Now the production pattern is as follows:
Year Production
2010 2000 units
2011 4500 units
2012 3000 units
2013 3,500 units
2014 2,000 units
Required:
1. Prepare necessary journal entry for the acquisition of equipment.
2. Calculate the depreciation expense, accumulated depreciation, and book value for each year of the equipment's life.
3. Prepare journal entries for depreciation on December 31, 2011.
4. Prepare journal entry to record sales of asset on December 31, 2012 for Rs.60,000.
5. Prepare journal entry to record sales of asset on 31st June 2013 for Rs.25,000.
 Solution
Required 1:
Journal Entry
Date Particulars LF Debit Credit
Jan 1, 2010 Equipment Dr 170,00
To Cash 0 170,000
(To record purchase of equipment)
Required 2:
Cost of equipment−Salvage value
Depreciation Expense = × yearly production
Total Production Units
Schedule showing depreciation expense, accumulated depreciation and book value
Year Beginning book Depreciation Accumulated Ending book
value (40%) Depreciation value
2010 170,000 20,000 20,000 150,000
2011 150,000 45,000 65,000 105,000
2012 105,000 30,000 95,000 75,000
2013 75,000 35,000 130,000 40,000
2014 40,000 20,000 150,000 20,000
Required 3:
Journal Entry
Date Particulars LF Debit Credit
Dec 31, 2011 Depreciation expense Dr 45,000
To Accumulated Depreciation 45,000
(To record depreciation expense)
Required 4:
Journal Entry
Date Particulars LF Debit Credit
Dec 31,2012 Cash Dr 60,000
Accumulated depreciation Dr 95,000
Loss on sale of equipment Dr 15,000
To Equipment 170,000
(To record sales of equipment)
Required 5:
Journal Entry
Date Particulars LF Debit Credit
June 31, 2013
Cash Dr 25,000
Accumulated depreciation Dr 112,50
Loss on sale of equipment Dr 0
To Equipment 32,500 170,000
(To record sale of equipment)
Problem 5 Double Declining Balance Method
A company uses the double-declining-balance method of depreciation. The company purchases an asset for $40,000,
which is expected to have a ten-year life and a $4,000 residual value.
Required:
What depreciation rate will be applied each year?
 What amount will be charged for depreciation in the first and second years?
What amount will be treated as depreciation over the ten-year life?
Solution:
Required 1:
100 100
Rate of Depreciation = ×2= ×2=20 %
n 10
Required 2:
Depreciation expense:
1st year : 40000 ×20% = 8,000
nd
2 year : (40,000-8,000) × 20% = 6,400
Required 3:
Total depreciation over the ten year life = 40,000 – 4,000 = 36,000
Problem 6 Double Declining Balance Method
Koffman’s Warehouse purchased a forklift on January 1, 2010, for $6,000. The forklift is expected to last for five years
and have a residual value of $600. Koffman’s uses the double-declining-balance method for depreciation.
Required
1. Calculate the depreciation expense, accumulated depreciation, and book value for each year of the forklift’s life.
2. Prepare journal entry for depreciation expense for 2010.
3. Refer to Exhibit 8-2. What factors may have influenced Koffman to use the double-declining-balance method?
Solution
Required 1:
100 100
Rate of Depreciation = ×2= ×2=40 %
n 5
Schedule showing depreciation expense, accumulated depreciation and book value
Year Beginning book Depreciation Accumulated Ending book
value (40%) Depreciation value
2010 6,000 24,00 2,400 3,600
2011 3,600 1,440 3,840 2,160
2012 2,160 864 4,704 1,296
2013 1,296 518 5,222 778
2014 778 178 5,400 600
Required 2:
Journal Entry
Date Particulars LF Debit Credit
Dec 31, 2010 Depreciation expense Dr 2,400
To Accumulated depreciation 2,400
(To record depreciation expense)
Required 3:
Koffman may believe that the double-declining-balance method best matches the decline in usefulness of the asset with
the revenues produced by the asset. Koffman may also choose this method because it allows more depreciation to be taken
in the early years of the asset life and thus delays taxes until the later years.
Problem 7 Straight-Line and Units-of-Production Methods
Assume that Sample Company purchased factory equipment on January 1, 2010, for $60,000. The equipment has an
estimated life of five years and an estimated residual value of $6,000. Sample’s accountant is considering whether to use
the straight-line or the units-of-production method to depreciate the asset. Because the company is beginning a new
production process, the equipment will be used to produce 10,000 units in 2010, but production subsequent to 2010 will
increase by 10,000 units each year.
Required
Calculate the depreciation expense, accumulated depreciation, and book value of the equipment under both methods for
each of the five years of its life. Would the units-of production method yield reasonable results in this situation? Explain.
Solution:
Straight Line Method
Schedule showing depreciation expense, accumulated depreciation and book
Year Beginning book Depreciation Accumulated Ending book
value (40%) Depreciation value
2010 60,000 10,800 10,800 49,200
2011 49,200 10,800 21,600 38,400
2012 38,400 10,800 32,400 27,600
2013 27,600 10,800 43,200 16,800
2014 16,800 10,800 54,000 6,000

Cost−Salvage value 60,000−6,000

Depreciation Expense = = =10,800 p .a .
Life 5
Units-of-Production Method:
Schedule showing depreciation expense, accumulated depreciation and book
Year Beginning book Depreciation Accumulated Ending book
value (0.36 per unit) Depreciation value
2010 60,000 3,600 3,600 56,400
2011 56,400 7,200 10,800 49,200
2012 49,200 10,800 21,600 38,400
2013 38,400 14,400 36,000 24,000
2014 24,000 18,000 54,000 6,000

Acquisition cost−Residual value 60,000−6,000

Depreciation expense per unit = = =0.36 per unit
Life∈units 150,000
Students may note that the units-of-production method results in a depreciation pattern in this exercise that is the opposite
of accelerated depreciation. That is appropriate because of the pattern of usage of the asset.

Problem 8 Sale of Asset

A machine with a cost of $100,000 and accumulated depreciation
of $80,000 was sold at a loss of $6,000. Required:
Pass journal entry for the sales of machine.
Solution:
Journal Entry
Date Particulars LF Debit Credit
Cash Dr 14,000
Accumulated depreciation Dr 80,000
Loss on sale of machine Dr 6,000
To Machine 100,000
(To record sale of Machine)

Problem 9 Asset Disposal

Assume that Gonzalez Company purchased an asset on January 1, 2008, for
$60,000. The asset had an estimated life of six years and an estimated residual value
of $6,000. The company used the straight-line method to depreciate the asset. On
July 1, 2010, the asset was sold for $40,000.
Required
1. Make the journal entry to record depreciation for 2008. Also record all
necessary for the sale of the asset.
2. How should the gain or loss on the sale of the asset be presented on the
income statement?
Solution:
Required 1:
Journal Entry
Date Particulars LF Debit Credit
Dec 31, 2008 Depreciation expense Dr 9,000
To Accumulated depreciation 9,000
(To record deprecation expense)
July 1, 2010 Cash Dr 40,000
Accumulated depreciation Dr 22,500
To Asset 60,000
To Gain on sale of asset 2,500
(To record sale of asset)
Working Note
60,000−6,000
Depreciation expense p.a. = =9,000 p . a .
6
Accumulated depreciation up to the date of sales = 9,000 × 2.5 years = 22,500
Gain or Loss = 40000 – (60,000-22,500) = 2,500
Required 2
The account Gain on Sale of Asset or Loss on Sale of Asset should appear
on the income statement in the Other Income/Expense category because it
is not part of the normal operating activity of the company.
Problem 10 Asset Disposal
Refer to Problem 9. Assume that Gonzalez Company sold the asset on July 1,
2010, and received $15,000 cash and a note for an additional $15,000.
Required
1. Make the journal entry to record depreciation for 2008. Also record all
necessary for the sale of the asset.
2. How should the gain or loss on the sale of the asset be presented on the
income statement?
Solution
Required 1:
Journal Entry
Date Particulars LF Debit Credit
Dec 31, 2008 Depreciation expense Dr 9,000
To Accumulated depreciation 9,000
(To record depreciation expense)
July 1, 2010 Cash Dr 15,000
Note receivable Dr 15,000
Accumulated depreciation Dr 22,500
Loss on sale of asset Dr 7,500 60,000
To Asset
(To record sale of asset)
Working Note
60,000−6,000
Depreciation expense p.a. = =9,000 p . a .
6
Accumulated depreciation up to the date of sales = 9,000 × 2.5 years = 22,500
Gain or Loss = 30,000 – (60,000-22,500) = 7,500
Required 2:
A gain occurs when the selling price of the asset exceeds its book value. A loss occurs when the selling price of the asset
is less than its book value. The account Gain on Sale of Asset or Loss on Sale of Asset should appear on the income
statement in the Other Income/Expense category because it is not part of the normal operating activity of the company.
Problem 11 Capitalization of Interest and Depreciation
During 2010, Mercator Company borrowed $80,000 from a local bank. In addition, Mercator used $120,000 of cash to
construct a new corporate office building. Based on average accumulated expenditures, the amount of interest capitalized
during 2010 was $8,000. Construction was completed, and the building was occupied on January 1, 2011.
Required
1. Determine the acquisition cost of the new building.
2. The building has an estimated useful life of 20 years and a $5,000 salvage value. Assuming that Mercator uses the
straight-line basis to depreciate its operating assets, determine the amount of depreciation expense for 2010 and 2011.
Solution
Required 1:
Acquisition cost of new building
Bank loan 80,000
Cash 120,000
Interest 8,000
Acquisition cost 208,000
Required 2:
The amount of depreciation expense for 2010 is zero because the asset was not completed and put into use until January 1,
2011.
208,000−5000
Depreciation expense (2011) = =10,150
20
Problem 12 Lump-Sum Purchase
On December 1, 2010, Company X bought from Company Y land and an accompanying warehouse for $800,000. The
fair market values of the land and the building at the time of purchase were $700,000 and $300,000, respectively. How
much of the purchase price should Company X allocate to land? How much to the building?
Solution:
Market Value of Assets
Land 700,000
Building 300,000
Total 1,000,000

Acquisition cost $800,000 should be allocated on the basis of market value as given below:
700,000
Acquisition cost of Land = 800,000 × =560,000
1,000,000
300,000
Acquisition cost of building = 800,000 × =240,000
1,000,000
Problem 13 Lump-Sum Purchase
To add to his growing chain of grocery stores, on January 1, 2010, Danny Marks bought a grocery store of a small
competitor for $520,000. An appraiser, hired to assess the acquired assets’ value, determined that the land, building, and
equipment had market values of $200,000, $150,000, and $250,000, respectively.
Required
1. What is the acquisition cost of each asset? Prepare journal entry for the acquisition of asset.
2. Danny plans to depreciate the operating assets on a straight-line basis for 20 years. 2. Determine the amount of
depreciation expense for 2010 on these newly acquired assets. You can assume zero residual value for all assets.
3. How would the assets appear on the balance sheet as of December 31, 2010?
Solution:
Required 1
Calculation of Acquisition of Assets
Market Value
Land 200,000
Building 150,000
Equipment 250,000
Total 600,000

Now, acquisition cost should be allocated on the basis of market value as given below:
Acquisition cost of Land = $520,000 × $200,000/$600,000 = $173,333
Acquisition cost of Building $520,000 × $150,000/$600,000 = $130,000
Acquisition cost of Equipment $520,000 × $250,000/$600,000 = $216,667
Required 2:
The amount of depreciation expense that should be recorded for 2010 is as follows:
Land = $0
Building $130,000/20 years = $6,500
Equipment $216,667/20 years = $10,833
Required 3
The assets would appear on the balance sheet as follows:
Long Term Assets:
Land 173,333
Building 130,000
Less: Accumulated depreciation 6,500 123,500
Equipment 216,667
Less: Accumulated depreciation 10,833 205,834
Total Long-term Assets 502,667
Problem 14 Change in Depreciation Estimate
A company purchased an asset on January 1, 2008, for $10,000. The asset was expected to have a ten-year life and a
$1,000 salvage value. The company uses the straight-line method of depreciation. On January 1, 2010, the company
determines that the asset will last only five more years.
Calculate the amount of depreciation for 2010.
Solution:
Depreciation expense for 2008 and 2009:
10000−1000
Depreciation = =900 per year
10
Depreciation expense for 2010
Original cost 10,000
Less: Depreciation of 2008 and 2009 1800
Book Value (Beginning of 2010) 8,200
Now,
 8,200−1000
Depreciation expense for 2010 = =1440
5
Problem 15 Change in Estimate
Assume that Bloomer Company purchased a new machine on January 1, 2010, for $80,000. The machine has an estimated
useful life of nine years and a residual value of $8,000. Bloomer has chosen to use the straight-line method of
depreciation. On January 1, 2012, Bloomer discovered that the machine would not be useful beyond December 31, 2015,
and estimated its value at that time to be $2,000.
Required
1. Calculate the depreciation expense, accumulated depreciation, and book value of the asset for each year 2010 to 2015.
2. Was the depreciation recorded in 2010 and 2011 wrong? If so, why was it not corrected?
Solution
Required 1
Depreciation, accumulated depreciation, and book value for the straight-line method should be as follows:
Year Beginning book Depreciation Accumulated Ending book
value depreciation value
2010 80,000 8,000 8,000 72,000
2011 72,000 8,000 16,000 64,000
2012 64,000 15,500 31,500 48.500
2013 48,500 15,500 47,000 33,000
2014 33,000 15,500 62,500 17,500
2015 17,500 15,500 78,000 2,000
Working Note:
80,000−8,000
Depreciation for 2010 and 2011 = =8,000 p . a .
9
( 80,000−16,000 )−2,000
Depreciation for 2012 onward = =15,500 p . a .
4
Required 2:
Depreciation for 2010 and 2011 was not wrong. The company used the best information available at that time to develop
its estimate of depreciation. The information available in 2012 made it necessary to revise the estimate of depreciation.
This illustrates the difference between a change in estimate and a correction of an error.
Problem 16 Capital Expenditure
A company purchased an asset on January 1, 2008, for $10,000. The asset was expected to have a ten-year life and a
$1,000 salvage value. The company uses the straight-line method of depreciation. On January 1, 2010, the company made
a major repair to the asset of $5,000, extending its life. The asset is expected to last ten years from January 1, 2010.
Calculate the amount of depreciation for 2010.
Solution:
Original cost, January 1, 2008 10,000
Less: Accumulated depreciation (900 * 2 years) 1,800
Book Value, January 1, 2010 8,200
Add: Capital expenditure 5,000
Less: Residual Value 1,000
 Remaining depreciable value 12,200

10,000−1000
Depreciation for the year 2008 and 2009 = =900 p . a .
10
12,200
Depreciation for the year 2010 = =1,220 p . a .
10
Problem 17 Capital versus Revenue Expenditures
On January 1, 2008, Jose Company purchased a building for $200,000 and a delivery truck for $20,000. The following
expenditures have been incurred during 2010:
 The building was painted at a cost of $5,000.
 To prevent leaking, new windows were installed in the building at a cost of $10,000.
 To improve production, a new conveyor system was installed at a cost of $40,000.
 The delivery truck was repainted with a new company logo at a cost of $1,000.
 To allow better handling of large loads, a hydraulic lift system was installed on the truck at a cost of $5,000.
 The truck’s engine was overhauled at a cost of $4,000.
Required
1. Determine which of those costs should be capitalized. Also record the journal entry for the capitalized costs.
Assume that all costs were incurred on January 1, 2010.
2. Determine the amount of depreciation for the year 2010. The company uses the straight-line method and
depreciates the building over 25 years and the truck over 6 years. Assume zero residual value for all assets.
3. How would the assets appear on the balance sheet of December 31, 2010?
Solution
1. The cost of the new conveyor system and the hydraulic lift installed in the truck should be capitalized. Note: Some may
choose to capitalize the engine overhaul costs of $4,000 and the window repair costs of $10,000. However, both costs
appear to keep the asset in its normal operating condition and are more properly treated as expenses.
Journal Entry
Date Particulars LF Debit Credit
Jan 1, 2010 Building Dr 40,000
Truck Dr 5,000
To Cash 45,000
(To record capital expenditure
relating to building and truck)
2. The depreciation for 2010 should be calculated as follows:
Building Truck
Original cost 200,000 20,000
Less: Depreciation for 2008 and 2009 (WN) 16,000 6,667
Book Value, Jan 1, 2010 184,000 13,333
Add: Capitalized costs 40,000 5,000
Depreciable Amount, Jan 1 , 2010 224,000 18,333
Depreciation per year (2010) 224,000 18,333
23 4
=9,739 =4,583
Working Note:
200,000
Depreciation for 2008 and 2009: Building = =8,000 per annum
25
 20,000
Depreciation for 2008 and 2009: Truck = =3,333 per annum
6
3. The assets should appear on the 2010 balance sheet as follows:
Assets Amount Amount
Property, Plant and Equipment
Building 240,000
Less: Accumulated depreciation 25,739 214,261
Truck 25,000
Less: Accumulated depreciation 11,250 13,750
$228,011
Working Note:
Accumulated depreciation: Building =8000+8000+9739 = 25,739
Accumulated depreciation: Truck =3333.50 +3333.50+4583 = 11,250
Problem 18 Cost of Assets and the Effect on Depreciation
Early in its first year of business, Toner Company, a fi tness and training center, purchased new workout equipment. The
acquisition included the following costs:
Purchase price $150,000
Tax 15,000
Transportation 4,000
Setup* 25,000
Painting* 3,000
*The equipment was adjusted to Toner’s specific needs and painted
to match the other equipment in the gym.

The bookkeeper recorded an asset, Equipment, $165,000 (purchase price and tax). The remaining costs were expensed for
the year. Toner used straight-line depreciation. The equipment was expected to last ten years with zero salvage value.
Required
1. How much depreciation did Toner report on its income statement related to this equipment in Year 1? What is the
correct amount of depreciation to report in Year 1?
2. Income is $100,000 before costs related to the equipment are reported. How much income will Toner report in Year 1?
What amount of income should it report? You can ignore income tax.
3. Using the equipment as an example, explain the difference between a cost and an expense.
Solution:
Required 1
165,000
Reported depreciation in Year 1 = =16,500 per annum
10
197,000
Correct depreciation in Year 1 = =19,700 Per annum
10
Working Note:
Reported cost of assets = 150,000 + 15,000 = 165,000
Correct cost of assets = 150,000 + 15,000 + 4,000 + 25,000 + 3,000 = 197,000
Required 2
 Reported Corrected
Income before costs related to the equipment 100,000 100,000
Less: Depreciation expense 16,500 19,700
Less: Transportation 4,000 -
Less: Setup cost 25,000 -
Less: Painting 3,000 -
Net Income 51,500 80,300
Required 3
A cost is the amount incurred to acquire an asset or pay an expense, and an expense is the amount of an expired asset or
a cost that is incurred to generate revenue.
Problem 19 Cost of Assets and the Effect on Depreciation
Early in its first year of business, Key Inc., a locksmith and security consultant, purchased new equipment. The acquisition
included the following costs:
Purchase price $168,000
Tax 16,500
Transportation 4,400
Setup* 1,100
Operating cost for first year 26,400
*The equipment was adjusted to Key’s specific needs.
The bookkeeper recorded the asset Equipment at $216,400. Key used straight-line depreciation. The equipment was
expected to last ten years with zero residual value.
Required
1. Was $216,400 the proper amount to record for the acquisition cost? If not, explain how each expenditure should be
recorded.
2. How much depreciation did Key report on its income statement related to this equipment in Year 1? How much should
have been reported?
3. If Key’s income before the costs associated with the equipment is $55,000, what amount of income did Key report?
What amount should it have reported? You can ignore income tax.
4. Explain how Key should determine the amount to capitalize when recording an asset. What is the effect of Key’s error
on the income statement and balance sheet?
Solution:
Required 1:
The proper cost to record for the acquisition is $190,000 ($168,000 + $16,500 + $4,400 + $1,100). All costs, except the
operating costs for the first year, should be capitalized as part of the cost of the equipment. The operating costs of $26,400
should be expensed.
Required 2
216,400
Reported depreciation in Year 1 = =21,640 per annum
10
190,000
Correct depreciation in Year 1 = =19,000 Per annum
10
Required 3
Reported Corrected
Income before costs related to the equipment 55,000 55,000
Less: Depreciation expense 21,640 19,000
Less: Operating expense 26,400
Net Income 33,360 9,600
Required 4
Key should not include operating costs in the value of the asset recorded on the balance sheet. The effect of this error is to
overstate assets on the balance sheet and also overstate net income.
Problem 20 Capital Expenditures, Depreciation, and Disposal
Merton Company purchased a building on January 1, 2009, at a cost of $364,000. Merton estimated that its life would be
25 years and its residual value would be $14,000. On January 1, 2010, the company made several expenditures related to
the building. The entire building was painted and floors were refinished at a cost of $21,000. A federal agency required
Merton to install additional pollution control devices in the building at a cost of $42,000. With the new devices, Merton
believed it was possible to extend the life of the building by six years. In 2011, Merton altered its corporate strategy
dramatically. The company sold the building on April 1, 2011, for $392,000 in cash and relocated all operations to another
state.
Required
1. Determine the depreciation that should be on the income statement for 2009 and 2010.
2. Explain why the cost of the pollution control equipment was not expensed in 2010. What conditions would have
allowed Merton to expense the equipment? If Merton has a choice, would it prefer to expense or capitalize the equipment?
3. What amount of gain or loss did Merton record when it sold the building? What amount of gain or loss would have
been reported if the pollution control equipment had been expensed in 2010?
Solution
Required 1:
The depreciation that should be on the income statement for 2009 is:
364,000−14,000
Depreciation expense = =$ 14,000
25
The depreciation for 2010 should be calculated as follows:
Original Cost, Jan 1, 2009 364,000
Less: 2009 depreciation 14,000
Book Value, Jan 1, 2010 350,000
Add: Capitalized costs 42,000
Book Value, Jan 1, 2010 after capitalized costs 392,000
Now,
392,000−14,000
Depreciation expense for 2010 = =12,600
30
Required 2:
The pollution control equipment extended the life of the asset and should be capitalized rather than expensed. It is difficult
to determine whether Merton would rather expense or capitalize the equipment. If the company can expense the
equipment for tax purposes, it would normally desire to do so.
Required 3:
Calculation of gain or loss on sales of equipment:
Original cost of building 364,000
Add: Pollution divice capitalized 42,000
Less: Depreciation
2009 (14,000)
2010 (12,600)
2011 (12,600 *3/12) (3,150)
Book Value at sales date 376,250
Now,
Gain or Loss = Sales Value – Book Value
Gain or Loss = 392,000 – 376,250 = 15,750 gain
Reported gain or loss if the pollution control equipment had been expense in 2010.
Original cost of building 364,000
Less: Depreciation
2009 (14,000)
2010 (14,000)
2011 (14,000 * 3/12) (3,500)
Book Value at sales date 332,500
Now,
Gain or Loss = Sales Value – Book Value
Gain or Loss = 392,000 – 332,500 = 59,500 gain
Problem 21 Capital Expenditures, Depreciation, and Disposal
Wagner Company purchased a retail shopping center on January 1, 2009, at a cost of $612,000. Wagner estimated that its
life would be 25 years and its residual value would be $12,000. On January 1, 2010, the company made several
expenditures related to the building. The entire building was painted and floors were refinished at a cost of $115,200. A
local zoning agency required Wagner to install additional fire protection equipment, including sprinklers and built-in
alarms, at a cost of $87,600. With the new protection, Wagner believed it was possible to increase the residual value of the
building to $30,000. In 2011, Wagner altered its corporate strategy dramatically. The company sold the retail shopping
center on January 1, 2011, for $360,000 cash.
Required
1. Determine the depreciation that should be on the income statement for 2009 and 2010.
2. Explain why the cost of the fi re protection equipment was not expensed in 2010. What conditions would have allowed
Wagner to expense it? If Wagner has a choice, would it prefer to expense or capitalize the equipment?
3. What amount of gain or loss did Wagner record when it sold the building? What amount of gain or loss would have
been reported if the fi re protection equipment had been expensed in 2010?
Solution
Required 1:
 The depreciation that should be on the income statement for 2009 is:
612,000−12,000
Depreciation expense = =$ 24,000
25
The depreciation for 2010 should be calculated as follows:
Original Cost, Jan 1, 2009 612,000
Less: 2009 depreciation (24,000)
Book Value, Jan 1, 2010 588,000
Add: Capitalized costs 87,600
Book Value, Jan 1, 2010 after capitalized costs 675,600
Now,
675,600−30,000
Depreciation expense for 2010 = =26,900
24
Required 2:
The cost of the fire equipment increased the value of an asset that will last for more than one year. The cost would have
been expensed if it was maintenance. Wagner would prefer to expense the cost of the fire equipment for taxes in order to
take advantage of the tax shield immediately. However, Wagner would prefer to capitalize the cost for accounting
purposes in order to better match revenue with the costs incurred to generate that revenue.
Required 3:
Calculation of gain or loss on sales of equipment:
Original cost of building 612,000
Add: Pollution divice capitalized 87,600
Less: Depreciation
2009 (24,000)
2010 (26,900)
Book Value at sales date 648,700
Now,
Gain or Loss = Sales Value – Book Value
Gain or Loss = 360,000 – 648,700 = 288,700 Loss
Reported gain or loss if the pollution control equipment had been expense in 2010.
Original cost of building 612,000
Less: Depreciation
2009 (24,000)
2010 (24,000)
Book Value at sales date 564,000
Now,
Gain or Loss = Sales Value – Book Value
Gain or Loss = 360,000 – 564,000 = 204,000 Loss
 Chapter

Accounting for Current

Liabilities and Contingencies

Concept and Nature of Current Liabilities

Liabilities can be simply defined as an obligation of business firm towards outsiders. In other words, the claim of external
parities over the assets of business is called liabilities. It arises due to purchase of goods and services on credit,
borrowing loan from bank and financial institution etc. On the basis of maturity period, liabilities can be divided into two
types. They are: Current liabilities and non-current liabilities.
The obligation and debt that are expected to be paid within the next 12 months is called current liabilities. In other
words, Current liabilities are debts that are due to be paid within one year or the operating cycle, whichever is longer.
Further, such obligations will typically involve the use of current assets, the creation of another current liability, or the
providing of some service. The following are common examples of current liabilities: Accounts payable or trade
payables, Notes payable that will be due within one year, The principal portion of a long-term loan that must be paid
within one year, Wages payable, Income taxes payable, Interest payable, Other accrued expenses payable

Types of Current Liabilities

Account Payable
Accounts Payable is the amounts due to suppliers relating to the purchase of goods and services on credit. This is
perhaps the simplest and most easily understood current liability. Although an account payable may be supported by a
written agreement, it is more typically based on an informal working relation where credit has been received with the
expectation of making payment in the very near term. It is also called a trade creditor which does not bear interest
expense.
Accounting Entries
Date Particulars LF Debit Rs. Credit Rs.
For purchase of goods on credit
Purchase / Asset Dr.
To Accounts payable
For payment of accounts payable
Accounts payable Dr.
To Cash
To Purchase discount
 ILLUSTRATION 1
Prepare necessary journal entries from the following transactions of Bishal Trading Corp. Assume that the
Bishal Trading follows the periodic system.
Jan 10: Purchase inventory on account from a supplier for Rs.20,000 with terms of 3/10, net/30.
Jan 15: Paid amount owed to suppliers.

Solution
BISHAL TRADING CORP.
Journal Entries
Date Particulars LF Debit Rs. Credit Rs.
Jan 10 Purchase Dr. 20,000
To Accounts payable 20,000
(To record purchase of inventory on credit)
Jan 15 Accounts payable Dr. 20,000
To Purchase discount 600
To Cash 19,600
(To record payment of accounts payable with discount)

Tax Payable
Income tax payable is a current liabilities and is reported on the current liabilities section of balance sheet. Income tax
payable can also be considered as current income tax expenses and does not equal the total income tax expenses for
financing reporting using the accrual method.
Date Particulars LF Debit Rs. Credit Rs.
a) When tax payable is recorded
Tax expenses Dr. ×××
To Tax payable ×××
(To record tax payable)
b) When tax is paid
Taxable payable Dr. ×××
To Bank ×××
(To record payment of tax)

ILLUSTRATION 2
A company has total revenue of Rs.2,00,000 and operating expenses is Rs.1,70,000. It has in 25% bracket.
Required: a) Journal entry to record of tax payable
b) Journal entry to record of tax paid.
Solution
Journal Entries
Date Particulars LF Debit Rs. Credit Rs.
(a) Tax expenses Dr. 7,500
To Tax payable 7,500
(To record tax payable)
(b) Taxable payable Dr. 7,500
To Bank 7,500
(To record payment of tax)

Working note:
Tax expenses = (Rs.2,00,000 – Rs.1,70,000) × 25% = Rs.7,500.

Accrued Expense
The expenses that are incurred or expensed but unpaid at the end of reporting period is called accrued expenses. Such
as salaries and wages payable, utilities bill payable, rent payable, income tax payable, interest payable etc.
Accounting Entries
Date Particulars LF Debit Rs. Credit Rs.
 For expense incurred but not paid
Expenses Dr. ×××
To Accrued expenses/outstanding expense ×××
For payment of accrued expense
Accrued expense/outstanding expense Dr. ×××
To Cash ×××

ILLUSTRATION 3
From the following transactions, prepare necessary journal entries:
31st Dec. 2018:Salaries owed to employees but unpaid at the end of the month amount to Rs.10,000.
15th Jan. 2019: Paid the unpaid salary of 2018.
Solution
Journal Entry
Date Particulars LF Debit Rs. Credit Rs.
Dec. 31 Salaries expense Dr. 10,000
To Salaries payable 10,000
(To record salary due for the month)
Jan. 15 Salaries payable Dr. 10,000
To Cash 10,000
(To record payment of salary payable)

Unearned Revenue
The revenue that is received in advance is called unearned revenue. It represents the amount received before providing
goods and services to the customers.
Accounting Entries
Date Particulars LF Debit Rs. Credit Rs.
For cash received but not earned
Cash Dr. ×××
To Unearned revenue ×××
For recording unearned revenue earned
Unearned revenue Dr. ×××
To Sales revenue/Service revenue ×××

ILLUSTRATION 4
Butwal Law Firm collected Rs.18,000 from a customer on April 1 and agreed to provide legal services during
the next three months. Butwal Law Firm expects to provide an equal amount of services each month.
Required: a) Prepare the journal entry for the receipt of the customer deposit on April 1.
b) Prepare the adjusting entry on April 30.
c) What would be the effect on net income for April if the entry in (b) is not recorded?
Solution
a) Journal entry for the receipt of the customer deposit on April 1:
Date Particulars LF Debit Rs. Credit Rs.
April 1 Cash Dr. 18,000
To Unearned Revenue 18,000
(To record service revenue received in advance)

b) Adjusting entry on April 30:

Date Particulars LF Debit Rs. Credit Rs.
April 30 Unearned revenue Dr. 6,000
To Service Revenue 6,000
(To record service revenue received in advance)

c) Net income would be understated by Rs.6,000 if entry in (b) is not recorded.

Current Maturity of Long Term Liabilities
Sometimes firms borrow long-term money on an installment basis. That is, the firm makes periodic payments over the
life of the loan that includes principal reduction as well as interest. The current maturities of long-term liability represent
the principal portion of these installment payments that is due over the next 12 months. It is also called Current portion
of long-term debt.
Accounting Entries
Date Particulars LF Debit Rs. Credit Rs.
For recording long term debt borrowed
Cash Dr. ×××
To Long term debt ×××
For Transferring long term debt to current maturity of long term debt
Long term debt Dr. ×××
To Current maturity of long term debt ×××
For Transferring long term debt to current maturity of long term debt
Current maturity of long term debt Dr. ×××
To Cash ×××

ILLUSTRATION 5
On Baishak 1, 2075, ABC Company borrowed Rs.100,000 loan from Sunrise Bank. The term of the loan require
to make payments in the amount of Rs.10,000 per year for 10 years, payable each Baishak 1, beginning
Baishak 1, 2076. Prepare necessary journal entries required for 2075 and 2076.
Solution
In the book of ABC Company
Journal Entries
Date Particulars LF Debit Rs. Credit Rs.
1/1 2075 Cash Dr. 100,000
To Long term debt 1000,000
(To record long term loan taken)
31/12/2075 Long term debt Dr. 10,000
To Current portion of long term debt 10,000
(To record transfer of long term debt to current portion on long term
debt)
1/1/2076 Current portion of long term debt Dr. 10,000
To Cash 10,000
(To record payment of current portion of long term debt)

Notes Payable
A promissory note is a written agreement to pay a specific amount to specific party at a future date or on demand. In
other words, it’s a written loan agreement between two parties that requires the borrower to pay the lender on a day in
the future. The party that agrees to repay money is the maker of the note, and the party that receives money in the
future is the payee. A Company that holds a promissory note received from another company has an asset, called a note
receivable; the company that makes or gives a promissory note to another company has a liability, a note payable. Over
the life of the note, the maker incurs interest expense on its note payable and the payee earns interest revenue on its
note receivable
Therefore, Note payable is a written promise to pay stated sums of money, on specific dates, to the owners of the notes.
It arises due to purchase of goods and assets on credit or borrowing loan from bank and financial institution or to
replace an existing overdue account payable. The note payable which is due within 12 months is classified as current
liabilities.
 Difference between Notes Payable and Accounts Payable
Notes Payable Accounts Payable
Note payable is a written promise to pay stated sums of money, on Accounts Payable is the amounts due to suppliers relating to the
specific dates, to the owners of the notes. purchase of goods and services on credit.
It arises due to purchase of goods and assets on credit or borrowing It arises due to purchase of goods and inventories on credit.
loan from bank and financial institution or to replace an existing
overdue account payable.
Notes payable is based on formal and written agreement. Accounts payable is based on informal and verbal agreement.
Interest expense is involved in notes payable Interest expense is not involved in accounts payable
Notes payable can be short term or long term obligation of the Accounts payable is always a short term obligation of the business
business.
Notes payable can never be converted into accounts payable. Accounts payable can be converted into notes payable

Accounting Entries
Interest Bearing Notes Payable
The interest-bearing note payable is a note on which interest rate is quoted and interest is paid on the due date along
with the principal amount. This notes receivable also called non-discounted notes receivable.
Date Particulars LF Debit Rs. Credit Rs.
For recording issuance of promissory note:
Cash (If loan is borrowed) Dr. ×××
OR Purchase/assets (if goods or assets purchased) Dr. ×××
OR Accounts payable (if account payable is converted in to notes ×××
payable) Dr.
To Long term debt ×××
For recording outstanding interest expense at the end of accounting year
Interest expenses Dr. ×××
To Interest payable ×××
For recording retirement of notes payable with interest
Notes payable Dr. ×××
Interest payable Dr. ×××
Interest expenses Dr. ×××
To Cash ×××

ILLUSTRATION 6
On July 1, 2010, Jo’s Flower Shop borrowed Rs.25,000 from the bank. Jo signed a ten month, 8% promissory
note for the entire amount. Jo’s uses a calendar year-end.
Required: a) Prepare the journal entry for on July 1 to record the issuance of the promissory note
b) Prepare any adjusting entries needed at year-end.
c) Prepare the journal entry on May 1 to record the payment of principal and interest.
Solution
In the book of Jo's Flower Shop
Journal Entries
Date Particulars LF Debit Rs. Credit Rs.
a) For recording issuance of promissory note:
July 1 Cash Dr. 25,000
To Notes payable 25,000
(To record issuance of promissory note)
b) For recording outstanding interest expense at the end of accounting year
Dec. 31 Interest expense Dr. 1,000
To Interest payable 1,000
(To record interest expense due for six months)
c) For recording retirement of notes payable with interest
May 1 Notes payable Dr. 25,000
Interest payable Dr. 1,000
Interest expense Dr. 667
To Cash 26,667
(To record retirement of note with interest)
Non-Interest Bearing Notes Payable
A note receivable on which interest rate is not specified but the total interest amount is deducted on advance is called
non-interest bearing notes receivable. This notes receivable also called discounted note receivables because the
payment made to the client by discounting or deducting the interest amount from on the agreed principal amount. And
on the due date, the client should pay the agreed principal amount.
Date Particulars LF Debit Rs. Credit Rs.
For recording issuance of promissory note:
Cash (If loan is borrowed) Dr. ×××
OR Purchase/assets (if goods or assets purchased) Dr. ×××
OR Discount on notes payable Dr. ×××
To Long term debt ×××
For transferring discount on notes payable to interest expenses at the end of accounting period
Interest expenses Dr. ×××
To Discount on notes payable ×××
For transferring remaining discount to interest expense at maturity date:
Interest expense Dr. ×××
To Discount on notes payable ×××
For retirement of notes payable at maturity date:
Notes payable Dr. ×××
To Cash ×××

ILLUSTRATION 7
On October 1, 2018, Ratkowski Inc. borrowed Rs.18,000 from Second National Bank by issuing a 12-month
note. The bank discounted the note at 9%.
Required: a) Prepare the journal entry needed to record the issuance of the note.
b) Prepare the journal entry needed at December 31, 2018, to accrue interest.
c) Prepare the journal entry to record the payment of the note on October 1, 2019
d) How notes payable is presented immediately after the issuance of note.
e) How notes payable is presented at December 31, 2018.
f) What effective rate of interest did Ratkowski pay?
Solution
In the book of Ratkowski Inc.
Journal Entry
Date Particulars LF Debit Rs. Credit Rs.
For recording issuance of promissory note:
Oct 1, 2018 Cash Dr. 16,380
Discount on notes payable Dr. 1,620
To Notes payable 18,000
(To record issuance of non-interest bearing note)
For transferring discount on notes payable to interest expense at the end of accounting period.
Dec. 31, Interest expense Dr. 405
2018 To Discount on notes payable 405
(To record transfer of discount on notes payable to interest expense)
For transferring remaining discount to interest expense at maturity date:
Oct 1, 2019 Interest expense Dr. 1,215
To Discount on notes payable 1,215
(To record transfer of discount on notes payable to interest expense)
For retirement of notes payable at maturity date:
Oct 1, 2019 Notes payable Dr. 18,000
To Cash 18,000
(To record retirement of notes payable on its due date)

Balance Sheet Presentation of notes payable as on October 1, 2018:

Notes payable 18,000
Less: Discount on notes payable 1,620
Net liability 16,380
 Balance Sheet Presentation of notes payable as on December 31, 2018:
Notes payable 18,000
Less: Discount on notes payable 1,215
Net liability 16,785

Effective interest rate = × 1 = × 100 = 9.89

Presentation of Notes Payable on the Balance Sheet

Notes payable which is due within 12 months period from the date of balance sheet is presented under the current
liability section of the balance sheet. Interest bearing note is presented at face value of notes payable where as non-
interest bearing note is presented at face value less remaining discount which is not transferred to interest expense
account.
Interest Bearing Note Non-Interest Bearing Note
Notes payable (Face Value) ××× Notes payable (Face Value) ×××
Less: Discount on notes (×××) ×××
payable

Contingent Liabilities
A contingent liability is an obligation that involves an existing condition for which the outcome is not known with
certainty and depends on some event that will occur in the future. Contingent liability is a potential liability that may
occur, depending on the outcome of an uncertain future event. Examples of contingent liabilities are product warranties
and guarantees, premium or coupons, some lawsuits and legal claims etc.
A contingent liability is recorded in the accounting records if the contingency is likely and the amount of the liability can
be reasonably estimated. The liability may be disclosed in a footnote on the financial statements or not reported at all if
both conditions are not met.

Product Warranty and Guarantees

When a product is manufactured and ready to sell than some companies give product warranty i.e. a minimum
guarantee for a certain period of time and when the product fails to perform within the warranty period than the
product has to be replaced or repaired by the company which is a liability to the company.
Let us see the example, when a person has purchased a motorcycle from a showroom and has a warranty for the engine
for two years and the engine failed to work within six months of the purchase then the company has to replace the
engine and hence this is a contingent liability to the company.

1. For recording estimated liability at the end of accounting period when sales is made:
Date Particulars LF Debit Rs. Credit Rs.
Warranty expense Dr. ×××
To Estimated Liability ×××

2. For recording repair or replacement of a parts:

Date Particulars LF Debit Rs. Credit Rs.
Estimated liability Dr. ×××
To Cash (If repaired) ×××
To Inventory (if parts replaced)
 ILLUSTRATION 8
Clean Corporation manufactures and sells dishwashers. Clean provides all customers with a two-year warranty
guaranteeing to repair, free of charge, any defects reported during this time period. During the year, it sold
100,000 dishwashers for Rs.325 each. Analysis of past warranty records indicates that 12% of all sales will be
returned for repair within the warranty period. Clean expects to incur expenditures of Rs.14 to repair each
dishwasher. The account Estimated Liability for Warranties had a balance of Rs.120,000 on January 1. Clean
incurred Rs.150,000 in actual expenditures during the year.
Required: Prepare all journal entries necessary to record the events related to the warranty transactions during
the year. Determine the adjusted ending balance in the Estimated Liability for Warranties account.
Solution
CLEAN CORPORATION
Journal Entry
Date Particulars L.F. Debit Credit
Warranty expense (12,000 × 14) 168,000
To Estimated liability 168,000
(To record estimated warranty liability)
Estimated liability 150,000
To Cash 150,000
(To record actual expenditure of repair)

Adjusted ending balance in the Estimated Liability for Warranties

Beginning balance of estimated liability 120,000
Add: Liability estimated during the year 168,000
Total estimated liability 288,000
Less: Actual expenditure during the year 150,000
Ending Balance of Estimated Liability 138,000

Analyzing Management of Current Liability

Current Ratio
The current ratio is computed by dividing current assets by current liabilities. Current ratio measures the liquidity of a
firm. Although there is no hard and fast rule, conventionally a current ratio, 2:1 is considered satisfactory. If the ratio is
less than two, it is considered to be difficult for a manufacturing industry. If the ratio is higher than two, it indicates an
idle fund and a lack of enthusiasm for work. Again, it depends upon the nature of business.
Current ratio =

Quick Ratio
The ratio is computed by dividing quick assets by current liabilities. Some assets belonging to current assets cannot be
converted into cash in short period. Therefore, Current Ratio does not provide a satisfactory answer to solvency. The
ratio is a better test of the financial strength than the current ratio. It gives no consideration to inventory and prepaid
expenses are slow in conversion and cannot be converted into cash. A Quick ratio of 1:1 has usually been considered
favourable. But, it varies from company to company or depends on the nature of business. The quick ratio is also called
liquid ratio and acid test ratio. It is calculated as follows:
Quick ratio =
Where, Quick assets = Total current assets – Prepaid -Inventory
Working Capital
Working capital (abbreviated WC) is a financial metric that represents the operational liquidity of a business,
organization, or other entity. Along with fixed assets, such as property, plant, and equipment, working capital is
considered a part of operating capital. Positive working capital is required to ensure that a firm is able to continue its
operations and has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses. A
company can be endowed with assets and profitability but short on liquidity if its assets cannot be converted into cash.
It is calculated as follows:
Working Capital = Current assets – Current liabilities

ILLUSTRATION 9
Following are the accounts balance taken from the record of Nitesh and Co.
Current portion of LTD....................................................... Rs.5,000 Accounts payable................................................ Rs.20,000
Notes payable-current....................................................... 20,000 Cash.................................................................... 80,000
Allowance for doubtful account.......................................... 1,000 Interest payable................................................... 4,000
Interest receivable............................................................. 2,000 Unearned revenue............................................... 1,000
Accounts receivable.......................................................... 31,00 Salary payable..................................................... 15,000
Income Tax payable.......................................................... 5,000 Plant, property and equipment............................. 100,000
Bonds payable.................................................................. 30,000 Prepayment......................................................... 2,000
Closing stock..................................................................... 10,000

Required: a) Current liability section of balance sheet.

b) Compute working capital
c) Compute current ration and quick ratio. What do these ratios indicate?
Solution
a) Current Liability Section of the Balance Sheet
Current portion of LTD 5,000
Accounts payable 20,000
Notes payable 20,000
Interest payable 4,000
Unearned revenue 1,000
Salary payable 15,000
Income tax payable 5,000
Total Current liability 70,000
b) Working Capital
Current assets 124,000
Less: Current liabilities 70,000
Working Capital 54,000

Current assets = 80,000 + 2,000 + 31,000 – 1,000 + 2,000 + 10,000 = 124,000

Interpretation: Working capital is positive by Rs.54,000. It indicates a firm is able to continue its operations
and has sufficient funds to satisfy both maturing short-term debt and upcoming operational expenses.
c) Current ratio and quick ratio
Current ratio = = = 1.77 : 1
Quick ratio = = = 1.60 : 1
Interpretation: Current ratio and quick ratios are greater than 1. It indicates that the liquidity position of the
company is better to pay its short term obligations.

 Theoretical Questions
1. What do you mean by current liabilities?
2. Explain different types of current liabilities.
3. Define promissory note.
4. Differentiate between notes payable and accounts payable.
 5. Differentiate between interest bearing and non-interest bearing notes payable.
6. What is contingent liability?
7. Explain current portion of long term debt with example.
8. What is warranty liability? Explain with example.
9. "Liquidity ratio helps in analyzing the management of current liabilities." Explain.

 Practical Problems
PP 1 (Accounts Payable) Prepare necessary journal entries from the following transactions of Sunrise Supermarket.
Assume that the Supermarket follows the periodic system.
Nov 18: Purchase inventory on account from a supplier for Rs.100,000 with terms of 2/10, net/30.
Nov 25: Paid amount owed to suppliers.
PP 2 (Accounts payable) Journalize the following transactions assuming company uses periodic system.
Feb 1: Purchased merchandise from ABC Company for Rs.48,000 with term 3/10, net 30.
Feb 20: Paid the amount owed to ABC Company.
PP 3 (Accounts payable) Journalize the following transaction assuming company uses periodic system.
March 1 Bought goods from National Trading for Rs.10,000 with terms of net/30.
March 5 Paid amount owed to National Trading.
PP 4 (Accrued Expense) From the following transactions, prepare necessary journal entries:
Jan 30 Rent due for the month, Rs.17,000.
Feb 15 Paid the outstaying rent of previous month.
PP 5 Following transactions are taken from the record of Om Traders, Ktm. :
Dec 31 Salaries and wages owed to employees but unpaid for the month Rs.70,000.
Jan 5 Paid salaries and wages to employees of previous month.
Required: Prepare necessary journal entries.
PP 6 (Unearned Revenue) On December 9, a customer paid an advance of Rs. 9,300 for future services. The
company provided services worth Rs. 7,100 to the customer in December.
Required: Prepared necessary journal entries
PP 7 (Current maturity of long term debt) On January 1, 2012, Shiva Company borrowed Rs.500,000 from Janata
Bank. The term of the loan require to make payments in the amount of Rs.100,000 per year for 5 years,
payable each January 1, beginning January 1, 2013. Prepare necessary journal entries required for 2012 and
2013.
PP 8 (Interest Bearing Note) On November 1, 2017, Buddha Book Shop borrowed Rs.200,000 from the Himalayan
Bank Ltd. Buddha Book signed a 9 month, 12% promissory note for the entire amount. Buddha Book Shop
follows a calendar year-end.
Required: Prepare necessary journal entries in the book of Buddha Book Shop.
PP 9 (Interest Bearing Note) On April 1, 2017 Hari Om Trading Company took a loan Rs.100,000 from bank signing
a 10 months, 10% promissory note. Interest will be paid at maturity along with principal. Assume that the
company follows calendar year and paid entire amount with interest at maturity.
Required: a) Journal entry for the issuance of promissory note.
b) Journal entry for the interest expense accrued at the end of accounting year.
c) Journal entry for the retirement of promissory note with interest.
[Ans.: (b) Rs.7,500 (interest payable); (c) Rs.833 (Interest expenses)]

PP 10 (Interest Bearing Note) On March 1, 2018, XYZ Company borrowed Rs.50,000 from bank. The company signed
4 months, 12% promissory note. Interest will be paid at maturity along with principal amount.
Required: Prepare necessary journal entries relating to notes payable in the book of XYZ Company.
PP 11 (Interest Bearing Notes Payable) On July 1, 2017, Dev Company purchased inventory for Rs.500,000 from
Sulav Trader. Dev Company paid Rs.100,000 and signed 8 months, 12% promissory note for the reminder.
Dev follows calendar year. Interest will be paid at maturity along with interest.
 Required: Prepare all necessary journal entries relating to notes payable.
PP 12 (Non-Interest Bearing Note) On July 1, 2018, Shree Inc. borrowed Rs.40,000 from NIC Asia Bank Ltd. by issuing
a 12-month note. The bank discounted the note at 12%.
Required: a) Prepare the journal entry needed to record the issuance of the note.
b) Prepare the journal entry needed at December 31, 2018, to accrue interest.
c) Prepare the journal entry to record the payment of the note on October 1, 2019.
d) How notes payable is presented immediately after the issuance of note.
e) How notes payable is presented at December 31, 2018.
f) What effective rate of interest did Ratkowski pay?
[Ans.: (d) Rs.35,200; (e) Rs.36,600; (f) 13.64%]

PP 13 (Non-Interest Bearing Notes Payable) Shrestha Company purchased machine from Pradhan Company on Aplil
1, 2017. Shrestha Company made a Rs.50,000 down payment and signed 10 months note for Rs.160,000. The
normal price of the machine is Rs.200,000 in cash. Shrestha Company follows calendar year. Shrestha Co.
paid Pardhan Co. in full on the maturity date.
Required: Prepare the journal entries on Shrestha's book on April 1, December 31 and maturity date.
[Ans.: Rs.1,60,000 (Notes payable at maturity)]

PP 14 (Interest bearing and Non-interest bearing note) On July 1, 2010, Leach

Company needs exactly Rs.103,200 in cash to pay an existing obligation.
Leach has decided to borrow from State Bank, which charges 14% interest on
loans. The loan will be due in one year. Leach is unsure, however, whether to
ask the bank for (a) an interest-bearing loan with interest and principal
payable at the end of the year or (b) a loan due in one year but with interest
deducted in advance.
Required: a) What will be the face value of the note assuming that?
i) Interest is paid when the loan is due?
ii) Interest is deducted in advance?
b) Calculate the effective interest rate on the note assuming that:
i) Interest is paid when the loan is due.
ii) Interest is deducted in advance.
c) Assume that Leach negotiates and signs the one-year note with
the bank on July 1, 2010. Also, assume that Leach’s accounting
year ends December 31. Prepare necessary journal entry relating
to notes assuming that:
i) Interest is paid when the loan is due.
ii) Interest is deducted in advance.
d) Prepare the appropriate balance sheet presentation for July 1,
2010, immediately after the note has been issued assuming that:
i) Interest is paid when the loan is due.
ii) Interest is deducted in advance.
[Ans.: (a) (i) Rs.1,03,200; (ii) Rs.1,20,000; (b) (i) 14%; (ii) 16.28%; (c) (i) Rs.7,224
(interest payable); (ii) Rs.8,400 (d) (i) Rs.1,03,200; (ii) Rs.1,03,200]
PP 15 (Contingent Liability) Sapana Electronic manufactures and
sells TV. Sapana provides all customers with a two-year warranty
 guaranteeing to repair, free of charge, any defects reported during
this time period. During the year, it sold 10,000 TV for
Rs.10,000 each. Analysis of past warranty records
indicates that 10% of all sales will be returned for
repair within the warranty period. Sapana expects to incur
expenditures of Rs.500 to repair each TV. The account Estimated
Liability for Warranties had a balance of Rs.250,000 on January 1.
Sapana incurred Rs.300,000 in actual expenditures during the
year.
Required: Prepare all journal entries necessary to record the
events related to the warranty transactions during the year.
Determine the adjusted ending balance in the Estimated
Liability for Warranties account.
[Ans.: Rs.4,50,000]

PP 16 (Contingent Liabilities) Clearview Company manufactures and

sells high-quality television sets. The most popular line sells for
Rs.1,000 each and is accompanied by a three-year warranty to
repair, free of charge, any defective unit. Average costs to repair
each defective unit will be Rs.90 for replacement parts and Rs.60
for labor. Clearview estimates that warranty costs of Rs.12,600 will
be incurred during 2010. The company actually sold 600 television
sets and incurred replacement part costs of Rs.3,600 and labor
costs of Rs.5,400 during the year. The adjusted 2010 ending
balance in the Estimated Liability for Warranties account is
Rs.10,200.
Required: a) How many defective units from this year’s
sales does Clearview Company estimate will be returned
for repair?
 b) What percentage of sales does Clearview Company
estimate will be returned for repair?
c) Prepare all journal entries necessary to record the events
related to the warranty transactions during the year.
[Ans.: (a) 84 units; (b) 14%]
PP 17 (Contingent Liability) Bombeck Company sells a
product for Rs.1,500. When the customer buys it, Bombeck
provides a one-year warranty. Bombeck sold 120 products
during 2010. Based on analysis of past warranty records,
Bombeck estimates that repairs will average 3% of total
sales.
Required: a) Prepare journal entry for recording
warranty expense.
b) Assume that during 2010, products under warranty
must be repaired using repair parts from inventory
costing Rs.4,950. Prepare journal entry for
recording the repair of products.
[Ans.: (a) Rs.5,400 (Warranty expenses) ; (b) Rs.4,950]
PP 18 (Current Liabilities Section) Following are the accounts balances taken from the record of Sunshine Corp. at
Dec. 31, 2018
Accounts payable................................................... Rs.15,000 Accounts receivable............................................ Rs.30,000
Notes payable (due at March 2019)........................ 20,000 Allowance for doubtful account............................ 4,000
Discount on notes payable.......................................... 2,000 Salary payable..................................................... 4,500
Current maturity of long term debt............................... 9,500 Tax payable......................................................... 1,800
Cash ........................................................................... 50,000 Unearned revenue............................................... 4,800
Interest payable........................................................... 3,000 Interest receivable............................................... 10,000

Required: a) Current liability section of balance sheet.

b) Compute working capital
c) Current ratio and its interpretation.
[Ans.: (a) Rs.56,600; (b) 29,400; (c) 1.52 : 1]

PP 19 (Current Liability Section) Following are the accounts balance taken from the record of KTM Corp.
Accounts receivable............................................... Rs.9,2000 Accounts payable................................................ Rs.10,200
Notes payable-current............................................ 10,000 Cash.................................................................... 30,000
Allowance for doubtful account............................... 2,000 Interest payable................................................... 1,200
Interest receivable.................................................. 1,500 Unearned revenue............................................... 3,000
Current portion of LTD............................................ 10,000 Salary payable..................................................... 3,000
Income Tax payable............................................... 5,000 Plant, property and equipment............................. 100,000
Bonds payable........................................................ 50,000 Prepaid insurance................................................ 7,000
Inventory................................................................. 12,000

Required: a) Current liability section of balance sheet.

b) Compute working capital
c) Compute current ration and quick ratio. What do these ratios indicate?
[Ans.: (a) Rs.42,400; (b) Rs.98,100; (c) 3.31 : 1 & 2.87 : 1]

PP 20 Polly's Cards & Gifts Shop had the following transactions during the year:
– Polly’s purchased inventory on account from a supplier for Rs.8,000. Assume that Polly’s uses a periodic
 inventory system.
– On May 1, land was purchased for Rs.44,500. A 20% down payment was made, and an 18-month, 8%
notes was signed for the remainder.
– Polly’s returned $450 worth of inventory purchased in (a), which was found broken when the inventory
was received.
– Polly’s paid the balance due on the purchase of inventory.
– On June 1, Polly signed a one-year, Rs.15,000 note to First State Bank and received Rs.13,800.
– Polly’s sold 200 gift certificates for Rs.25 each for cash. Sales of gift certificates are recorded as a liability.
At year-end, 35% of the gift certificates had been redeemed.
– Sales for the year were Rs.120,000, of which 90% were for cash. State sales tax of 6% applied to all sales
must be remitted to the state by January 31.
Required: a) Record all necessary journal entries relating to these transactions
b) Assume that Polly’s accounting year ends on December 31. Identify and analyze the effect of any
adjustments that are necessary.
c) What is the total of the current liabilities at the end of the year?
[Ans.: (c) 62,449]

Chapter

Accounting for Long Term

Liabilities

Meaning and concept of Bond:

A bond is a security or financial instrument that allows firms to borrow money and repay the loan over a long period of
time. The bonds are sold or issued to investors who have amounts to invest and want a return on their investment. The
borrower (issuing firm) promises to pay interest on specified dates, usually annually or semiannually. The borrower also
promises to repay the principal on a specified date, the due date or maturity date.
A bond certificate is issued at the time of purchase and indicates the terms of bond. Generally, bonds are issued in
denominations of $1000. The denomination of the bond is usually referred to as the face value or par value. This is the
amount that the firm must pay at the maturity date of the bond.
Characteristics of Bond:
We have described the general nature of bonds, but all bonds do not have the same terms and features. The following
are some importance features that often appear in the bond certificate.
 Par Value: the par value is the stated face value of the bond, which is paid at maturity. It is also called maturity
value or face value or principal. In Nepal, par value of corporate bond must be Rs. 1000.
 Coupon Interest Rate: The bond requires the issuer to pay a fixed amount of interest at the end of each period
(year or six months). This amount is called coupon payment. When coupon payment is divided by the par value,
the result is the coupon interest rate. Coupon interest rate is also stated in the indenture and bond certificates.
It generally remains constant throughout the life of bond or term loan.
 Indenture: An indenture is a legal document or contract that contains terms and conditions of bond issue. It
includes details of debt issue, description of property pledged (if any), the method of principle payment,
restriction placed on the firm by the lenders, rights and responsibilities of both borrower and lender.
 Call provision: an indenture may have call provision. A call provision gives the issuer the right to call the bonds
prior to maturity. Generally, a company pays the bondholders an amount greater than the par value, if they are
called before maturity. The amount paid to the bondholder is called call price and the excess amount over par
value is called call premium.
 Collateral or debenture: The bond certificate should indicate the collateral of the loan. Collateral represents the
assets that back the bonds in case the issuer cannot make the interest and principal payment and must default
on the loan. Debenture bonds are not backed by specific collateral of the issuing company. Rather, the investor
must examine the general creditworthiness of the issuer. Of a bond id a secured bond, the certificate indicates
specific assets that serve as collateral in case of default.
 Due date: the bond certificate specifies the date the bond principal must be repaid. Normally, bonds are term
bonds, meaning that the entire principal amount is due on a single date. Alternatively, bond may be issued as
serial bonds, meaning that not the entire principal is due on the same date. For example, a firm may issue serial
bonds that have a portion of the principal due each year for the next 10 years. Issuing firms may prefer serial
bonds because a firm does not need to accumulate the entire amounts for principal repayment at one time.
Bond Issue Price: The bond issue prices equal the present value of the cash flows that the bond will produce. Bonds
produce two types of cash flows for the investor: interest receipts and repayment of principle (face value). The
interest receipts constitute an annuity of payment each interest period over the life of the bonds. The repayment of
principal (face value) is a onetime receipt that occurs at the end of the term of the bonds. We must calculate the
present value of the interest receipts and the present value of the principal amount. The total of the two present
value calculations represents the issue price of the bond.
Present value of interest payment (interest × PVIFA) ×××
Present value of principle (Principle × PVIF) ×××
Issue Price of Bond ×××
Factors affecting bond price:
  Face Rate of Interest: it is also called the stated rate, nominal rate, contract rate or coupon rate. It is the
rate specified on the bond certificate. It is the amount of interest that will be paid each interest period.
 Market rate of interest: market rate of interest is also called the effective rate or bond yield. The market
rate of interest is the rate that bondholders could obtain by investing in other bonds that are similar to the
issuing firm’s bonds. The issuing firm does not set the market rate of interest. That rate is determined by the
bond market on the basis of many transactions for similar bonds.
Note:
If market rate = face rate: Issued at par
If market rate >face rate: Issued at discount
If market rate<face rate: issued at premium
Journal entry for issue of bond:
1. Issue of bond at par: when the issue price of bond is equal to the par value (face value), it is called issue of bond
at par value. The entry will be:
Date Particulars L.F. Debit Credit
Cash Dr
To Bonds payable
(To record issue of bond at par)

2. Issue of bond at premium: when the issue price of bond is greater than the par value (face value), it is called
issue of bond at premium. The entry will be:
Date Particulars L.F. Debit Credit
Cash Dr
To Bonds payable
To Premium on bond payable
(To record issue of bond at premium)

3. Issue of bond at discount: when the issue price of bond is less than the par value (face value), it is called issue
of bond at discount. The entry will be:
Date Particulars L.F. Debit Credit
Cash Dr
Discount on bond payable Dr
To Bonds payable
(To record issue of bond at discount)
Bond Amortization:
Amortization refers to the process of transferring an amount from the discount or premium account to interest expense
each time period to adjust interest expense.
Effective Interest Method of Bond Amortization:
The effective interest method of amortization amortizes discount or premium in a manner that produces a constant
effective interest rate from period to period. The amount of interest expense will vary form period to period, but the
rate of interest will be constant. This interest rate is referred to as the effective interest rate and is equal to the market
rate of interest at the time the bonds are issued.
Bond Amortization Schedule:
year Cash interest Interest expense Discount or Carrying value
(Coupon rate) (market rate) premium
 amortization

Carrying value:
The value of bond which is presented in the balance sheet after adjustment of unamortized discount or premium is
called Carrying value of Bond. It is calculated as follows:
Carrying value (if issued at par) = Face value
Carrying value (if issued at discount) = Face value – unamortized discount
Carrying value (if issued at premium) = Face value + unamortized premium
Presentation of bond payable in Balance sheet:
Bond payable is presented at their carrying value in the balance sheet. Carrying value can be calculated by adjusting
unamortized discount or premium in face value of bond payable. The bond is presented in balance sheet as follows:
 If issued at par: (carrying value is equal to face value)
Long Term Liabilities:
Bond Payable ×××
 If issued at discount: Carrying value is equal to face value less unamortized discount.
Long Term Liabilities:
Bond Payable ×××
Less: Discount on bond payable ×××
×××
 If issued at Premium: Carrying value is equal to face value plus unamortized premium.
Long Term Liabilities:
Bond Payable ×××
Add: Premium on bond payable ×××
×××
Journal entry for recording interest expense:
a. If bond is issued at par
Date Particulars L.F. Debit Credit
Interest Expense Dr
To Cash
b. If Bond is issued at discount
Date Particulars L.F. Debit Credit
i. For payment of coupon interest (Cash interest)
Interest Expense Dr
To Cash
ii. For amortization of discount on bond (transferring discount on bond to interest expense account)
Interest expense Dr
To Discount on bond payable
c. If Bond is issued at premium
Date Particulars L.F. Debit Credit
i. For payment of coupon interest (Cash interest)
Interest Expense Dr
To Cash
ii. For amortization of premium on bond (transferring premium on bond to interest expense account)
 Premium on bond payable Dr
To Interest expense
Redemption of Bond:
The term redemption refers to retirement of bonds by repayment of the principal. The bond which is repaid at the end
of maturity period, it is called redemption at maturity. Company can retires bond before maturity date which is called
redemption before maturity. Company can redeemed bond before maturity, if bond indenture contain call provision.
Normally call price of bond is higher than face value because it creates interest rate risk to the bondholders. The
accounting treatment of redemption of bond is given below:
a. Redemption at maturity:
Date Particulars L.F. Debit Credit
Bonds payable Dr
To Cash
d. Redemption of bond before maturity: if company calls bond before maturity date, it is necessary to recognize
gain or loss on retirement of bond. Gain or loss on retirement of bond can be calculated as follows:
 If Carrying value = Redemption price: No gain/ no loss
 If carrying value> Redemption price: Gain
 If carrying value < Redemption price: Loss
Journal entry
i. If Bonds are issued at discount:
Date Particulars L.F. Debit Credit
Bonds payable Dr (Face value)
Loss on retirement of bond Dr (if carrying value < redemption price)
To Discount on bond payable (Unamortized discount)
To Cash (Redemption price)
To Gain on retirement of bond (If carrying value > redemption price)

ii. If Bonds are issued at premium:

Date Particulars L.F. Debit Credit
Bonds payable Dr (Face value)
Premium on bond payable Dr (Unamortized premium)
Loss on retirement of bond Dr (if carrying value < redemption price)
To Cash (Redemption price)
To Gain on retirement of bond (If carrying value > redemption price)
Lease:
A lease is an agreement whereby the lesser (owner) conveys asset to the lessee (user) in return for rent the right to use
an asset for an agreed period of time. The common example of a lease arrangement is the rental of an apartment. The
tenant is the lessee and the lessee and the landlord is the lesser. Lease agreements are a form of financing. In some
cases, it is more advantageous to lease an asset than to borrow money to purchase it. The lessees can conserve cash
because a lease does not require a large initial cash outlay. A wide varied of lease arrangements exists, ranging from
simple agreements to complex ones that span a long time period. Lease arrangements are popular because of their
flexibility. The terms of lease can be structured in many ways to meet the needs of the lessee and lesser.
Types of leases:
Operating lease:
An operating lease is a rental arrangement under which the lesser provides an asset to a lessee but does not transfer the
risks and rewards of ownership of the asset. In an operating lease, the lessee acquires the right to use an asset for a
limited period of time. The lessee is not required to record the right to use the property as an asset or to record the
obligation for payments as a liability. Therefore, the lessee is able to attain a form of off-balance-sheet financing. That is,
the lessee has attained the right to use property but has not recorded that right, or the accompanying obligation, on the
balance sheet.
Journal Entry
Date Particulars L.F. Debit Credit
Lease rent expense Dr
To Cash

Capital lease:
A capital lease is an arrangement under which the lessor transfers all risks and rewards of ownership of an asset to the
lessee. A finance lease is usually non-cancelable for a specified period and secures for the lessor the recovery of this
capital outlay plus a return for the funds invested. In this type of lease, the lessee has acquired sufficient rights of
ownership and control of the property to be considered its owner. The lease is called a capital lease by the lessee if one
or more of the following criteria are met.
 The lease transfers ownership of the property to the lessee at the end of the lease term.
 The lease contains a bargain-purchase option to purchase the asset at an amount lower than its fair market
value
 The lease term is 75% or more of the property’s economic life.
 The present value of the minimum lease payments is 90% or more of the fair market value of the property at the
inception of the lease.
A capital lease is recorded as an asset, in an account such as leased asset and as a liability, in an account such as lease
obligation. The lease is recorded at the amount of the present value of the lease payments. When a lease payment is
made, the portion of the payment that is interest is recorded to the interest expense account, the portion of the
payment that is principal is considered a reduction in the lease obligation account.
Journal entry
 For leased asset is acquired:
Date Particulars L.F. Debit Credit
Leased Asset Dr
To Lease Obligation

 For depreciation charged on leased asset:

Date Particulars L.F. Debit Credit
Depreciation Expense Dr
To Accumulated Depreciation-Leased Asset

 For making annual payment of lease obligation

Date Particulars L.F. Debit Credit
Interest Expense Dr
Lease Obligation Dr
 To Cash

Balance sheet presentation

Assets:
Leased assets ×××
Less: Accumulated depreciation ××× ×××

Liabilities;
Current liabilities:
Current portion of lease obligation ×××
Long-term liabilities:
`Lease obligation ×××

Note:
 Acquisition cost of leased asset/ Present value of lease payment = Lease payment × PVIFA
Present Value of Lease Payment
 Lease payment =
PVIFA

 Practical Problems with Solution

Problem 1 Issue Price
Youngblood Inc. plans to issue $500,000 face value bonds with a stated interest rate of 8%. They will mature in ten years.
Interest will be paid semiannually. At the date of issuance, assume that the market rate is (a) 8%, (b) 6%, and (c) 10%.
Required
For each market interest rate, answer the following questions:
1. What is the amount due at maturity?
2. How much cash interest will be paid every six months?
3. At what price will the bond be issued?
4. Prepare journal entry for issue of bond.
Solution:
Required 1: If the market rate is 8% p.a.
1. Amount due at maturity = Face Value
 = 500,000
2. Cash interest paid every six months = Face Value × Semiannual stated rate
= 500000 × 4% = 20000
3. Issue price of bond = (Cash Interest × PVIFA4%, 20 periods) × (Face Value × PVIF 4%, 20 periods)
= (20000 × 13.590)+ (500000 × 0.456)
= 271800 + 228000 = 499800 or 500000
4.
Journal Entry
Date Particulars L.F. Debit Credit
Cash Dr 500,000
To Bonds payable 500,000
(To record issue of bonds at par)

Required 2:
1. Amount due at maturity = Face Value
= 500,000
2. Cash interest paid every six months = Face Value × Semiannual stated rate
= 500000 × 4% = 20000
3. Issue price of bond = (Cash Interest × PVIFA 3%, 20 periods) × (Face Value × PVIF 3%, 20 periods)
= (20000 ×14.877 )+ (500000 ×0.554 )
= 297540 + 277000 = 574540
4.
Journal Entry
Date Particulars L.F. Debit Credit
Cash Dr 574,540
To Bonds payable 500,000
To Premium on bonds payable 74,540
(To record issue of bonds at premium)

Required 3:
1. Amount due at maturity = Face Value
= 500,000
2. Cash interest paid every six months = Face Value × Semiannual stated rate
= 500000 × 4% = 20000
3. Issue price of bond = (Cash Interest × PVIFA 5%, 20 periods) × (Face Value × PVIF 5%, 20 periods)
= (20000 ×12.462 )+ (500000 ×0.377 )
= 249240 + 188500 = 437740
4.
Journal Entry
Date Particulars L.F. Debit Credit
Cash Dr 437,740
 Discount on bonds payable Dr 62,260
To Bonds payable 500,000
(To record issue of bonds at discount)

Problem 2 Issue Price

The following terms relate to independent bond issues:
a. 500 bonds; $1,000 face value; 8% stated rate; 5 years; annual interest payments
b. 500 bonds; $1,000 face value; 8% stated rate; 5 years; semiannual interest payments
c. 800 bonds; $1,000 face value; 8% stated rate; 10 years; semiannual interest payments
d. 2,000 bonds; $500 face value; 12% stated rate; 15 years; semiannual interest payments
Required
Assuming the market rate of interest is 10%, calculate the selling price for each bond issue.
Solution:
a. Face value of bond = 500 ×1000 =500,000
Coupon rate = 8% p.a.
Market rate = 10% p.a.
Cash interest = Face Value × Coupon rate = 500,000 × 8% = 40,000
Now,
Issue price of bond = (Cash Interest × PVIFA 10%, 5 periods) × (Face Value × PVIF 10%, 5 periods)
= (40,000 × 3.791) + ( 500,000 × 0.621)
= 151,640 + 310,500 = 462,140
b. Face value of bond = 500 ×1000 =500,000
Coupon rate = 8% p.a. (8/2 =4% semiannual rate)
Market rate = 10% p.a. ( 10/2=5% semiannual rate)
Cash interest = Face Value × Coupon rate = 500,000 × 4% = 20000
No. of periods = 5 × 2 = 10 semiannual periods
Now,
Issue price of bond = (Cash Interest × PVIFA 5%, 10 periods) × (Face Value × PVIF 5%, 10 periods)
= (20000 × 7.722) + ( 500,000 × 0.614)
= 154,440 + 307,000 = 461,440
c. 800 bonds; $1,000 face value; 8% stated rate; 10 years; semiannual interest payments
Face value of bond = 800 ×1000 =800,000
Coupon rate = 8% p.a. (8/2 =4% semiannual rate)
Market rate = 10% p.a. ( 10/2=5% semiannual rate)
Cash interest = Face Value × Coupon rate = 800,000 × 4% = 32000
No. of periods = 10 × 2 = 20 semiannual periods
Now,
 Issue price of bond = (Cash Interest × PVIFA 5%, 20 periods) × (Face Value × PVIF 5%, 20 periods)
= (32000 × 12.462) + ( 800,000 × 0.377)
= 398,784 + 301,600 = 700,384
d. 2,000 bonds; $500 face value; 12% stated rate; 15 years; semiannual interest payments
Face value of bond = 2000 ×500 =1,000,000
Coupon rate = 12% p.a. (12/2 =6% semiannual rate)
Market rate = 10% p.a. ( 10/2=5% semiannual rate)
Cash interest = Face Value × Coupon rate = 1,000,000 × 6% = 60,000
No. of periods = 15 × 2 = 30 semiannual periods
Now,
Issue price of bond = (Cash Interest × PVIFA 5%, 30 periods) × (Face Value × PVIF 5%, 30 periods)
= (60,000 × 15.372) + ( 1,000,000 × 0.231)
= 922,320 + 231,000 = 1,153,320
Problem 3
A bond due in ten years with face value of $1,000 and face rate of interest of 8% is issued when the market rate of interest
is 6%.
Required
1. What is the issue price of the bond?
2. What is the amount of premium or discount on the bond at the time of issuance?
3. What amount of interest expense will be shown on the income statement for the first year of the bond?
4. What amount of the premium or discount will be amortized during the first year of the bond?
Solution
1. Issue price of bond = (Cash Interest × PVIFA 6%, 10 periods) × (Face Value × PVIF 6%, 10 periods)
= (80 × 7.360) + ( 1,000× 0.558)
= 588.80 + 588 = 1,176.80
2. Premium on bonds payable = Issue price – Face value
= 1176.80 -1000 = 176.80
3. Interest expense for the first year = Carrying value × Market rate
= 1176.80 × 6% = 70.60
4. Amortization of premium = (Face value × Coupon rate) – (Carrying value × Market rate)
= (1000 × 8%) – (1176.80 × 6%)
= 80 – 70.60 = 9.40
Problem 4 Bond Issue Price
A bond payable is dated January 1, 2010, and is issued on that date. The face value of the bond is $100,000, and the face
rate of interest is 8%. The bond pays interest semiannually. The bond will mature in five years.
Required
 1. What will be the issue price of the bond if the market rate of interest is 6% at the time of issuance?
2. What will be the issue price of the bond if the market rate of interest is 8% at the time of issuance?
3. What will be the issue price of the bond if the market rate of interest is 10% at the time of issuance?
Solution
1. Issue price of bond = (Cash Interest × PVIFA 3%, 10 periods) × (Face Value × PVIF 3%, 10 periods)
= (4000 × 8.530) + ( 100,000× 0.744)
= 34,120 + 74,400 = 108,520
2. Issue price of bond = (Cash Interest × PVIFA 4%, 10 periods) × (Face Value × PVIF 4%, 10 periods)
= (4000 × 8.111) + ( 100,000× 0.676)
= 32,444 + 67,600 = 100,044 or 100000
3. Issue price of bond = (Cash Interest × PVIFA 5%, 10 periods) × (Face Value × PVIF 5%, 10 periods)
= (4000 × 7.722) + ( 100,000× 0.614)
= 30,888 + 61,400 = 92,288
Problem 5 Amortization of Discount
Stacy Company issued five-year, 10% bonds with a face value of $10,000 on January 1, 2010. Interest is paid annually on
December 31. The market rate of interest on this date is 12%, and Stacy Company receives proceeds of $9,275 on the
bond issuance.
Required
1. Prepare a five-year table (similar to Exhibit 10-4) to amortize the discount using the effective interest method.
2. What is the total interest expense over the life of the bonds? cash interest payment? discount amortization?
3. Prepare the journal entry for the payment of interest and the amortization of discount on December 31, 2012 (the
third year), and determine the balance sheet presentation of the bonds on that date.
Solution:
1. Amortization Schedule
Discount Amortization
Effective Interest Method of Amortization
Date Cash Interest Interest Expense Discount Carrying
(10%) (12%) Amortization Value
Col. 1 Col. 2 Col. 2 – Col. 1
1/1/2010 9275
31/12/2010 1000 1113 113 9388
31/12/2011 1000 1127 127 9515
31/12/2012 1000 1142 142 9657
31/12/2013 1000 1159 159 9816
31/12/2014 1000 1184 184 10000
Total 5000 5725 725
2.
Total interest expense 5725
Total Cash interest payment 5000
Total discount amortized 725
3.
 Journal Entry
Date Particulars L.F. Debit Credit
31/12/2012 Interest expense Dr 1142
To Cash 1000
To Discount on bonds payable 142
(To record interest and amortize discount)
Balance Sheet
As on 31 Dec, 2012
Bonds payable 10,000
Less: Discount on bonds payable 343
9,657

Problem 6 Amortization of Discount

Ortega Company issued five-year, 5% bonds with a face value of $50,000 on January 1, 2010. Interest is paid annually on
December 31. The market rate of interest on this date is 8%, and Ortega Company receives proceeds of $44,011 on the
bond issuance.
Required
1. Prepare a five-year table (similar to Exhibit 10-4) to amortize the discount using the effective interest method.
2. What is the total interest expense over the life of the bonds? cash interest payment? discount amortization?
3. Prepare the journal entry to record interest expense on December 31, 2012 (the third year), and the balance sheet
presentation of the bonds on that date.
Solution:
1. Amortization Schedule
Discount Amortization
Effective Interest Method of Amortization
Date Cash Interest Interest Expense Discount Carrying
(5%) (8%) Amortization Value
Col. 1 Col. 2 Col. 2 – Col. 1
1/1/2010 44011
31/12/2010 2500 3521 1021 45032
31/12/2011 2500 3603 1103 46135
31/12/2012 2500 3691 1191 47326
31/12/2013 2500 3786 1286 48612
31/12/2014 2500 3888 1388 50000
Total 12500 18489 5989
2.
Total interest expense 18489
Total Cash interest payment 12500
Total discount amortized 5989
3.
Journal Entry
Date Particulars L.F. Debit Credit
31/12/2012 Interest expense Dr 3691
 To Cash 2500
To Discount on bonds payable 1191
(To record interest and amortize discount)
Balance Sheet
As on 31 Dec, 2012
Bonds payable 50000
Less: Discount on bonds payable 2674
47326

Problem 7 Amortization of Premium

Assume the same set of facts for Stacy Company as in Problem 10-2 except that the market rate of interest of January 1,
2010, is 8% and the proceeds from the bond issuance equal $10,803.
Required
1. Prepare a five-year table (similar to Exhibit 10-5) to amortize the premium using the effective interest method.
2. What is the total interest expense over the life of the bonds? cash interest payment? premium amortization?
3. Prepare the journal entry for the payment of interest of interest and the amortization of premium on December 31, 2012
(the third year), and determine the balance sheet presentation of the bonds on that date.
Solution:
1. Amortization Schedule

Premium Amortization
Effective Interest Method of Amortization
Date Cash Interest Interest Expense (8%) Premium Carrying
(10%) Amortization Value
Col. 1 Col. 2 Col. 2 – Col. 1
1/1/2010 10803
31/12/2010 1000 864 136 10667
31/12/2011 1000 853 147 10520
31/12/2012 1000 842 158 10362
31/12/2013 1000 829 171 10191
31/12/2014 1000 809 191 10000
Total 5000 4197 803
2.
Total interest expense 4197
Total Cash interest payment 5000
Total discount amortized 803
3.
Journal Entry
 Date Particulars L.F. Debit Credit
31/12/2012 Interest expense Dr 842
Premium on bond payable Dr 158
To Cash 1000
(To record interest and amortize discount)
Balance Sheet
As on 31 Dec, 2012
Bonds payable 10,000
Add: Premium on bonds payable 362
10,362

Problem 8 Amortization of Premium

Assume the same set of facts for Ortega Company as in Problem 10-2A except that the market rate of interest of January
1, 2010, is 4% and the proceeds from the bond issuance equal $52,230.
Required
1. Prepare a five-year table (similar to Exhibit 10-5) to amortize the premium using the effective interest method.
2. What is the total interest expense over the life of the bonds? cash interest payment? premium amortization?
3. Prepare the journal entry to record interest expense on December 31, 2012 (the third year), and the balance sheet
presentation of the bonds on that date.
1. Amortization Schedule
Premium Amortization
Effective Interest Method of Amortization
Date Cash Interest Interest Expense (8%) Premium Carrying
(10%) Amortization Value
Col. 1 Col. 2 Col. 2 – Col. 1
1/1/2010 52230
31/12/2010 2500 2089 411 51819
31/12/2011 2500 2073 427 51392
31/12/2012 2500 2056 444 50948
31/12/2013 2500 2038 462 50486
31/12/2014 2500 2014 486 50000
Total 12500 10270 2230
2.
Total interest expense 10270
Total Cash interest payment 12500
Total discount amortized 2230
3.
Journal Entry
Date Particulars L.F. Debit Credit
31/12/2012 Interest expense Dr 2056
Premium on bond payable Dr 444
To Cash 2500
(To record interest and amortize discount)
Balance Sheet
As on 31 Dec, 2012
Bonds payable 50000
 Add: Premium on bonds payable 948
50948

Problem 9 Amortization of Premium or Discount

Bonds payable are dated January 1, 2010, and are issued on that date. The face value of the bonds is $100,000, and the
face rate of interest is 8%. The bonds pay interest semiannually. The bonds will mature in five years. The market rate of
interest at the time of issuance was 6%.
Required
1. Using the effective interest amortization method, what amount should be amortized for the first six-month period? What
amount of interest expense should be reported for the first six-month period?
2. Using the effective interest amortization method, what amount should be amortized for the period from July 1 to
December 31, 2010? What amount of interest expense should be reported for the period from July 1 to December 31,
2010?
Solution:
. Issue price of bond = (Cash Interest × PVIFA 3%, 10 periods) × (Face Value × PVIF 3%, 10 periods)
= (4000 × 8.530) + ( 100,000× 0.744)
= 34,120 + 74,400 = 108,520

Date Cash Interest (4%) Interest Expense (3%) Premium Carrying

Amortization Value
Col. 1 Col. 2 Col. 2 – Col. 1
1/1/2010 108,520.00
31/12/2010 4,000 3,255.60 744.40 107,775.60
31/12/2011 4,000 3,233.27 766.73 107,008.90
1. Premium amortized = 744.40
Interest expense = 3,255.60
2. Premium amortized = 766.73
Interest expense = 3,233.27

Problem 10 Redemption of a Bond at Maturity

On March 31, 2010, Sammonds Inc. issued $250,000 face value bonds at a discount of $7,000. The bonds were retired at
their maturity date, March 31, 2020.
Required
Assuming that the last interest payment and the amortization of the discount have already been recorded, calculate the
gain or loss on the redemption of the bonds on March 31, 2020. Prepare the journal entry to record the redemption of the
bonds.
Solution:
Since the bonds are fully matured, the carrying value equals the face value and there will be no gain or loss on the
redemption of the bonds.
Journal Entry
Date Particulars L.F. Debit Credit
31/3/2020 Bonds payable Dr 250,000
To Cash 250,000
(To record retirement of bonds at maturity)

Problem 11 Redemption of Bonds

Reynolds Corporation issued $75,000 face value bonds at a discount of $2,500. The bonds contain a call price of 103.
Reynolds decides to redeem the bonds early when the unamortized discount is $1,750.
Required
1. Calculate Reynolds Corporation’s gain or loss on the early redemption of the bonds.
2. Describe how the gain or loss would be reported on the income statement and in the notes to the financial statements.
Solution:
1. Calculation of gain or loss on the early redemption of the bonds.

Carrying Value (75000-1750) 73,250

Less: Redemption price (75,000 × 103%) 77,250
Loss on retirement of bonds 4,000

2. The gain or loss on bond redemption should be presented on the income statement. In most cases, the gain or loss on
bond redemption should not be considered unusual or infrequent and therefore should not be presented in the section
of the statement where extraordinary items are presented.

Problem 12 Redemption of Bonds

McGee Company issued $200,000 face value bonds at a premium of $4,500. The bonds contain a call provision of 101.
McGee decides to redeem the bonds due to a significant decline in interest rates. On that date, McGee had amortized only
$1,000 of the premium.
Required
1. Calculate the gain or loss on the early redemption of the bonds.
2. Calculate the gain or loss on the redemption assuming that the call provision is 103 instead of 101.
3. Indicate where the gain or loss should be presented on the financial statements.
4. Why do you suppose the call price is normally higher than 100?
Solution:
1. Calculation of gain or loss on the early redemption of the bonds
 Carrying Value (200000+3500) 203500
Less: Redemption price (200000 × 101%) 202000
Gain on retirement of bonds 1500
2. Calculation of gain or loss on the early redemption of the bonds
Carrying Value (200000+3500) 203500
Less: Redemption price (200000 × 103%) 206000
Loss on retirement of bonds 2500
3. The gain or loss on bond redemption should be presented on the income statement. In most cases, the gain or loss on
bond redemption should not be considered unusual or infrequent and therefore should not be presented in the section
of the statement where extraordinary items are presented.
4. Bonds are redeemed early only if it is advantageous to the issuing firm. However, early redemption is usually not
favorable to the investor because it usually means the investor can no longer benefit from a favorable interest rate. To
compensate the investor for foregone interest, as well as for the costs and inconvenience involved, the call price is
normally set at an amount higher than 100.
Problem 13 Redemption of Bonds
Elliot Company issued $100,000 face value bonds at a premium of $5,500. The bonds contain a call provision of 101.
Elliot decides to redeem the bonds due to a significant decline in interest rates. On that date, Elliot had amortized only
$2,000 of the premium.
Required
1. Calculate the gain or loss on the early redemption of the bonds.
2. Calculate the gain or loss on the redemption assuming that the call provision is 104 instead of 101.
3. Indicate how the gain or loss would be reported on the income statement and in the notes to the financial statements.
4. Why do you suppose the call price is normally higher than 100?
Solution:
1. Calculation of gain or loss on the early redemption of the bonds
Carrying Value (100000+3500) 103500
Less: Redemption price (100000 × 101%) 201000
Gain on retirement of bonds 2500
2. Calculation of gain or loss on the early redemption of the bonds
Carrying Value (100000+3500) 203500
Less: Redemption price (100000 × 104%) 204000
Loss on retirement of bonds 500
3. The gain or loss on bond redemption should be presented on the income statement. In most cases, the gain or loss on
bond redemption should not be considered unusual or infrequent and therefore should not be presented in the section
of the statement where extraordinary items are presented.
4. Bonds are redeemed early only if it is advantageous to the issuing firm. However, early redemption is usually not
favorable to the investor because it usually means the investor can no longer benefit from a favorable interest rate. To
compensate the investor for foregone interest, as well as for the costs and inconvenience involved, the call price is
normally set at an amount higher than 100.

Problem 14 Financial Statement Impact of a Bond

Worthington Company issued $1,000,000 face value, six-year, 10% bonds on July 1, 2010, when the market rate of
interest was 12%. Interest payments are due every July 1 and January 1. Worthington uses a calendar year-end.
Required
1. Prepare the journal entry to record the issuance of the bonds on July 1, 2010.
2. Prepare the adjusting journal entry on December 31, 2010, to accrue interest expense.
3. Prepare the journal entry to record the interest payment on January 1, 2011.
4. Prepare the journal entry to record the retirement of the bonds on the maturity date.
Solution:
1.
Journal Entry
Date Particulars L.F. Debit Credit
1/7/2010 Cash Dr 916,200
Discount on bonds payable Dr 83,800
To Bonds payable 1,000,000
(To record issuance of bond)
Issue price of bond = (Cash Interest × PVIFA 6%, 12 periods) × (Face Value × PVIF 6%, 12 periods)
= (50,000 ×8.384 ) + ( 1,000,000 × 0.497)
= 419,200 +497,000 = 916,200
2. Journal entry on December 31, 2010 to accrue interest expense.
Journal Entry
Date Particulars L.F. Debit Credit
31/12/2010 Interest expense Dr 54,972
To Discount on bonds payable 4,972
To Interest payable 50,000
(To record interest and amortization of discount)
Working Note:
Amortization of discount on bonds payable:
Cash Interest = 1,000,000 × 5% = 50,000
Interest Expense = 916,200×6% = 54,972
Discount amortized = 54972 – 50,000 = 4,972
3. Journal entry for payment of interest on January 1, 2011
Date Particulars L.F. Debit Credit
1/1/2011 Interest payable Dr 50,000
To Cash 50,000
(To record payment of interest )
4. Journal entry for retirement of bonds at maturity:
Date Particulars L.F. Debit Credit
1/7/2016 Bonds payable Dr 1,000,000
To Cash 1,000,000
(To record retirement of bonds)
Note:

On the maturity date, July 1, 2016, the balance in the Discount on Bonds Payable will have been reduced to zero.
The only remaining amount to be paid is the principal on the bond as shown in the Bonds Payable account,
$1,000,000.

Problem 15 Bond Transactions

Brand Company issued $1,000,000 face value, eight-year, 12% bonds on April 1, 2010, when the market rate of interest
was 12%. Interest payments are due every October 1 and April 1. Brand uses a calendar year-end.
Required
1. Prepare the journal entry to record the issuance of the bonds on April 1, 2010.
2. Prepare the journal entry to record the interest payment on October 1, 2010.
3. Explain why additional interest must be recorded on December 31, 2010. What impact does this have on the amounts
paid on April 1, 2011?
4. Determine the total cash inflows and outflows that occurred on the bonds over the eight-year life.
Solution:
1. Journal entry to record the issuance of the bonds:
Date Particulars L.F. Debit Credit
1/4/2010 Cash Dr 1,000,000
To Bonds payable 1,000,000
(To record issuance of bond )
2. Journal entry to record the interest payment on October 1, 2010.
Date Particulars L.F. Debit Credit
1/10/2010 Interest expense Dr 60,000
To Cash 60,000
(To record payment of interest)

3. Additional interest must be recorded on December 31 to accrue interest for the time period of October 1–December
31. The interest should be recorded as an expense when it is incurred under the accrual accounting process. The
accrual does not affect the amount of interest paid on April 1, 2011. A full semiannual payment of $60,000 should
occur on that date.
4. Total cash inflows and outflows that occurred on the bonds over the eight-year life.
Total cash inflow (issue price) 1,000,000
Total cash outflow
Interest (60000×16 periods) 960,000
Principal 1,000,000
Total Outflow 1,960,000
Difference 960,000

Problem 16 Effect of Bond Issuance

A bond with a face value of $10,000 is issued at a discount of $800 on January 1, 2010. The face rate of interest on the
bond is 7%.
Required
1. Was the market rate at the time of issuance greater than 7% or less than 7%?
2. If a balance sheet is presented on January 1, 2010, how will the bonds appear on the balance sheet?
3. If a balance sheet is presented on December 31, 2010, will the amount for the bonds be higher or lower than on January
1, 2010?
Solution:
1. If the bond was issued at a discount, then the market rate of interest exceeded the face rate.
2. Balance sheet presentation as on 1/1/2010
 Bonds payable 10,000
Less: Discount on bonds (800)
9,200
3. Since the discount will be amortized, the amount will be higher than $9,200.

Problem 17 Issuance of a Bond at Face Value

On January 1, 2010, Whitefeather Industries issued 300, $1,000 face value bonds. The bonds have a five-year life and pay
interest at the rate of 10%. Interest is paid semiannually on July 1 and January 1. The market rate of interest on January 1
was 10%.
Required
1. Calculate the issue price of the bonds and identify and journalize the issuance of the bonds on January 1, 2010.
2. Explain how the issue price would have been affected if the market rate of interest had been higher than 10%.
3. Prepare the journal entry to record the payment of interest on July 1, 2010.
4. Prepare the journal entry to record the accrual of interest on December 31, 2010.
Solution:
1.
Issue price of bond = (Cash Interest × PVIFA 5%, 10 periods) × (Face Value × PVIF 5%, 10 periods)
= (15,000 ×7.722) + (300,000 × 0.614)
= 115,830 + 184,200 = 300,030 or 300,000
Note: Issue price should be $300,000; difference due to rounding in present value factors.
Journal Entry
Date Particulars L.F. Debit Credit
1/1/2010 Cash Dr 300,000
To Bonds payable 300,000
(To record issuance of bond )
2. If the market rate of interest had been higher than 10%, the issue price would have been less than the face value of the
bonds. The bonds would have been issued at a discount.
3.
Journal Entry
Date Particulars L.F. Debit Credit
1/7/2010 Interest expense Dr 15,000
To Cash 15,000
(To record payment of interest)
4.
Journal Entry
Date Particulars L.F. Debit Credit
31/12/2010 Interest expense Dr 15,000
To Interest payable 15,000
(To record accrued interest)
Note: The amount of interest to be accrued, on December 31, 2010, is calculated as follows:
= $300,000 × 10% × 1/2 year = $15,000.
Problem 18 Impact of a Discount
Berol Corporation sold 20-year bonds on January 1, 2010. The face value of the bonds was $100,000, and they carry a 9%
stated rate of interest, which is paid on December 31 of every year. Berol received $91,526 in return for the issuance of
the bonds when the market rate was 10%. Any premium or discount is amortized using the effective interest method.
Required
1. Prepare the journal entry to record the sale of the bonds on January 1, 2010, and the proper balance sheet presentation
on this date.
2. Prepare the journal entry to record interest expense on December 31, 2010, and the proper balance sheet presentation on
this date.
3. Explain why it was necessary for Berol to issue the bonds for only $91,526 rather than $100,000.
Solution:
1.
Journal Entry
Date Particulars L.F. Debit Credit
1/1/2010 Cash Dr 91,526
Discount on bonds payable Dr 8,474
To Bonds payable 100,000
(To record issuance of bonds at discount)
Balance Sheet (1/1/2010)
Bonds payable 100000
Less: Discount on bonds payable 8,474
91,526
2.
Journal Entry
Date Particulars L.F. Debit Credit
31/12/2010 Interest expense Dr 9153
To Cash 9000
To Discount on bonds payable 153
(To record payment of interest and amortization of discount)
Balance Sheet (31/12/2010)
Bonds payable 100000
Less: Discount on bonds payable (8,474 – 153) 8,321
91,679
3. The market rate of interest was greater than the interest rate that Berol Corporation. is paying. Therefore, the issuance
price, discounted at 10%, the market rate, will be less than face value.

Problem 19 Impact of a Premium

Assume the same set of facts for Berol Corporation as in Exercise 10-16 except that it received $109,862 in return for the
issuance of the bonds when the market rate was 8%.
Required
1. Prepare the journal entry to record the sale of the bonds on January 1, 2010, and the proper balance sheet presentation
on this date.
2. Prepare the journal entry to record interest expense on December 31, 2010, and the proper balance sheet presentation on
this date.
3. Explain why the company was able to issue the bonds for $109,862 rather than for the face amount.
Solution:
1.
Journal Entry
Date Particulars L.F. Debit Credit
1/1/2010 Cash Dr 109,862
To Bonds payable 100,000
To Premium on bonds payable 9,862
(To record issuance of bonds at premium)
Balance Sheet (1/1/2010)
Bonds payable 100000
Add: Premium on bonds payable 9,862
109,862
2.
Journal Entry
Date Particulars L.F. Debit Credit
31/12/2010 Interest expense Dr 8,789
Premium on bonds payable Dr 211
To Cash 9,000
(To record interest and amortize premium on bond)
Balance Sheet (31/12/2010)
Bonds payable 100000
Add: Premium on bonds payable (9,862 – 211)) 9,651
109,651
3. The market rate of 8% is lower than the interest rate Berol is paying. Therefore, investors will be willing to pay more
on the basis of the future cash flows discounted at the market rate.
Problem 20 Factors That Affect the Bond Issue Price
Becca Company is considering the issue of $100,000 face value, ten-year term bonds. The bonds will pay 6% interest
each December 31. The current market rate is 6%; therefore, the bonds will be issued at face value.
Required
1. For each of the following situations, indicate whether you believe the company will receive a premium on the bonds or
will issue them at a discount or at face value. Without using numbers, explain your position.
a. Interest is paid semiannually instead of annually.
b. Assume instead that the market rate of interest is 7%; the nominal rate is still 6%.
2. For each situation in (1), prove your statement by determining the issue price of the bonds given the changes in (a) and
(b).
Solution:
1. a. The bonds would be issued at par, since the face or coupon rate is equal to the market rate of interest.
b. The bonds would be issued at a discount in this situation because investors would demand a 7% return on their
investment. Since the cash flows are fixed, the investment must be decreased to increase the effective interest rate.
2. a. Issue price of bond = (Cash Interest × PVIFA 3%, 20 periods) × (Face Value × PVIF 3%, 20 periods)
= (3000 ×14.877) + (100000 × 0.554)
= 44,631 + 55,400 = 100,031
Note: Issue price should be $100,000; difference due to rounding in present value factors.
 b. . Issue price of bond = (Cash Interest × PVIFA 7%, 10 periods) × (Face Value × PVIF 7%, 10 periods)
= (6000 × 7.024) + (100000 × 0.508)
= 42,144 + 50,800 = 92,944

Problem 21 Factors that Affect the Bond Issue Price

Rivera Inc. is considering the issuance of $500,000 face value, ten-year term bonds. The bonds will pay 5% interest each
December 31. The current market rate is 5%; therefore, the bonds will be issued at face value.
Required
1. For each of the following situations, indicate whether you believe the company will receive a premium on the bonds or
will issue them at a discount or at face value. Without using numbers, explain your position.
a. Interest is paid semiannually instead of annually.
b. Assume instead that the market rate of interest is 4%; the nominal rate is still 5%.
2. For each situation in (1), prove your statement by determining the issue price of the bonds given the changes in (a) and
(b).
Solution:
1. a. The bonds would be issued at par, since the face or coupon rate is equal to the market rate of interest.
b. The bonds would be issued at a premium in this situation because investors would bid the price upward on a bond
with a 5% return. Since the cash flows are fixed, the investment must be increased to decrease the effective
interest rate.
2. a. Issue price of bond = (Cash Interest × PVIFA 2.5%, 20 periods) × (Face Value × PVIF 2.5%, 20 periods)
= (12,500 ×15.599) + (500000 × 0.610)
= 194,988 + 305,000 = 499,988
Note: Issue price should be $500,000; difference due to rounding in present value factors.
b. Issue price of bond = (Cash Interest × PVIFA 4%, 10 periods) × (Face Value × PVIF 4%, 10 periods)
= (25,000 × 8.111) + (500000 × 0.676)
= 202,775 + 338,000 = 540,775

Lease
Problem 1
You have signed an agreement to lease a car for four years and will make annual payments of $4,000 at the end of each
year. (Assume that the lease meets the criteria for a capital lease.)
Required
1. Calculate the present value of the lease payments assuming an 8% interest rate.
2. What is the journal entry to record the leased asset?
3. When the first lease payment is made, what portion of the payment will be considered interest?
Solution:
1. Present value of lease payment = Annual Lease Payment × PVIFA 8%, 4 periods
= 4,000 × 3.312 = 13,248
2.
Date Particulars L.F. Debit Credit
1/1/1st year Leased Car Dr 13,248
To Lease Obligation 13,248
(To record signing of lease)
3. The amount of interest can be calculated as follows:
Interest = 13,248 × 8% = 1059.84

Problem 2 Lease Classification

Dianne Company signed a ten-year lease agreement on January 1, 2010. The lease requires payments of $5,000 per year
every December 31. Dianne estimates that the leased property has a life of 12 years. The interest rate that applies to the
lease is 8%.
Required
1. Should Dianne Company treat the lease as an operating lease or a capital lease?
2. If a balance sheet is presented on January 1, 2010, what amounts related to the lease will appear on the balance sheet?
3. Assume that the leased asset is depreciated using the straight-line method. Assume that the lease is amortized using the
effective interest method. What amounts should appear on the balance sheet of December 31, 2010?
Solution:
[Link] lease is a capital lease because the length of the lease exceeds 75% of the life of the asset.
2. Present value of lease payment = Annual Lease Payment × PVIFA 8%, 10 periods
= 5,000 × 6.710 = 33,550
Now,
If a balance sheet is presented on January 1, 2010, amounts related to the lease will appear on the balance sheet as
follows:
Lease asset (under the heading of fixed asset) = 33,550
Lease obligation (under the heading of long term liability) = 33,550
3.
Balance Sheet (Dec 31, 2010)
Assets
Leased Asset 33,550
Less: Accumulated depreciation 3,355
30,195
Long Term Liabilities
Lease Obligation (33,550 -2,326) 31,224
Problem 3 Leased Asset
Hopper Corporation signed a ten-year capital lease on January 1, 2010. The lease requires annual payments of $8,000
every December 31.
Required
1. Assuming an interest rate of 9%, calculate the present value of the minimum lease payments.
2. Explain why the value of the leased asset and the accompanying lease obligation are not reported on the balance sheet
initially at $80,000.
Solution:
1. Present value of lease payment = Annual Lease Payment × PVIFA 9%, 10 periods
= 8,000 × 6.418 = 51,344
2. $80,000 is not a correct amount to record because it does not recognize the time value of money. Since the payments
will extend over 10 years, the lease must be recorded at the present value of the payments.

Problem 4 Financial Statement Impact of a Lease

Benjamin’s Warehouse signed a six-year capital lease on January 1, 2010, with payments due every December 31. Interest
is calculated annually at 10%, and the present value of the minimum lease payments is $13,065.
Required
1. Calculate the amount of the annual payment that Benjamin’s must make every December 31.
2. Calculate the amount of the lease obligation that would be presented on the December 31, 2011, balance sheet (after
two lease payments have been made).
Solution:
1. Present value of lease payment = Annual Lease Payment × PVIFA 9%, 10 periods
Present value of lease payment 13,065
Or, Annual Lease Payment = = =3000 per year
PVIFA 9 % ,10 periods 4.355
2. Amount of the lease obligation that would be presented on the December 31, 2011, balance sheet (after two lease
payments have been made) = $9,508.65

Working Note:
Date Lease payment Interest Reduction of Lease
expense obligation obligation
1/1/2010 13,065.00
31/12/2010 3,000 1,306.50 1,693.50 11,371.50
31/12/2011 3,000 1,137.15 1,862.85 9,508.65

Problem 5 Leased Assets

Koffman and Sons signed a four-year lease for a forklift on January 1, 2010. Annual lease payments of $1,510, based on
an interest rate of 8%, are to be made every December 31, beginning with December 31, 2010.
Required
1. Assume that the lease is treated as an operating lease.
a. Will the value of the forklift appear on Koffman’s balance sheet?
b. What account will indicate that lease payments have been made?
2. Assume that the lease is treated as a capital lease.
a. Prepare any journal entries needed when the lease is signed. Explain why the value of the leased asset is not recorded
at $6,040 ($1,510 × 4).
b. Prepare the journal entry to record the first lease payment of December 31, 2010.
c. Prepare the adjusting entry to record depreciation expense on December 31, 2010.
d. At what amount would the lease obligation be presented on the balance sheet as of December 31,
2010?
Solution:
1. a. The value of the forklift will not appear on the balance sheet.
b. The lease payments will appear on the income statement as lease expense.
2.
a. Journal entry:
Date Particulars L.F. Debit Credit
1/1/2010 Leased Asset Dr 5,001
To Lease Obligation 5,001
(To record signing of lease)

The leased asset should be reported at the present value of the payments which is $5,001, not at $6,040.
b. Journal entry
Date Particulars L.F. Debit Credit
31/12/2010 Lease obligation Dr 1,110
Interest Expense Dr 400
To Cash 1,510
(To record payment of annual lease payment)
c. Depreciation expense = $5,001/4 years = $1,250.
Date Particulars L.F. Debit Credit
31/12/2010 Depreciation expense Dr 1,250
To Accumulated depreciation 1,250
(To record depreciation of leased asset)
c. Balance sheet presentation as on 31 Dec, 2010
Current Liabilities
Lease obligation (current portion) 1510 -311* 1,199
Long Term Liabilities
Lease obligation (5001-1110-1199) 2,692
311* = (5001 -1110) × 8% = 311
Problem 6 Financial Statement Impact of a Lease
On January 1, 2010, Muske Trucking Company leased a semitractor and trailer for fi ve years. Annual payments of
$28,300 are to be made every December 31 beginning December 31, 2010. Interest expense is based on a rate of 8%. The
present value of the minimum lease payments is $113,000 and has been determined to be greater than 90% of the fair
market value of the asset on January 1, 2010. Muske uses straight-line depreciation on all assets.
Required
1. Prepare a table similar to Exhibit 10-7 to show the five-year amortization of the lease obligation.
2. Journalize the lease transaction on January 1, 2010.
3. Prepare all necessary journal entries on December 31, 2011 (the second year of the lease).
4. Prepare the balance sheet presentation as of December 31, 2011, for the leased asset and the lease obligation.
Solution:
1.
Date Lease payment Interest Reduction of Lease
expense obligation obligation
1/1/2010 - - - 113000
31/12/2010 28,300 9040 19260 93740
31/12/2011 28,300 7499 20801 72939
31/12/2012 28,300 5835 22465 50474
31/12/2013 28,300 4038 24262 26212
31/12/2014 28,300 2088 26212 0
2.
Date Particulars L.F. Debit Credit
1/1/2010 Leased Truck Dr 113,000
To Lease Obligation 113,000
(To record acquisition by lease)
3.
Date Particulars L.F. Debit Credit
31/12/2011 Lease Obligation Dr 20,801
Interest Expense Dr 7,499
To Cash 28,300
(To record payment of lease obligation and interest)
31/12/2011 Depreciation Expense Dr 22,600
To Accumulated Depreciation-Leased Truck 22,600
(To record depreciation of leased asset)
4. Balance sheet presentation as on 31/12/2011
Assets
Leased Truck 113,000
Less: Accumulated depreciation 45,200
67,800
Current Liabilities
Lease obligation (current portion) 22,465
Long Term Liabilities
Lease obligation 50,474
Problem 7 Financial Statement Impact of a Lease
On January 1, 2010, Kiger Manufacturing Company leased a factory machine for six years. Annual payments of $21,980
are to be made every December 31 beginning December 31, 2010. Interest expense is based on a rate of 9%. The present
value of the minimum lease payments is $98,600 and has been determined to be greater than 90% of the fair market value
of the machine on January 1, 2010. Kiger uses straight-line depreciation on all assets.
Required
1. Prepare a table similar to Exhibit 10-7 to show the six-year amortization of the lease obligation.
2. Prepare the journal entry to record the signing of the lease transaction on January 1, 2010.
3. Prepare the journal entries necessary on December 31, 2011 (the second year of the lease).
4. Prepare the balance sheet presentation as of December 31, 2011, for the leased asset and the lease obligation.
Solution:
1.
 Date Lease payment Interest Reduction of Lease
expense obligation obligation
1/1/2010 98600
31/12/2010 21,980 8,874 13106 85494
31/12/2011 21,980 7,694 14286 71208
31/12/2012 21,980 6,409 15571 55637
31/12/2013 21,980 5,007 16973 38664
31/12/2014 21,980 3,480 18500 20164
31/12/2015 21,980 1,816 20164 0
2.
Date Particulars L.F. Debit Credit
1/1/2010 Leased Machine Dr 98,600
To Lease Obligation 98,600
(To record acquisition by lease)
3.
Date Particulars L.F. Debit Credit
31/12/2011 Lease Obligation Dr 14,286
Interest Expense Dr 7,694
To Cash 21,980
(To record payment of lease obligation and interest)
31/12/2011 Depreciation Expense Dr 16,433
To Accumulated Depreciation-Leased Truck 16,433
(To record depreciation of leased asset)
4. Balance sheet presentation as on 31/12/2011
Assets
Leased Truck 98,600
Less: Accumulated depreciation 32,866
65,734
Current Liabilities
Lease obligation (current portion) 15,571
Long Term Liabilities
Lease obligation 55,637

Chapter
 Accounting for Stockholders'
Equity

Meaning of Corporation:
A corporation is a business that is recognized by law as a separate legal entity with its own power, responsibilities and
liabilities. It is a separate legal entity having separate existence and distinct from their owners (stockholders/
shareholders). Corporations are artificial persons existing only in the eye of law. The corporation can do all those
business transactions which are permitted for it. It can purchase or sale property as an individual. It also can file suits in
its own name. As the company is created by law, it can be liquidated only by law.
The owners of corporation are referred to as stockholders or shareholders, because they hold the shares of stock, which
serve as the evidence of their ownership. The board of directors formulates the corporation’s policies and appoints
officers of the corporation to carry out those policies.
Stockholders Equity on the Balance Sheet:
Asset = Liabilities + Stockholders’ Equity
Stockholders’ Equity = Contributed capital (Capital Stock) + Retained Earning
Specimen of Stockholders’ Equity Section
Contributed Capital (Capital Stock or Paid-in Capital)
Common stock ×××
Preferred stock ×××
Additional paid-in capital – Common stock ×××
Additional paid-in capital – Preferred stock ×××
Total Contributed Capital ×××
Retained Earnings ×××
Stockholders’ equity ×××

Contributed Capital (Capital Stock):

Capital stock is a tern that encompasses both common stock and preferred stock. It is that section of stockholders’
equity that reports the amount a corporation received when it issued its share of stock. It is also called paid-in capital or
contributed capital. It includes common stock, preferred stock and additional-paid-in capital.
Component of Contributed Capital
Common Stock:
Common stock is a security issued by a company to raise equity capital. It is one of the major sources of long-term
(Permanent) capital. Common stock represents ownership of the company. Common stockholders of a company are its
real owners. Their liability is limited to the amount of their investment. Common stockholders have residual claim on
income and asset. Common stock does not have a maturity date. Stockholders, however, can sell their stocks in the
secondary market. Hence, the company which needs fund for indefinite period issues shares of common stock.
Features of Common Stock:
1. No of shares of common stock: Common stock represents the total ownership capital where as share indicate
the units of ownership capital. The no. of common stock can be divided into 3 groups:
 Authorized shares: the corporation must specify the maximum number of shares that it will be allowed
to issue. The maximum no. of shares is called authorized shares.
 Issued shares: the number of shares issued indicates the number of shares that have been sold or
transferred to stockholders.
 Outstanding shares: the outstanding share indicates shares actually in the hand of the stockholders.
2. Maturity: Common stock has no maturity date. It exists as long as the firm does. Therefore, capital raised from
common stock is also called fixed or permanent capital.
3. Claim on income and assets: Common stockholders have residual claim on income. Common stockholders are
paid after satisfying claim of creditors, bondholders and preferred stockholders. It also has residual claim on
asset in case of liquidation. This residual claim on income and asset increases the risk to the common
stockholders.
4. Voting right: Generally, each share of common stock entitles the holders to one vote in the election of directors
and in other decision. Common stockholders can attend the annual general meeting and cast vote in person or
by means of a proxy.
5. Limited liability: common stockholders’ liability is limited to the par value of shares of common stock that they
have subscribed.
6. par value: the par value of share of common stock is defined as the legal value of shares. It is stated price in
common stock certificates. The liability of the stockholders’ is limited to the extent of par value.
Preferred Stock:
Preferred stock is those, which enjoy some preferential rights. The first is dividend at a fixed rate or amount before any
dividend to common stock. The later is the redemption of preferred stock is made before the redemption of common
stock on liquidation of the company. It occupies in intermediate position between long term debt and common stock. It
is a hybrid form of financing with combined features of both debt and common stock. Like common stock, preferred
stock is legally considered as ownership capita, non payment of preferred dividends does not force the company into
bankruptcy and dividend is paid out of after tax profit. On the other hand, like bonds, preferred stock has a par value,
preferred stock dividends are fixed in amount, and preferred stockholders generally do not have voting right.
Features:
 par value
 fixed dividends
 maturity period
 voting right
 claim on asset and income
 call features
 cumulative features
 participating features
 convertible features
Additional paid-in capital:
When stock is issued for an amount higher than the par value, the excess is reported as additional paid-in capital.
Several alternative titles are used for this account.
 Paid-in capital in excess of par
 Capital surplus
 Premium on stock
Retained Earnings:
When companies make profit, they pay some portion of earning in form of dividend and retain rest in the company for
reinvestment. The portion of profit retained in the firm is called retained earnings. It is also known as corporate saving
or self-financing and it can be used to finance assets and meet contingencies.
Journal Entry for Issuance of Stock:
 Stock issued for cash:
Date Particulars L.F. Debit Credit
Cash Dr
To Common stock/ Preferred stock
To Additional paid-in capital

 Stock issued for non cash consideration:

Date Particulars L.F. Debit Credit
Asset Dr
To Common stock/ preferred stock
To Additional paid-in capital

Treasury Stock
If a corporation reacquired some of its stock and does not retire those shares, the shares are called treasury stock. The
treasury stock account is created when a corporation buys its own stock sometime after issuing it. For an amount to be
treated as treasury stock,
 It must be the corporation’s own stock.
 It must have been issued to the stockholders at some point.
 It must have been repurchased from the stockholders.
 It must not retire but must be held for some purpose.
Treasury stock is a contra equity item. It is not reported as an asset; rather it is subtracted for stockholders’ equity. The
presence of treasury stock will cause a difference between the number of shares issued and the number of shares
outstanding.
Reasons of Repurchase Stock as Treasury Stock:
 The most common reason is to have stock available to distribute to employees for bonuses or as part of an
employee-benefit plan.
 Firms also might be treasury stock to maintain a favorable market price for the stock or to improve the
appearance of the firm’s financial ratio.
 Firms have repurchased their stock to maintain control of the ownership and to prevent unwanted takeover or
bought attempts.
 The lower the stock price, the more likely a company is to buy back its own stock and wait for the shares to rise
in value before reissuing them.
Journal entries:
  For purchase of treasury stock:
Date Particulars L.F. Debit Credit
Treasury stock Dr
To Cash

Stockholders’ Equity Section after repurchase of treasury stock:

Contributed Capital (Capital Stock or Paid-in Capital)
Common stock ×××
Preferred stock ×××
Additional paid-in capital – Common stock ×××
Additional paid-in capital – Preferred stock ×××
Total Contributed Capital ×××
Retained Earning ×××
×××
Less: Treasury stock ×××
Total Stockholders’ equity ×××
Note:
Treasury stock is a contra-equity account, and the balance sheet should appear as a reduction in the stockholders’
equity category of the balance sheet.
Treasury stock is still stock that has been issued and so does not affect the number of share issued. But it is stock that
is held by the company, rather than the stockholders, and the purchase of treasury stock reduces the number of share
of stock outstanding.
 For re-issue of treasury stock at a price equal to cost price:
Date Particulars L.F. Debit Credit
Cash Dr
To Treasury Stock

 For re-issue of treasury stock at a price higher than the cost price:
Date Particulars L.F. Debit Credit
Cash Dr
To Treasury Stock
To Additional paid-in capital-Treasury stock
 For re-issue of treasury stock at a price higher than the cost price:
Date Particulars L.F. Debit Credit
Cash Dr
Additional paid-in capital Dr
Retained earnings Dr
To Treasury Stock

Note:
Gain or loss does not go to an income statement, as there can be no income statement recognition of gains or loss on
treasury stock transactions. Gain or losses on treasury stock transaction are reported as follows:
 Gain on sales of treasury stock is recorded under stockholders’ equity section giving account name additional
paid-in capital from treasury stock.
 When treasury stock is resold at a loss, the loss is deducted from additional Paid-in capital from treasury stock
account. If that account does not exist, the difference should be deducted from the retained earning account.
Forms of Dividends:
Cash dividend:
Earning paid to the stockholders in the form of cash is known as cash dividend. It is the most common form of dividend
paid to the stockholders. Generally, two requirements must be met before the board of directors can declare a cash
dividend.
 First, sufficient cash must be available by the payment date to pay to the stockholders.
 Second, the retained earnings account must have a sufficient positive balance.
Journal entry:
 For cash dividend declared:
Date Particulars L.F. Debit Credit
Retained earnings Dr
To Cash dividend payable

 For cash dividend paid:

Date Particulars L.F. Debit Credit
Cash dividend payable Dr
To Cash

Note:
Dividends reduce the amount of retained earnings and increase the liability to stockholders when declared. When
dividend is paid, the company reduces the liability to stockholders and cash balance.
Stock Dividend:
Earning paid to stockholders in the form of stocks instead of cash is known as stock dividend. This action increases the
number of shares outstanding of the company. A stock dividend occurs when a corporation declares and issue additional
shares of its own stock to its existing stockholders. Firms use stock dividends for several reasons:
 First, a corporation may simply not have sufficient cash available to declare a cash dividend.
 Second, stock dividends results in additional shares of stock outstanding and may decrease the market price per
share of stock if the dividend is larger
 Finally, stock dividends normally do not represent taxable income to the recipients and may be attractive to
some wealth stockholders.
Small Stock Dividend:
A stock dividend is considered to be small if the new shares being issued are less than 20-25% of the total number of
shares outstanding prior to the stock dividend. Small stock dividends normally are recorded at the market value of the
stock as of the declaration.
 For small stock dividend declared:
Date Particulars L.F. Debit Credit
Retained earnings Dr
To Common stock dividend distributable
To Additional paid-in capital

 For stock dividend distributed:

Date Particulars L.F. Debit Credit
Common stock dividend distributable Dr
To Common stock

Large Stock Dividend:

A stock dividend is considered to be large if the new shares being issued are more than 20-25% of the value of shares
outstanding prior to the stock dividend. In large stock dividend the stock dividend is reported at par value rather than at
fair market value. That is, retained earnings is decreased in the amount of the par value per share times the number of
shares to be distributed.
 For large stock dividend declared:
Date Particulars L.F. Debit Credit
Retained earnings Dr
To Common stock dividend distributable

 For large stock dividend distributed:

Date Particulars L.F. Debit Credit
Common stock dividend distributable Dr
To Common stock

Effect of stock dividend:

A stock dividend does not change a firm’s total stockholders’ equity but does affect the balance of account within that
category of the balance sheet. Generally, a stock dividend will reduce the retained earning account and will increase the
capital stock account.
Stock Split:
Stock split refers to a corporate action in which a company’s existing shares are divided into multiple shares. Although
the number of shares outstanding increase by a specific multiple, the total value of the shares remains the same
compared to pre split amount, because no real value has been added as a result of the split.
Accounting treatments of stock split:
An accounting is not recorded when a corporation declares and executes a stock split. None of the stockholders’ equity
accounts are affected by the split. Rather, the note information accompanying the balance sheet must disclose the
additional shares and the reduction of the par value per share. The effects of stock split are:
 Increases the number of shares of stock
 Reduces the par value of shares of stock
 No effect on the value of accounts on stockholders’ equity
Book Value of Share:
Book value per share of common stock represents the rights that each share of common stock has to the net assets of
the corporation. The term net assets refers to the total assets of the firm minus total liabilities. In other words, net asset
equal the total stockholders’ equity of the corporations. It does not indicate the market value of the common stock.
 When only common stock is present:

'
Total Stockholder s Equity
Book Value per share =
No . of common stock outstanding

 When Preferred stock is present:

'
Total Stockholder s Equity−Redemption value of preferred stock
Book Value per share =
No .of common stock outstanding
 Practical Problems with Solution
Problem 1 Stock Issuance
Morris had the following transactions during 2010:
1. Issued 2,000 shares of $10 par common stock for cash at $17 per share.
2. Issued 1,000 shares of preferred stock to acquire land. The preferred stock has a par value of $5 per share. The land has
been appraised at $7,000.
3. Issued 5,000 shares of $10 par common stock as payment to a company that provided advertising for the company. The
stock was selling on the stock exchange at $12 per share at the time of issuance.
Required:
Record an event for each of the above transactions.
Solution:
Journal Entry
Date Particulars L.F. Debit Credit
1 Cash Dr 34,000
To Common stock 20,000
To Additional paid-in capital 14,000
(To record issuance of common stock)
2 Land Dr 7,000
To Preferred stock 5,000
To Additional paid-in capital 2,000
(To record issuance of preferred stock in exchange of land)
3 Advertising expense Dr 60,000
To Common stock 50,000
To Additional paid-in capital 10,000
(To record issuance of common stock for paying advertisement
expense)

Problem 2 Stock Issuance

Horace Company had the following transactions during 2010, its first year of business.
a. Issued 5,000 shares of $5 par common stock for cash at $15 per share.
b. Issued 7,000 shares of common stock on May 1 to acquire a factory building from Barkley Company. Barkley had
acquired the building in 2006 at a price of $150,000. Horace estimated that the building was worth $175,000 on May 1,
2010.
c. Issued 2,000 shares of stock on June 1 to acquire a patent. The accountant has been unable to estimate the value of the
patent but has determined that Horace’s common stock was selling at $25 per share on June 1.
Required:
1. Record an event for each of the above transactions.
2. Determine the balance sheet amounts for common stock and additional paid-in capital.
Solution
1. Journal Entries
Date Particulars L.F. Debit Credit
1 Cash Dr 75,000
To Common stock 25,000
To Additional paid-in capital 50,000
(To record issuance of common stock)
2 Building Dr 175,000
To Common stock 35,000
To Additional paid-in capital 140,000
(To record issuance of preferred stock in exchange of land)
3 Patent Dr 50,000
To Common stock 10,000
To Additional paid-in capital 40,000
(To record issuance of common stock for paying advertisement
expense)
2. Stockholders' Equity:
Contributed Capital:
Common stock 70,000
Additional paid in capital 230,000
 Total contributed capital 300,000
Retained earnings 0
Total Stockholders' Equity 300,000

Problem 3 Stock Issuance

The following transactions are for Weber Corporation in 2010:
a. On March 1, the corporation was organized and received authorization to issue 5,000 shares of 8%, $100 par value
preferred stock and 2,000,000 shares of $10 par value common stock.
b. On March 10, Weber issued 5,000 shares of common stock at $35 per share.
c. On March 18, Weber issued 100 shares of preferred stock at $120 per share.
d. On April 12, Weber issued another 10,000 shares of common stock at $45 per share.
Required:
1. Record an event for each of the above transactions.
2. Prepare the Stockholders’ Equity section of the balance sheet as of December 31, 2010.
3. Does the balance sheet indicate the market value of the stock at year-end? Explain.
Solution:
1. Journal entries:
Date Particulars L.F. Debit Credit
a No entry is required
b Cash Dr 175000
To Common stock 50,000
To Additional paid-in capital 125,000
(To record issuance of common stock)
c Cash Dr 12,000
To Preferred stock 10,000
To Additional paid-in capital 2,000
(To record issuance of preferred stock)
d Cash Dr 450,000
To Common stock 100,000
To Additional paid-in capital 350,000
(To record issuance of common stock)
2. Stockholders' Equity:
Contributed Capital:
Common stock 150,000
Preferred stock 10,000
Additional paid in capital-common 475,000
Additional paid in capital-Preferred 2000
Total contributed capital 637,000
Retained earnings 0
Total Stockholders' Equity 637,000
3. The balance sheet does not indicate the market value of the stock. Market value is a function of the demand for the
stock at various economic indicators such as interest rates and inflation.
Problem 4 Treasury Stock
The Stockholders’ Equity category of Bradford Company’s balance sheet on January 1, 2010, appeared as follows:
Common stock, $10 par, 10,000 shares issued and outstanding $100,000
Additional paid-in capital 50,000
Retained earnings 80,000
Total stockholders’ equity $230,000
The following transactions occurred during 2010:
a. Reacquired 2,000 shares of common stock at $20 per share on July 1.
b. Reacquired 400 shares of common stock at $18 per share on August 1.
Required:
1. Record the entries in journal form.
2. Assume that the company resold the shares of treasury stock at $28 per share on October 1. Did the company benefit
from the treasury stock transaction? If so, where is the “gain” presented on the balance sheet?
Solution:
1. Journal Entries:
Date Particulars L.F. Debit Credit
July 1 Treasury Stock Dr 40,000
To Cash 40,000
(To record purchase of treasury stock)
August 1 Treasury stock Dr 7,200
To Cash 7,200
(To record purchase of treasury stock)
2.
Sales value (2400 ×28) 67,200
Less: Cost of treasury stock (40,000 +7,200) 47,200
Gain on sales of treasury stock 20,000

This “excess,” or “gain,” is shown on the balance sheet as an increase in the Additional Paid-In Capital -Treasury
Stock account.
Problem 5 Treasury Stock Transactions
The Stockholders’ Equity category of Little Joe’s balance sheet on January 1, 2010, appeared as follows:
Common stock, $5 par, 40,000 shares issued and outstanding $200,000
Additional paid-in capital 90,000
Retained earnings 100,000
Total stockholders’ equity $390,000
The following transactions occurred during 2010:
a. Reacquired 5,000 shares of common stock at $20 per share on February 1.
b. Reacquired 1,200 shares of common stock at $13 per share on March 1.
Required:
1. Record the entries in journal form.
2. Assume that the treasury stock was reissued on October 1 at $12 per share. Did the company benefit from the treasury
stock reissuance? Where is the “gain” or “loss” presented on the financial statements?
3. What effect did the two transactions to purchase treasury stock and the later reissuance of that stock have on the
Stockholders’ Equity section of the balance sheet?
Solution:
1. Journal Entrie
Date Particulars L.F. Debit Credit
Feb 1 Treasury stock Dr 100,000
To Cash 100,000
(To record purchase of Treasury stock)
March 1 Treasury stock Dr 15,600
To Cash 15,600
(To record purchase of Treasury stock)
2. Calculation of gain or loss on reissue of treasury stock
Sales value (6,200 * 12) 74,400
Less: Cost of treasury stock (100,000+15,600) 115,600
Loss on sales of treasury stock 41,200
Loss on sale of treasury stock is not shown on the income statement. Instead, the “loss” reduces stockholders’ equity.
3. Stockholders' Equity after the purchase and sale of treasury stock:
Contributed Capital:
Common stock, $5 par 40,000 shares issued and outstanding 200,000
Preferred stock 0
Additional paid in capital-common 90,000
Additional paid in capital-Preferred 0
Total contributed capital 290,000
Retained earnings (100,000 – 41200) 58,800
 Total Stockholders' Equity 348,800

Problem 6 Cash Dividends

Kerry Company has 1,000 shares of $100 par value, 9% preferred stock and 10,000 shares of $10 par value common stock
outstanding. The preferred stock is cumulative and nonparticipating. Dividends were paid in 2006. Since 2006, Kerry has
declared and paid dividends as follows:
2007 $ 0
2008 10,000
2009 20,000
2010 25,000
Required:
1. Determine the amount of the dividends to be allocated to preferred and common stockholders for each year 2008 to
2010.
2. If the preferred stock had been noncumulative, how much would have been allocated to the preferred and common
stockholders each year?
Solution:
1. Dividend distribution:
Year Preferred Dividend Common Dividend
2007 Nil Nil
2008 10,000 Nil
2009 17,000 3,000
2010 9,000 16,000
2. Dividend distribution:
Year Preferred Dividend Common Dividend
2007 Nil Nil
2008 9,000 1,000
2009 9,000 11,000
2010 9,000 16,000

Problem 7 Cash Dividends

The Stockholders’ Equity category of Jackson Company’s balance sheet as of January 1, 2010, appeared as follows:
Preferred stock, $100 par, 8%, 2,000 shares issued and outstanding $200,000
Common stock, $10 par, 5,000 shares issued and outstanding 50,000
Additional paid-in capital 300,000
Total contributed capital $550,000
Retained earnings 400,000
Total stockholders’ equity $950,000
The notes that accompany the financial statements indicate that Jackson has not paid dividends for the two years prior to
2010. On July 1, 2010, Jackson declares a dividend of $100,000 to be paid to preferred and common stockholders on
August 1.
Required:
1. Determine the amounts of the dividends to be allocated to preferred and common stockholders assuming that the
preferred stock is noncumulative, nonparticipating stock.
2. Record the appropriate journal entries on July 1 and August 1, 2010.
3. Determine the amounts of the dividends to be allocated to preferred and common stockholders assuming instead that
the preferred stock is cumulative, nonparticipating stock.
Solution:
1. Dividends to be allocated to preferred and common stockholders assuming that the preferred stock is noncumulative,
nonparticipating stock.
Preferred Dividend Common Dividend
1. Current year dividend to preferred stock 16,000 -
2. Paid remaining dividend to common stock (100,000-16,000) - 84,000
Total Dividend paid 16,000 84,000
2. Journal Entries
 Date Particulars L.F. Debit Credit
July 1 Retained earnings Dr 100,000
To Cash dividend payable – Preferred 16,000
To Cash dividend payable – Common 84,000
(To record cash dividend declared)
Aug 1 Cash dividend payable-Preferred Dr 16,000
Cash dividend payable-Common Dr 84,000
To Cash 100,000
(To record cash dividend paid)
3. Dividends to be allocated to preferred and common stockholders assuming that the preferred stock is cumulative,
nonparticipating stock.
Preferred Dividend Common Dividend
1. Arrears of dividend paid to preferred stock 32,000 -
2. Current year dividend to preferred stock 16,000
3. Paid remaining dividend to common stock (100,000-32,000-16,000) - 52,000
Total Dividend paid 48,000 52,000

Problem 8 Stock Dividends

The Stockholders’ Equity category of Worthy Company’s balance sheet as of January 1, 2010, appeared as follows:
Common stock, $10 par, 40,000 shares issued and $400,000
outstanding
Additional paid-in capital 100,000
Retained earnings 400,000
Total stockholders’ equity $900,000
The following transactions occurred during 2010:
a. Declared a 10% stock dividend to common stockholders on January 15. At the time of the dividend, the common stock
was selling for $30 per share. The stock dividend was to be issued to stockholders on January 30, 2010.
b. Distributed the stock dividend to the stockholders on January 30, 2010.
Required:
1. Record the above transactions in journal form.
2. Develop the Stockholders’ Equity category of Worthy Company’s balance sheet as of January 31, 2010, after the stock
dividend was issued.
3. What effect did those transactions have on total stockholders’ equity?
Solution:
1. Journal Entries
Date Particulars L.F. Debit Credit
Jan 15 Retained earnings Dr 120,000
To Common stock dividend distributable 40,000
To Additional paid-in capital 80,000
(To record common stock dividend declared)
Jan 30 Common stock dividend distributable Dr
To Common stock
(To record common stock dividend distributed)
2. Stockholders' Equity:
Contributed Capital:
Common stock, $10 par 44,000 shares issued and outstanding 440,000
Additional paid in capital-common 180,000
Total contributed capital 620,000
Retained earnings (400,000 – 120,000) 280,000
Total Stockholders' Equity 900,000
4. Overall, these transactions did not change total stockholders’ equity. They reclassified some equity from the
Retained Earnings category to contributed capital.

Problem 9 Stock Dividends versus Stock Splits

Campbell Company wants to increase the number of shares of its common stock outstanding and is considering a stock
dividend versus a stock split. The Stockholders’ Equity section of the firm’s most recent balance sheet appeared as
follows:
Common stock, $10 par, 50,000 shares issued and outstanding $ 500,000
Additional paid-in capital 750,000
Retained earnings 880,000
Total stockholders’ equity $2,130,000

If a stock dividend is chosen, the firm wants to declare a 100% stock dividend. Because the stock dividend qualifies as a
“large stock dividend,” it must be recorded at par value. If a stock split is chosen, Campbell will declare a 2-for-1 split.
Required:
1. Compare the effects of the stock dividends and stock splits on the accounting equation.
2. Prepare accounting entries for stock dividend.
2. Develop the Stockholders’ Equity category of Campbell’s balance sheet (a) after the stock dividend and (b) after the
stock split.
Solution:
1. Effect of Stock Dividend on the accounting equation:
Accounting Equation
Assets = Liabilities + Stockholders' Equity
0 0 Retained earnings (500,000)
Common Stock +500,000
Stock Split: No Entry
2.
Date Particulars L.F. Debit Credit
Retained earnings Dr 500,000
To Common stock dividend distributable 500,000
(To record common stock dividend declared)
Common stock dividend distributable Dr 500,000
To Common stock 500,000
(To record common stock dividend distributed)
3. Stockholders' Equity Category:
a. After Stock Dividend
Common stock, $10 par, 100,000 shares issued and outstanding $ 1,000,000
Additional paid-in capital 750,000
Retained earnings (880,000-500000) 380,000
Total stockholders’ equity $2,130,000
b. After Stock Split
Common stock, $5 par, 100,000 shares issued and outstanding $ 500,000
Additional paid-in capital 750,000
Retained earnings 880,000
Total stockholders’ equity $2,130,000

Problem 10 Stock Dividends and Stock Splits

Whitacre Company’s Stockholders’ Equity section of the balance sheet on December 31, 2009, was as follows:
Common stock, $10 par value, 60,000 shares issued and outstanding $ 600,000
Additional paid-in capital 480,000
Retained earnings 1,240,000
Total stockholders’ equity $2,320,000
On May 1, 2010, Whitacre declared and issued a 15% stock dividend, when the stock was selling for $20 per share. Then
on November 1, it declared and issued a 2-for-1 stock split.
Required:
1. How many shares of stock are outstanding at year-end?
2. What is the par value per share of these shares?
3. Pass necessary journal entries for stock dividend.
4. Develop the Stockholders’ Equity category of Whitacre’s balance sheet as of December 31, 2010.
Solution:
1. No. of shares of stock outstanding at year-end:
Beginning balance 60,000
Add: Stock dividend (60000*15%) 9,000
69,000
(×) Stock split (2-for-1 stock split) 2
No. of shares of stock outstanding at year-end 138,000 Shares
10
2. Par value per share = =$ 5 per share
2
3. Journal Entries for Stock Dividend
Date Particulars L.F. Debit Credit
May 1 Retained earnings Dr 180,000
To Common stock dividend distributable 90,000
To Retained earnings 90,000
(To record common stock dividend declared)
Nov 1 Common stock dividend distributable Dr 90,000
To Common stock 90,000
(To record common stock dividend distributed)
4. Stockholders' Equity Category:
Common stock, $5 par, 138,000 shares issued and outstanding $ 690,000
Additional paid-in capital (480,000 +90,000) 570,000
Retained earnings (1,240,000 - 180,000) 1,060,000
Total stockholders’ equity $2,320,000

Problem 11 Dividends and Stock Splits

On January 1, 2010, Frederiksen Inc.’s Stockholders’ Equity category appeared as follows:
Preferred stock, $80 par value, 7%, 3,000 shares issued and outstanding $ 240,000
Common stock, $10 par value, 15,000 shares issued and outstanding 150,000
Additional paid-in capital—Preferred 60,000
Additional paid-in capital—Common 225,000
Total contributed capital $ 675,000
Retained earnings 2,100,000
Total stockholders’ equity $2,775,000
The preferred stock is noncumulative and nonparticipating. During 2010, the following transactions occurred:
a. On March 1, declared a cash dividend of $16,800 on preferred stock. Paid the dividend on April 1.
b. On June 1, declared a 5% stock dividend on common stock. The current market price of the common stock was $18.
The stock was issued on July 1.
c. On September 1, declared a cash dividend of $0.50 per share on the common stock; paid the dividend on October 1.
d. On December 1, issued a 2-for-1 stock split of common stock when the stock was selling for $50 per share.
Required:
1. Explain each transaction’s effect on the stockholders’ equity accounts and the total stockholders’ equity.
2. Pass necessary journal entries for the above transactions.
3. Develop the Stockholders’ Equity category of the December 31, 2010, balance sheet. Assume that the net income for
the year was $650,000.
4. Write a paragraph that explains the difference between a stock dividend and a stock split.
Solution:
1.
Mar. 1 Retained Earnings and total stockholders’ equity decrease.
Apr. 1 Total stockholders’ equity remains unchanged.
June 1 Common Stock Distributable increases by $7,500 (15,000 × 5% × $10). Additional Paid-in
Capital—Common Stock increases by $6,000 [(15,000 × 5%) × ($18 – $10)]. Retained Earnings
decreases by $13,500. Total stockholders’ equity does not change.
July 1 Common Stock Distributable decreases and Common Stock increases by $7,500.
 Sept. 1 Retained Earnings and total stockholders’ equity decrease by $7,875 [(15,000 + 750) × $0.50].
Oct. 1 Total stockholders’ equity does not change.
Dec. 1 The par value of common stock changes from $10 to $5 as the number of shares issued and
outstanding doubles from 15,750 to 31,500, but the total par value does not change. The total
stockholders’ equity also does not change.
2.
Date Particulars L.F. Debit Credit
March 1 Retained earnings Dr 16,800
To Cash dividend payable-Preferred 16,800
(To record cash dividend declared to preferred stock)
April 1 Cash dividend payable-Preferred Dr 16,800
To Cash 16,800
(To record distribution of cash dividend)
June 1 Retained earnings Dr 13,500
To Common stock dividend distributable 7,500
To Additional paid in capital 6,000
(To record stock dividend declared to common stockholders')
July 1 Common stock dividend distributable Dr 7,500
To Common stock 7,500
(To record distribution of stock dividend)
Sept 1 Retained earnings Dr 7,875
To Cash dividend payable-Common 7,875
(To record cash dividend declared to common stock)
Oct 1 Cash dividend payable-common Dr 7,875
To Cash 7,875
(To record cash dividend paid to common stockholders')
Dec 1 No Entry

3. Stockholders' Equity Category

Preferred stock, $80 par value, 7%, 3,000 shares issued and outstanding $ 240,000
Common stock, $5 par value, 31,500 shares issued and outstanding 157,500
Additional paid-in capital—Preferred 60,000
Additional paid-in capital—Common 231,000
Total contributed capital $ 675,000
Retained earnings 2,711,825
Total stockholders’ equity $3,400,325
4. A stock dividend results in the capitalization of part of the Retained Earnings account. The value of the shares issued
in the stock dividend is deducted from the Retained Earnings account and added to the Capital Stock account (and the
Additional Paid-In Capital account for small stock dividends). The number of outstanding shares is increased, and the
par value of the shares is unchanged. In a stock split, there is no change to any of the capital accounts. There is an
increase in the number of outstanding shares, which is offset by a corresponding decrease in the par value of those
shares.

Problem 12 Dividends and Stock Splits

On January 1, 2010, Svenberg Inc.’s Stockholders’ Equity category appeared as follows:
Preferred stock, $80 par value, 8%, 1,000 shares issued and outstanding $ 80,000
Common stock, $10 par value, 10,000 shares issued and outstanding 100,000
Additional paid-in capital—Preferred 60,000
Additional paid-in capital—Common 225,000
Total contributed capital $ 465,000
Retained earnings 1,980,000
Total stockholders’ equity $ 2,445,000
The preferred stock is noncumulative and nonparticipating. During 2010, the following transactions occurred:
a. On March 1, declared a cash dividend of $6,400 on preferred stock. Paid the dividend on April 1.
b. On June 1, declared an 8% stock dividend on common stock. The current market price of the common stock was $26.
The stock was issued on July 1.
c. On September 1, declared a cash dividend of $0.70 per share on the common stock; paid the dividend on October 1.
d. On December 1, issued a 3-for-1 stock split of common stock, when the stock was selling for $30 per share.
Required:
1. Explain each transaction’s effect on the stockholders’ equity accounts and the total stockholders’ equity.
2. Pass necessary journal entries for the above transactions.
3. Develop the Stockholders’ Equity category of the balance sheet. Assume that the net income for the year was $720,000.
4. Write a paragraph that explains the difference between a stock dividend and a stock split.
Solution:
Mar. 1 Cash dividends increase (or Retained Earnings decreases) and total stockholders’ equity decreases.
Apr. 1 Total stockholders’ equity remains unchanged.
June 1 Common Stock Distributable increases by $8,000 (10,000 × 8% × $10). Additional Paid-In Capital—
Common Stock increases by $12,800 (10,000 × 8% × $16). Retained Earnings decreases by $20,800.
Total stockholders’ equity does not change.
July 1 Common Stock Distributable decreases, and Common Stock increases by $8,000.
Sept. 1 Retained Earnings and total stockholders’ equity decrease by $7,560 [(10,000 + 800) × $0.70].
Oct. 1 Total stockholders’ equity does not change.
Dec. 1 The par value of common stock changes from $10 to $3.33 as the number of shares issued and
outstanding triples from 10,800 to 32,400, but the total par value does not change. The total stockholders’
equity also does not change.
2.
Date Particulars L.F. Debit Credit
March 1 Retained earnings Dr 6400
To Cash dividend payable-Preferred 6400
(To record cash dividend declared to preferred stock)
April 1 Cash dividend payable-Preferred Dr 6400
To Cash 6400
(To record distribution of cash dividend)
June 1 Retained earnings Dr 20800
To Common stock dividend distributable 8000
To Additional paid in capital 12800
(To record stock dividend declared to common stockholders')
July 1 Common stock dividend distributable Dr 8000
To Common stock 8000
(To record distribution of stock dividend)
Sept 1 Retained earnings Dr 7560
To Cash dividend payable-Common 7560
(To record cash dividend declared to common stock)
Oct 1 Cash dividend payable-common Dr 7560
To Cash 7560
(To record cash dividend paid to common stockholders')
Dec 1 No Entry

3. Stockholders' Equity Category

Preferred stock, $80 par value, 8%, 1,000 shares issued and outstanding $ 80,000
Common stock, $3.3333 par value, 32,400 shares issued and outstanding 108,000
Additional paid-in capital—Preferred 60,000
Additional paid-in capital—Common 237,800
Total contributed capital $ 485,800
Retained earnings 2,665,240
Total stockholders’ equity $ 3,151,040
4. A stock dividend results in the capitalization of part of the Retained Earnings account. The value of the shares issued
in the stock dividend is deducted from the Retained Earnings account and added to the Capital Stock account (and the
Additional Paid-In Capital account for small stock dividends). The number of outstanding shares is increased, and the
par value of the shares is unchanged. In a stock split, there is no change to any of the capital accounts. There is an
increase in the number of outstanding shares, which is offset by a corresponding decrease in the par value of those
shares.

Problem 13 Review Problem & Solution

Andrew Company was incorporated on January 1, 2010, under a corporate charter that authorized the issuance of 50,000
shares of $5 par common stock and 20,000 shares of $100 par, 8% preferred stock. The following events occurred during
2010. Andrew wants to record the events and develop financial statements on December 31, 2010.
a. Issued for cash 10,000 shares of common stock at $25 per share and 1,000 shares of preferred stock at $110 per share
on January 15, 2010.
b. Acquired a patent on April 1 in exchange for 2,000 shares of common stock. At the time of the exchange, the common
stock was selling on the local stock exchange for $30 per share.
c. Repurchased 500 shares of common stock on May 1 at $20 per share. The corporation is holding the stock to be used
for an employee bonus plan.
d. Declared a cash dividend of $1 per share to common stockholders and an 8% dividend to preferred stockholders on July
1. The preferred stock is noncumulative, nonparticipating. The dividend will be distributed on August 1.
e. Distributed the cash dividend on August 1.
f. Declared and distributed to preferred stockholders a 10% stock dividend on September 1. At the time of the dividend
declaration, preferred stock was valued at $130 per share.
g. On December 31, calculated the annual net income for the year to be $200,000.
Required:
1. Record the accounting entries for items (a) through (g).
2. Develop the Stockholders’ Equity section of Andrew Company’s balance sheet at December 31, 2010. You do not need
to consider the notes that accompany the balance sheet.
3. Determine the book value per share of the common stock. Assume that the preferred stock can be redeemed at par.
Solution
1. Journal Entries:
Date Particulars L.F. Debit Credit
a) Jan 15 Cash Dr 360,000
To Common stock 50000
To Additional Paid-in Capital-common 200000
To Preferred stock 100000
To Additional paid-in capital-preferred 10000
(To record the issuance of stock for cash)
b) Apr 1 Patent Dr 60,000
To Common stock 10,000
To Additional paid-in capital-common 50,000
(To record the issuance of stock for patent)
c) May 1 Treasury stock Dr 10,000
To Cash 10,000
(To record purchase of treasury stock)
d) July 1 Retained earnings Dr 19,500
To Dividend payable-common 11,500
To Dividend payable-Preferred 8,000
(To record the declaration of a cash dividend)
e) Aug 1 Dividend payable-Common Dr 11,500
Dividend payable-Preferred Dr 8,000
To Cash 19500
(To record the payment of cash dividend)
f) Sept 1 Retained earnings Dr
To Preferred stock
To Additional paid-in capital
(To record declaration and distribution of stock dividend)
g) Dec 31 Income summary Dr 200,000
To Retained earnings 200,000
(To record the annual net income)
2. The Stockholders' Equity for Andrew Company after completing these transactions appears as follows:
Preferred stock, $100 par value, 8%, 20,000 shares authorized, 1,100 $ 110,000
shares issued and outstanding
Common stock, $5 par value, 50,000 shares authorized, 12,000 shares 60,000
issued and 11,500 shares outstanding
Additional paid-in capital—Preferred 13,000
Additional paid-in capital—Common 250,000
Total contributed capital $ 433,000
Retained earnings 167,500
Treasury stock (10,000)
Total stockholders’ equity $590,500
3. The book value per share of the common stock is calculated as follows:
'
Total shockholder s equity−Redemable value of preferred stock
Book Value per share = =
No . of shares of common stock outstanding
590500−110,000
=$ 41.78 per share
11500
Problem 14 Stockholders’ Equity Category
Peeler Company was incorporated as a new business on January 1, 2010. The corporate charter approved on that date
authorized the issuance of 1,000 shares of $100 par, 7% cumulative, nonparticipating preferred stock and 10,000 shares of
$5 par common stock. On January 10, Peeler issued for cash 500 shares of preferred stock at $120 per share and 4,000
shares of common stock at $80 per share. On January 20, it issued 1,000 shares of common stock to acquire a building site
at a time when the stock was selling for $70 per share.
During 2010, Peeler established an employee benefit plan and acquired 500 shares of common stock at $60 per share as
treasury stock for that purpose. Later in 2010, it resold 100 shares of the stock at $65 per share.
On December 31, 2010, Peeler determined its net income for the year to be $40,000. The firm declared the annual cash
dividend to preferred stockholders and a cash dividend of $5 per share to the common stockholders. The dividends will be
paid in 2011.
Required:
Develop the Stockholders’ Equity category of Peeler’s balance sheet as of December 31, 2010. Indicate on the statement
the number of shares authorized, issued, and outstanding for both preferred and common stock.
Solution
PEELER COMPANY
PARTIAL BALANCE SHEET
DECEMBER 31, 2010
Stockholders’ Equity
Preferred stock, $100 par, 7%, 1,000 shares authorized, 500 $ 50,000a
shares issued and outstanding
Common stock, $5 par, 10,000 shares authorized, 5,000 shares 25,000c
issued, 4,600 shares outstanding
Additional paid-in capital—Preferred stock 10,000b
Additional paid-in capital—Common stock 365,000d
Additional paid-in capital—Treasury stock 500e
Total contributed capital $450,500
Retained earnings 13,500g
Less: Treasury stock, 400 shares, common (24,000)f
Total stockholders’ equity $440,000

Working Note:
1/10 Preferred stock: 500 × $100 par = $50,000a
Additional paid-in capital: 500 × ($120 – $100) = $10,000b
1/10 Common stock: 4,000 × $5 par = $20,000c
Additional paid-in capital: 4,000 × ($80 – $5) = $300,000d
1/20 Common stock: 1,000 × $5 par = $5,000c
Additional paid-in capital: 1,000 × ($70 – $5) = $65,000d
Acquisition of treasury stock:
Treasury stock: 500 × $60 = $30,000 increasef
Resale of treasury stock:
Treasury stock: 100 × $60 = $6,000 decreasef
Additional paid-in capital: 100 × ($65 – $60) = $500e
12/31 Net income: Retained earnings, $40,000 increase to Retained Earnings g
12/31 Preferred dividend:
(500 × $100 par × 7%) = $3,500 decrease to Retained Earningsg
Common stock dividend:
4,600 outstanding × $5 per share = $23,000 decrease to Retained Earningsg

Problem 15 Stockholders’ Equity Category

Kebler Company was incorporated as a new business on January 1, 2010. The corporate charter approved on that date
authorized the issuance of 2,000 shares of $100 par,
7% cumulative, nonparticipating preferred stock and 20,000 shares of $5 par common stock. On January 10, Kebler issued
for cash 1,000 shares of preferred stock at $120 per share and 8,000 shares of common stock at $80 per share. On January
20, it issued 2,000 shares of common stock to acquire a building site at a time when the stock was selling for $70 per
share.
During 2010, Kebler established an employee benefit plan and acquired 1,000 shares of common stock at $60 per share as
treasury stock for that purpose. Later in 2010, it resold 100 shares of the stock at $65 per share.
On December 31, 2010, Kebler determined its net income for the year to be $80,000. The firm declared the annual cash
dividend to preferred stockholders and a cash dividend of $5 per share to the common stockholders. The dividend will be
paid in 2011
Required:
Develop the Stockholders’ Equity category of Kebler’s balance sheet as of December 31, 2010. Indicate on the statement
the number of shares authorized, issued, and outstanding for both preferred and common stock.
Solution:
KEBLER COMPANY
PARTIAL BALANCE SHEET
DECEMBER 31, 2010
Stockholders’ Equity

Preferred stock, $100 par, 7%, 2,000 shares authorized, $100,000a

1,000 shares issued
Common stock, $5 par, 20,000 shares authorized, 10,000 50,000b
shares issued, 9,100 shares outstanding
Additional paid-in capital—Preferred stock 20,000c
Additional paid-in capital—Common stock 730,000d
Additional paid-in capital—Treasury stock 500f
Total contributed capital $900,500
Retained earnings 27,500g
Less: Treasury stock, 900 shares, common (54,000)e
Total stockholders’ equity $874,000

Working Notes:
1/10 Preferred stock: 1,000 × $100 par = $100,000a
Additional paid-in capital: 1,000 × ($120 – $100) = $20,000c
1/10 Common stock: 8,000 × $5 = $40,000b
Additional paid-in capital: 8,000 × ($80 – $5) = $600,000d
1/20 Common stock: 2,000 × $5 par = $10,000b
Additional paid-in capital: 2,000 × ($70 – $5) = $130,000d
Treasury stock acquired:
 Treasury stock: 1,000 × $60 = $60,000e increase
Treasury stock resold:
Treasury stock: 100 × $60 = $6,000e decrease
Additional paid-in capital: 100 × ($65 – $60) = $500f
12/31 Net income:
Retained earnings: $80,000g increase to Retained Earnings
12/31 Dividend:
Preferred: 1,000 × $100 par × 7% = $7,000g decrease to Retained Earnings
Common: 9,100 shares × $5 = $45,500g decrease to Retained Earnings

Problem 16 Dividends for Preferred and Common Stock

The Stockholders’ Equity category of Greenbaum Company’s balance sheet as of December 31, 2010, appeared as
follows:
Preferred stock, $100 par, 8%, 1,000 shares issued and outstanding $ 100,000
Common stock, $10 par, 20,000 shares issued and outstanding 200,000
Additional paid-in capital 250,000
Total contributed capital $ 550,000
Retained earnings 450,000
Total stockholders’ equity $1,000,000
The notes to the financial statements indicate that dividends were not declared and paid for 2008 and 2009. Greenbaum
wants to declare a dividend of $59,000 for 2010.
Required:
Determine the total and the per-share amounts that should be declared to the preferred and common stockholders under
the following assumptions:
1. The preferred stock is noncumulative, nonparticipating.
2. The preferred stock is cumulative, nonparticipating.
Solution
1. Preferred Stock Common Stock
$100,000 × 8% = $8,000 $59,000 – $8,000 = $51,000
Per share: $8,000/1,000 shares = $8.00 $51,000/20,000 shares = $2.55

2. Preferred Stock Common Stock

$8,000 × 3 years = $24,000 $59,000 – $24,000 = $35,000 in 2010
Per share: $24,000/1,000 = $24.00 $35,000/20,000 = $1.75

Problem 17 Dividends for Preferred and Common Stock

The Stockholders’ Equity category of Rausch Company’s balance sheet as of December 31, 2010, appeared as follows:
Preferred stock, $100 par, 8%, 2,000 shares issued and outstanding $ 200,000
Common stock, $10 par, 40,000 shares issued and outstanding 400,000
Additional paid-in capital 500,000
Total contributed capital $1,100,000
Retained earnings 900,000
Total stockholders’ equity $2,000,000
The notes to the financial statements indicate that dividends were not declared or paid for 2008 or 2009. Rausch wants to
declare a dividend of $118,000 for 2010.
Required:
Determine the total and the per-share amounts that should be declared to the preferred and common stockholders under
the following assumptions:
1. The preferred stock is noncumulative, nonparticipating.
2. The preferred stock is cumulative, nonparticipating.
Solution:
1. Preferred Stock Common Stock
$200,000 × 8% = $16,000 $118,000 – $16,000 = $102,000
Per share: $16,000/2,000 = $8.00 $102,000/40,000 = $2.55

2. Preferred Stock Common Stock

$16,000 × 3 years = $48,000 $118,000 – $48,000 = $70,000
Per share: $48,000/2,000 = $24.00 $70,000/40,000 = $1.75

Problem 18 Analysis of Stockholders’ Equity

The Stockholders’ Equity section of the December 31, 2010, balance sheet of Eldon Company appeared as follows:
Preferred stock, $30 par value, 5,000 shares authorized, ? shares issued $120,000
Common stock, ? par, 10,000 shares authorized, 7,000 shares issued 70,000
Additional paid-in capital—Preferred 6,000
Additional paid-in capital—Common 560,000
Additional paid-in capital—Treasury stock 1,000
Total contributed capital $757,000
Retained earnings 40,000
Less: Treasury stock, preferred, 100 shares (3,200)
Total stockholders’ equity $ ?
Required:
Determine the following items based on Eldon’s balance sheet.
1. The number of shares of preferred stock issued
2. The number of shares of preferred stock outstanding
3. The average per-share sales price of the preferred stock when issued
4. The par value of the common stock
5. The average per-share sales price of the common stock when issued
6. The cost of the treasury stock per share
7. The total stockholders’ equity
8. The per-share book value of the common stock assuming that there are no dividends in arrears and that the preferred
stock can be redeemed at its par value.
Solution:
1. Preferred Stock Issued = $120,000/$30 par = 4,000 shares issued
2. Preferred Stock Outstanding = 4,000 – 100 (Treasury Stock) = 3,900 shares
3. ($120,000 + $6,000)/4,000 = $31.50
4. $70,000/7,000 shares issued = $10 per share
5. ($70,000 + $560,000)/7,000 shares issued= $90 per share
6. $3,200/100 shares = $32 per share
7. $757,000 + $40,000 – $3,200 = $793,800
8. [$793,800 – (3,900 preferred shares × $30 par)]/7,000 = $96.69

Problem 19 Analysis of Stockholders’ Equity

The Stockholders’ Equity section of the December 31, 2010, balance sheet of Carter Company appeared as follows:
Preferred stock, $50 par value, 10,000 shares authorized, ? shares issued $ 400,000
Common stock, ? par value, 20,000 shares authorized, 14,000 shares issued 280,000
Additional paid-in capital—Preferred 12,000
Additional paid-in capital—Common 980,000
Additional paid-in capital—Treasury stock 2,000
Total contributed capital $1,674,000
Retained earnings 80,000
Less: Treasury stock, preferred, 200 shares (12,800)
Total stockholders’ equity $ ?
Required:
Determine the following items based on Carter’s balance sheet.
1. The number of shares of preferred stock issued
2. The number of shares of preferred stock outstanding
3. The average per-share sales price of the preferred stock when issued
4. The par value of the common stock
5. The average per-share sales price of the common stock when issued
6. The cost of the treasury stock per share
7. The total stockholders’ equity
8. The per-share book value of the common stock assuming that there are no dividends in arrears and that the preferred
stock can be redeemed at its par value
Solution:
1. Preferred Stock Issued = $400,000/$50 par = 8,000 shares
2. Preferred Stock Outstanding = 8,000 – 200 (Treasury Stock) = 7,800 shares
3. ($400,000 + $12,000)/8,000 = $51.50
4. $280,000/14,000 = $20
5. ($280,000 + $980,000)/14,000 = $90
6. $12,800/200 = $64
7. $1,674,000 + $80,000 – $12,800 = $1,741,200
8. [$1,741,200 – (7,800 × $50)]/14,000 = $96.51