Survey of Accounting Homework

Chapter 5
Written Assignment:
1. What is the difference between accounts receivable and notes receivable?
a. Accounts Receivable – expected future cash receipts arising from permitting a
customer to buy now and pay later; typically, a relatively small balance due within
a short time period.
b. Notes Receivable – notes that evidence rights to receive cash in the future from
the maker of a promissory note; usually specify the maturity date, interest rate,
and other credit terms.
2. What is the net realizable value of receivables?
a. The net realizable value of accounts receivable represents the number of
receivables a company estimates it will actually collect. The net realizable value is
the face value less an allowance for doubtful accounts.
3. What type of account is the Allowance for Doubtful Accounts?
a. Estimated account.
4. What are two ways in which estimating uncollectible accounts improves the accuracy of
the financial statements?
a. Estimating uncollectible accounts expense improves the accuracy of financial
statements by (1) reporting expected realizable value of the receivables and (2)
presenting a better matching of expenses with related revenues. This provides a
better measure of managerial performance.
5. When using the allowance method, why is uncollectible accounts expense an estimated
amount?
a. When using the allowance method, uncollectible accounts expense is matched
with current revenues. A company does not know which accounts will not be
collectible at the time a sale is made; consequently, in order to record the expense
currently, an estimate is made.
6. What is the most common format for reporting accounts receivable on the balance sheet?
a. The most common format for reporting accounts receivable on the balance sheet
is gross receivables less the allowance for doubtful accounts.
7. What information does this method provide beyond showing only the net amount?
a. This format allows the users to see both the total amount owed by the customers
and the amount the company expects to collect.
8. Why is it necessary to reinstate a previously written-off account receivable before the
collection is recorded?
a. The practice of reestablishing a previously written off account, then recording its
collection as a payment on account, reflects a complete record of account activity,
such a record provides an accurate picture of the source of cash flows and
improves the portrayal of the customer’s credit history.
9. What are some factors considered in estimating the amount of uncollectible accounts
receivable?
a. The percentage of uncollectible accounts from years past.
b. Adjustment for new circumstances that are anticipated to be experienced in the
future.
 c. Industry averages or experiences of similar businesses.
d. Examination of current accounts and company credit policies.
10. What is the effect on the accounting equation of recognizing uncollectible accounts
expense?
a. Recognizing uncollectible accounts expense reduces accounts receivable on the
asset side and reduces retained earnings on the equity side.
11. What is the effect on the accounting equation of writing off an uncollectible account
receivable when the allowance method is used?
a. A write-off of an uncollectible account when the allowance method is used had no
effect on the accounting equation because the allowance account, a contra asset
account, is reduced and the accounts receivable account, on the asset side, is also
reduced.
12. How does the recovery of a previously written off account effect the income statement
when the allowance method is used? How does the recovery of a previously written off
account affect the statement of cash flows when the allowance method is used?
a. The recovery of an uncollectible account when the allowance method is used does
not affect the income statement. Only accounts receivable, cash, and allowance
for doubtful accounts are affected. Cash flow from operations increases as a result
of the collection.
13. What is the advantage of using the allowance method of accounting for uncollectible
accounts?
a. The primary advantage of using the allowance method is that it improves the
accuracy of financial statements. It matches the expected expense with the
revenue produced in the period.
14. How do companies determine the percentage estimate of uncollectible accounts when
using the percent of revenue method?
a. The percentage used to make the estimate is usually based on the company’s past
collection experiences.
b. A new business must rely on trade publications and others experienced in the
industry to determine an appropriate expense.
15. What is an advantage of using the percent of receivables method of estimating
uncollectible accounts expense?
a. The percent of receivables is a more accurate measure because it uses the actual
receivables and the amount of time they have been outstanding. Those receivables
that have been outstanding for a longer time are less likely to be collected.
16. What is “aging of accounts receivable”?
a. Aging of accounts receivable – classifying each account receivable by the number
of days it has been outstanding. The aging schedule is used to develop an estimate
of the amount of the allowances for doubtful accounts.
17. What is a promissory note?
a. Promissory Note – a legal document representing a credit agreement between a
lender and a borrower. The note specifies technical details such as the maker,
payee, interest rate, maturity date, payment terms, and any collateral.
18. Define the following terms:
a. Maker – the party issuing a note (the borrower).
b. Payee – the party collecting cash.
 c. Principal – amount of cash actually borrowed.
d. Interest – fee paid for the use of borrowed funds; also refers to the revenue from
debt securities.
e. Maturity Date – the date a liability is due to be settled (the date the borrower is
expected to repay a debt).
f. Collateral – assets pledged as security for a loan.
19. What is the formula for computing interest revenue?
a. Principal X Annual Interest Rate X Time Outstanding = Interest Revenue
20. What is accrued interest?
a. Accrued Interest – interest revenue or expense that is recognized before cash has
been exchanged.
21. How does the accrual of interest revenue or expense illustrate the matching concept?
a. The matching concept matches revenue and expenses to the period in which they
are earned or incurrent. By accruing interest, the interest is recognized in the
period it is earned or incurred regardless of when the cash is collected or paid.
22. Assets are listed on the balance sheet in order of liquidity. Explain this statement.
a. Liquidity refers to how quickly assets are expected to be converted to cash during
normal operations.
23. When is an adjusting entry for accrued interest generally recorded?
a. The adjusting entry for accrued interest is generally recorded when financial
statements are prepared.
24. Assume that on July 1, 2018, Big Corp. loaned Little Corp. $12,000 for a period of one
year at 6% interest. What amount of interest revenue will Big report for 2018? What
amount of cash will Big receive upon maturity of the note?
a. In the given scenario on July 1, 2018 party A loaned party B $12,000 for a period
of one year at a 6% interest rate. The amount of interest for the entire year of the
loan will be $720. A total of $12,720 will be received by party A upon maturity.
25. In which section of the statement of cash flows will Big report the cash collected in
question 23?
a. $12,000 will be recorded in investing activities.
b. $720 will be recorded in the operating activities.
26. Why is it generally beneficial for a business to accept major credit cards as payment for
goods and services even when the fee charged by the credit card company is substantial?
a. It is generally beneficial to accept major credit cards because the business then
avoids the risk of bad debts as well as the cost of maintaining credit records. It
may also attract more customers.
27. What types of costs do businesses avoid when they accept major credit cards as compared
with handling credit sales themselves?
a. The acceptance of major credit cards enables a business to avoid the cost of
uncollectible accounts and the clerical costs of maintaining accounts receivable
records. In addition, the business avoids the implicit cost of lost opportunities fue
to delayed cash flows.
28. Name and describe the four cost flow methods discussed in this chapter.
a. Specific Identification – inventory method that allocates costs between cost of
goods sold and ending inventory using the cost of the specific goods sold or
retained in the business.
 b. FIFO – inventory cost flow method that treats the first items purchased as the first
items sold for the purpose of computing cost of goods sold.
c. LIFO – inventory cost flow method that treats the last items purchased as the first
items sold for the purpose of computing cost of goods sold.
d. Weighted Average – inventory cost flow method in which the cost allocated
between inventory and cost of goods sold is based on the average cost per unit,
which is determined by dividing total costs of goods available for sale during the
accounting period by total units available for sale during the period. If the average
is recomputed each time a purchase is made, the result is called a moving average.
29. What are some advantages and disadvantages of the specific identification method of
accounting for inventory?
a. One advantage of the specific identification method is that both the inventory
account and cost of goods sold reflect the actual amounts on hand and sold. This
method is usually required for high cost items.
b. One disadvantage of this method is that recordkeeping can become burdensome
for high-volume, lower-priced items.
30. What are some advantages and disadvantages of using the FIFO method of inventory
valuation?
a. FIFO allocates the cost of the first units purchased to the first units sold;
consequently, in a period of rising prices this would produce a higher net income.
This may be an advantage for the purpose of financial reporting if reporting a
higher profit is desired.
b. However, this is a disadvantage for tax reporting because a higher profit means
paying more tax.
c. FIFO also tends to best match physical flow for most products.
31. What are some advantages and disadvantages of using the LIFO method of inventory
valuation?
a. LIFO allocates the cost of the last units purchased to the first units sold;
consequently, in a period of rising prices, this would produce a lower net income.
This may be a disadvantage for the purpose of financial reporting if reporting a
higher profit is desired.
b. However, for tax reporting, a lower profit means paying less tax.
c. LIFO also matches current cost with current revenues.
32. In an inflationary period, which inventory cost flow will produce the highest net income?
a. FIFO
33. In an inflationary period, which inventory cost flow will produce the largest amount of
total assets on the balance sheet?
a. FIFO
34. What is the difference between the flow of costs and the physical flow of goods?
a. Flow of costs – refers to the assumption that is made for the purpose of
determining the cost of inventory items that are sold when preparing financial
statements. The cost flow assumption that a business makes may have nothing to
do with the actual flow of inventory into and out of the business.
b. The physical flow of goods refers to the actual timing of when goods are sold.

Homework Items:
Exercise 6
The accounts receivable balance for Renue Spa at December 31, 2017, was $61,000.
Also, on that date, the balance in the Allowance for Doubtful Accounts was $3,750. During 2018,
$2,100 of accounts receivable were written off as uncollectible. In addition, Renue unexpectedly
collected $500 of receivables that had been written off in a previous accounting period. Services
provided on account during 2018 were $215,000, and cash collections from receivables were
$218,000. Uncollectible accounts expense was estimated to be 2% of the sales on account for the
period.
a. Organize the information in accounts under an accounting equation.
a. Accounts receivable increased and the retained earnings account
increased as well. This event would be an asset source.
b. Based on the preceding information, compute (after year-end adjustments):
a. Balance of the Allowance for Doubtful Accounts at December 31,
2018.
i. This can be computed by adding the beginning balance to the
adjustment for reinstated receivables and the expectations for
uncollectible accounts for the period and subtracting the
amount of write offs as uncollectible.
b. Balance of the Accounts Receivable at December 31, 2018.
i. Can be computed by adding the beginning balance to the
amount of services sold on account and the number of
reinstated receivables then subtracting the cash collections and
the amount of write offs as uncollectible and the cash collected
on reinstated receivables.
c. Net realizable value of Accounts Receivable at December 31, 2018.
i. Found by subtracting the allowance for doubtful accounts from
the accounts receivable balance.
c. What amount of uncollectible accounts expense will Renue Spa have for
2018?
a. At the end of the year the company adjusted the accounts to reflect
management’s expectations that uncollectible accounts.
d. Explain how the $500 recovery of receivables affected the accounting
equation.
a. The company collected $500 of receivables that had been previously
written off. This event results in two entries. In the first entry, the
previously written off statement needs to be reinstated. In the second
entry the actual collection of cash must be recorded.
Exercise 11
Rainey Enterprises loaned $20,000 to Small Co. on June 1, 2018, for one year at 6%
interest. Show the effects of the following transactions in a horizontal statements model like the
one shown.
a. The loan to Small Co.
b. The adjusting entry at December 31, 2018.
c. The adjusting entry and collection of the note on June 1, 2019.
Exercise 14
 Ultra-Day Spa provided $120,000 of services during 2018. All customers paid for the
services with credit cards. Ultra-submitted the credit card receipts to the credit card company
immediately. The credit card company paid Ultra cash in the amount of face value less a 5%
service charge.
a. Record the credit card sales and the subsequent collection of accounts
receivable in a horizontal statements model like the one shown here. In the
cash flow column, indicate whether the item is an operating activity (OA),
investing activity (IA), or financing activity (FA). Use NA to indicate than an
element is not affected by the event.
b. Based on this information alone, answer the following questions:
a. What is the amount of total assets at the end of the accounting period?
b. What is the amount of revenue reported on the income statement?
c. What is the amount of cash flow from operating activities reported on
the statement of cash flows?
d. What costs would a business incur if it maintained its own accounts
receivable? What cost does a business incur by accepting credit cards?

Chapter 6
Homework Items:
Exercise 8
Golden Manufacturing Company started operations by acquiring $150,000 cash from the
issue of common stock. On January 1, 2018, the company purchased equipment that cost
$120,000 cash, had an expected useful life of six years, and had an estimated salvage value of
$4,000. Golden Manufacturing earned $72,000 and $83,000 of cash revenue of 2018 and 2019,
respectively. Golden manufacturing uses double-declining-balance depreciation.
a. Record the previous transaction in a horizontal statements model like the following
one.
b. Prepare income statements, balance sheets, and statements of cash flows for 2018 and
2019. Use the vertical statements format.
Exercise 12
Un Company sold office equipment with a cost of $23,000 and accumulated depreciation
of $12,000 for $14,000.
a. What is the book value of the asset at the time of sale?
a. $11,000
b. What is the amount of gain or loss on the disposal?
a. $3,000
c. How would the sale affect net income (increase, decrease, no effect) and by how
much?
a. The sale would increase net income by $3,000
d. How would the sale affect the amount of total assets shown on the balance sheet
(increase, decrease, no effect) and by how much?
a. The sale would result in an increase in total assets shown on the balance of
$3,000.
e. How would the event effect the statement of cash flows (inflow, outflow, no effect)
and in what section?
 a. Cash account would increase. Equipment account would decrease. Retained
earnings increases.

Exercise 16
Sellers Construction Company purchased a compressor for $28,000 cash. It had an
estimated useful life of four years and a $4,000 salvage value. At the beginning of the third year
of use, the company spent an additional $6,000 related to the equipment. The company’s
financial condition just prior to this expenditure is shown in the following statements model.
Record the $6,000 expenditure in the statements model under each of the following independent
assumptions:
a. The expenditure was for routine maintenance.
a. Assuming that the $6,000 spent on the equipment counts as a cost of routine
maintenance that is commonly incurred to keep an asset functioning and in
good working order then this is a cost that should be expensed in the period
that it is incurred rather than be capitalized.
b. The expenditure extended the compressor’s life.
a. Assuming that the $6,000 spent on the equipment was a sizable cost that was
spent with the purposing of extending the life of the asset then this is a cost
that should be capitalized by deducting the cost from the accumulated
depreciation account.
c. The expenditure improved the compressor’s operating capacity.
a. Assuming that the $6,000 spent on the equipment was a sizable cost that was
spent with the purpose of improving the asset’s capacity then this is a cost that
should be capitalized by adding it to the historical cost of the asset account.

Written Assignment:
1. What is the difference between the functions of long-term operational assets and
investments?
a. Long-term operational assets are those assets that are used by a business to
generate revenue.
b. Investments are simply held for the production of interest and dividends and/or
for price appreciation.
2. What is the difference between tangible and intangible assets? Give an example of each.
a. Tangible assets – have a physical existence.
i. Buildings
ii. Equipment
b. Intangible assets – represent some rights and privileges associated with owning
the asset.
i. Copyrights
ii. Leases
iii. Trademarks
3. What is the difference between goodwill and specifically identifiable intangible assets?
a. Specifically, identifiable intangible assets – are purchased for a specific value or
have a known value.
 b. Intangible assets – are not specifically identifiable are those purchased as part of
the purchased as a whole business or group of assets. The most common assets in
this group include goodwill and covenants not to compete.
4. Define depreciation. What kind of assets depreciate?
a. Depreciation – the systematic allocation of the cost of property, plant and
equipment to the accounting periods over which they are to be used.
i. Buildings
ii. Machinery
iii. Office equipment
5. When are natural resources expensed?
a. Natural resources are assets that are produced by nature. Some examples include
oil, coal, minerals. Their value wastes away as the resources are removed from the
earth.
6. Is land a depreciable asset? Why or why not?
a. Land is not a depreciable asset because land has an infinite life. Land is not
destroyed by its use.
7. Define amortization. What kind of assets are amortized?
a. Amortization – method of systematically allocating the costs of intangible assets
to expense over their useful lives; also, a term for converting the discount on a
note or a bond to interest expense over a designated period.
b. Patents, franchises, and copyrights.
8. Explain the historical cost concept as it applies to long term operational assets. Why is
the book value of an asset likely to be different from the current market value of an asset?
a. The historical cost concept requires that long-term operational assets be recorded
at the amount paid for them. This is the amount that will be shown on the balance
sheet as long as the asset is owned. As time passes the asset may increase or
decline in value, but this change is not reflected on the books of the company.
However, the historical cost of assets may be reduced by depreciation over their
lives.
9. What different kinds of expenditures might be included in the recorded cost of a
building?
a. The cost of a building includes the amount paid for the building plus any amounts
that are paid to put it to its intended use. Some common costs include the
purchase price, title search fee, legal fees, sales commissions, remodeling, and
improvements.
10. What is a basket purchase of assets? When a basket purchase is made, how is cost
assigned to individual assets?
a. A basket purchase of assets is the purchase of a group of assets for a single
purchase of price. When a group of assets are purchased together the purchase
price must be allocated among the different assets. One of the more common
methods of making the allocation is the relative fair market value method. The
fair market value of each asset is determined and then its ratio to the total fair
market value of all assets is applied to the total purchase price.
11. What are the stages in the life cycle of a long-term operational asset?
 a. The life cycle of a long-term operational asset simply describes the process of
acquiring, using and retiring the asset. The process includes obtaining the funding
to acquire the asset, acquiring the asset, using the asset, and disposing of the asset.
12. Explain straight-line, units-of-production, and double-declining-balance depreciation.
When is it appropriate to use each of these depreciation methods?
a. Straight-line depreciation – this method allocates an equal amount of depreciation
to each period over the useful life of the asset.
b. Units-of-production depreciation – when this method of depreciation is used,
depreciation is calculated for each estimated unit of use. This estimated unit cost
is then applied to the actual use of the asset for the period.
c. Double-declining balance depreciation – this is an accelerated depreciation
method that allocates more of the cost of an asset to expense in the early years of
the asset’s life. It is called double-declining balance because the method applies
twice the straight-line rate to the book value of the asset.
13. What effect does the recognition of depreciation expense have on total assets? On total
equity?
a. Recognition of depreciation expense reduces total assets; while the asset account
containing the asset that is being depreciated is not changed, the contra asset
account, accumulated depreciation, is increased which, in turn reduces total
assets.
b. Total equity is decreased when an expense is recognized.
14. Does the recognition of depreciation expense affect cash flows? Why or why not?
a. The recognition of depreciation expense does not affect cash flows. Depreciation
recognition is simply the allocation of part of a previously acquired asset to
expense. Cash is affected when the asset is purchased, when an improvement is
made to the asset, and when it is sold.
15. MalMax purchased a depreciable asset. What would be the difference in total assets at the
end of the first year if MalMax chooses straight line depreciation versus double declining
balance depreciation?
a. Total assets will be lower at the end of the first year of the asset’s life if MalMax
chooses the double-declining balance method of computing depreciation rather
than straight-line. This result because more expense is recognized in the early
years of an asset’s life when double-declining balance is used. However, at the
end of the asset’s life, total assets will be the same regardless of the method
chosen because the amount of total depreciation recognized over the asset’s life is
the same regardless of the depreciation method chosen.
16. John Smith mistakenly expensed the cost of a long-term asset tangible fixed asset.
Specifically, he charged the cost of a truck to a delivery expense account? How will this
error affect the income statement and the balance sheet in the year in which the mistake is
made?
a. When the total cost of an asset is expensed in the year acquired, total expense will
be overstated, and net income will be understated. Because all of a plant asset’s
cost is erroneously expensed, assets will be understated and retained earnings will
be understated because net income was understated.
17. What is salvage value?
a. Salvage Value – expected selling price of an asset at the end of its useful life.
18. What type of account (classification) is Accumulated Depreciation?
a. Accumulated Depreciation is a contra asset account.
19. How is the book value of an asset determined?
a. Book value of an asset is its historical cost less any accumulated depreciation.
20. Why is depreciation that has been recognized over the life of an asset shown in a contra
account? Why not just reduce the asset account?
a. Recording the depreciation recognized in the contra asset account allows the total
cost of the asset and the total amount expensed to be shown in the accounts and
on the balance sheet. This provides more information to the reader of the financial
statements. The use of the contra account is also required by GAAP.
21. Assume that a piece of equipment cost $5,000 and had accumulated depreciation of
$3,000. What is the book value of the equipment? Is the book value equal to the fair
market value of equipment? Explain.
a. Book value is computed as the cost of the equipment less the accumulated
depreciation of that equipment, $5,000-$3,000 = $2,000. This does not represent
the fair market value of the equipment because the accumulated depreciation is
only an allocation of the cost based on estimates. In addition, the market value of
the equipment may not be related to its original cost.
22. Why would a company choose to depreciate one piece of equipment using the double-
declining-balance method and another piece of equipment using straight-line
depreciation?
The method of depreciation chosen for a particular piece of equipment should
represent as closely as possible the pattern of its usage of that piece of equipment. For
instance, double-declining balance may be used for that piece of equipment whose
usefulness declines more in the early years of its life. Straight-line depreciation
should be used for that piece of equipment whose usefulness declines at a constant
rate over its useful life.
23. Why may it be necessary to revise the estimated life of a plant asset? When the estimated
life is revised, does it affect the amount of depreciation per year? Why or why not?
a. When an asset is purchased and put into service, an estimate is made of the
expected useful life of the asset. However, as the asset is used, it may become
apparent that the estimate was incorrect, or the circumstances may have changed
to cause the estimate to be incorrect. When these situations arise, it is necessary to
revise the estimated useful life of the asset and, consequently, the amount of
depreciation per year. If the estimated life is longer than originally expected, the
amount of depreciation per year will decrease; if the estimated useful life is
shorter than originally expected, the amount of depreciation per year will be
larger.
24. How are capital expenditures made to improve the quality of a capital asset accounted
for? Would the answer change if the expenditure extended the life of the asset but did not
improve quality? Explain.
a. When an expenditure improves the quality of an asset, this improvement is
accounted for as if a new asset is purchased; the equipment account is debited.
The improvement is depreciated over the remaining life of the original asset since
the life of the asset is not extended; only the quality is improved.
 b. When an expenditure extends the life of the asset, this expenditure in effect
reduces some of the depreciation already taken on the asset. This is accomplished
by reducing the accumulated depreciation account. Depreciation is recalculated by
spreading the remaining book value, reduced by salvage value, over the remaining
estimated life of the asset.
25. When a long-term operational asset is sold at a gain, how is the balance sheet affected? Is
the statement of cash flows affected? If so, how?
a. When a long-term operational asset is sold for a gain, total assets and equity
increase by the amount of the gain. The gain is the amount the asset is sold for
over the book value of the asset. However, the cash flow from the sale of the
equipment is the amount the asset is sold for (assuming it is sold for cash). The
total amount of cash received is shown as a cash inflow in the investing section of
the statement of cash flows.
26. Define depletion. What is the most commonly used method of computing depletion?
a. Depletion – method of systematically allocating the costs of natural resources to
expense as the resources are removed from the land.
b. The most common method used to calculate depletion of units-of-production.
27. List several common intangible assets. How is the life determined that is to be used to
compute amortization?
a. Some common intangible assets include patents, copyrights, and goodwill.
b. Amortization is generally based on the legal life of an asset, the useful life of an
asset, or, in the case of goodwill, the amount of impairment. The asset is generally
amortized over the shortest of these possible lives. The period over which an
intangible asset can be amortized for tax purposes is generally determined
according to terms specified by tax law.
28. How can judgment and estimation affect information reported in the financial statements?
a. The estimated useful life and salvage of an asset is determined based on the
judgment and estimation of the accountant or management. Because of the length
of time of actual use and the actual value at disposal is not known, these amounts
are based on the best judgment of the accountant. If the useful period is estimated
to be too long, then the amount of depreciation expenses each period will be less
than the actual use. If the useful period is estimated too short, then more cost will
be depreciated than is actually used. There are several acceptable methods
available to make these estimates, such as prior use of similar assets.

Chapter 7
Homework Items:
Exercise 9
Dan Dayle started a business by issuing an $80,000 face value note to First State Bank on
January 1, 2018. The note had an 8% annual rate of interest and a five-year term. Payments of
$20,037 are to be made each December 31 for five year. Round answers to the nearest whole
dollar.
a. What portion of the December 31, 2018 payments is applied to
a. Interest expense?
 i. The portion of the December 31, 2018 payment that is applied to the
interest expense is computed by multiplying the prior period’s
principal balance by the interest rate.
b. Principal?
i. The portion of the December 31, 2018 payment that is applied to the
principal repayment is computed by subtracting the interest expense
from the cash payment.
b. What is the principal balance on January 1, 2019?
a. The current periods principal balance is computed by subtracting the principal
repayment from the prior period’s principal balance.
c. What portion of the December 31, 2019, payment is applied to
a. Interest expense?
i. The portion of the December 31, 2019 payment that is applied to the
interest expense is computed by multiplying the prior period’s
principal balance by the interest rate.
b. Principal?
i. The portion of the December 31, 2019 payment that is applied to the
principal repayment is computed by subtracting the interest expense
from the cash payment.

Exercise 11
Colson Company has a line of with Federal Bank. Colson can borrow up to $800,000 at
any time over the course of the 2018 calendar year. The following table shows the prime rate
expressed as an annual percentage along with the amounts borrowed and repaid during the first
four months of 2018. Colson agreed to pay interest at an annual rate equal to 2% above the
bank’s prime rate. Funds are borrowed or repaid on the first day of each month. Interest is
payable in cash on the last day of the month. The interest rate is applied to the outstanding
monthly balance. For example, Colson pays 6% (4% + 2%) annual interest on $80,000 for the
month of January.

Month Amount Borrowed or (Repaid) Prime Rate for the Month

January $80,000 4.0%

February $50,000 4.25%
March ($30,000) 4.5%
April $20,000 4.25%

a. Compute the amount of interest that Colson will pay on the line of credit for the first four
months of 2018. Round answers to the nearest whole dollar.
a. The total amount of interest is simply the sum of all the monthly interest
payments during the year as reflected on the summary of the line of credit events.

Exercise 16
Indicate whether a bond will sell at a premium (P), discount (D), or face value (F) for
each of the following conditions:
 a. The stated rate of interest is higher than the market rate. PREMIUM
b. The market rate of interest is equal to the stated rate. FACE VALUE
c. The market rate of interest is less than the stated rate. PREMIUM
d. The stated rate of interest is less than the market rate. DISCOUNT
e. The market rate of interest is higher than the stated rate. DISCOUNT

Written Assignment:
1. What type of transaction is a cash payment to creditors? How does this type of
transaction affect the accounting equation?
a. Cash payments to creditors is an asset use transaction.
b. This type of transaction will reduce both assets and liabilities.
2. What is a current liability? Distinguish between a current liability and long-term debt.
a. Current Liability – obligation due within one year or an operating cycle,
whichever is longer.
b. Long-Term Debt – matures beyond the operating cycle.
3. How does recording accrued interest affect the accounting equation?
a. The entry to record accrued interest consists of an increase to Interest Expense
and an increase of Interest Payable. The transaction is a claims exchange
transaction and reduces equity and increases liabilities.
4. Who is the maker of a note payable?
a. The maker of a note is sometimes called the issuer. It is the party giving the note
to the payee.
5. How does the going concern assumption discussed in Chapter 1 affect the way liabilities
are reported in the financial statements?
a. The going concern assumption means that a business will continue to operate
indefinitely. This is why assets and liabilities are recorded because a business
benefits from its assets and paying its liabilities in full.
b. Liabilities need to be recorded accurately in order to properly reflect the financial
obligations a business has and to properly state the company’s position in the
financial statements.
6. Why is it necessary to make an adjustment at the end of the accounting period for unpaid
interest on a note payable?
a. An adjustment for accrued but unpaid interest is necessary for the accounting
records to reflect the correct amount of liability and the correct amount of interest
expense.
7. Assume that on October 1, 2018, Big Company borrowed $10,000 from the local bank at
6% interest. The note is due on October 1, 2019. How much interest does Big pay in
2018? How much interest does Big pay in 2019? What amount of cash does Big pay back
in 2019?
a. The amount of interest for the entire year of the loan will be $600.
b. The result is a total of $10,600 that will be paid back upon maturity.
8. When a business collects sales tax from customers, is it revenue? Why or why not?
a. Collection of sales taxes is not revenue. The retailer is merely acting as a
collection agency for the state. The retailer collects the sales tax and periodically
remits it to the state.
9. What is a contingent liability?
 a. Contingent Liability – a potential obligation, the amount of which depends on the
outcome of future events.
10. List the three categories of contingent liabilities.
a. Probable and reasonably estimated
b. Possible but not reasonably estimated
c. Remote
11. Are contingent liabilities recorded on a company’s books? Explain.
a. Only those contingent liabilities that are probable and reasonably estimated are
recorded on the books.
12. What is the difference in accounting procedures for a liability that is probable and
estimable and one that is reasonably possible but not estimable?
a. Contingent liabilities that are probable and reasonably estimated are recognized in
the financial statements, but contingent liabilities that are possible but not
estimable are only disclosed in the footnotes to the financial statement.
13. What type of liabilities are not recorded on a company’s books?
a. Contingent liabilities that are possible but not reasonably estimated are not
recorded on the books but are disclosed in the footnotes to the financial
statements. Contingent liabilities that are remote are not recorded or disclosed in
the financial statements.
14. What does the term warranty mean?
a. Warranty – promises to correct deficiencies or dissatisfactions in quality, quantity,
or performance of products or services sold.
15. What effect does recognizing future warranty obligations have on the balance sheet? On
the income statement?
a. Recognizing future warranty obligations will increase liabilities and decrease
equity. It has the effect of increasing expenses thereby decreasing net income.
16. When is the warranty cost reported on the statement of cash flows?
a. Warranty cost is not shown on the statement of cash flows until the business
experiences a cash outlay for warranty repairs.
17. What is the difference between classification of a note as short term or long term?
a. Short-term notes mature within one year or one operating cycle, whichever is
longer. Notes that do not mature within one year or operating cycle, whichever is
longer, are classified as long-term notes.
18. At the beginning of year 1, B Co. has a note payable of $72,000 that calls for an annual
payment of $16,246, which includes both principal and interest. If the interest rate is 8%,
what is the amount of interest expense in year 1 and in year 2? What is the balance of the
note at the end of year 2?
a. Interest in year 1 is $5,760. Interest in year 2 is $4,921.
b. The principal balance at the end of year 2 is $50,189.
19. What is the purpose of a line of credit for a business? Why would a company choose to
obtain a line of credit instead of issuing bonds?
a. A line of credit is a preapproved amount of credit available to a business to use as
needed. It eliminates the need to get loan approval each time the company needs
some additional cash. When using a line of credit, money can be borrowed one
day and paid the next or used for some prespecified period. A line of credit is
generally used for short-term financing where it is not practical to issue bonds.
20. What are the primary sources of debt financing for most large companies?
a. Most short-term financing is in the form of loans from financial institutions.
b. A company can obtain long-term permanent financing through the issuance of
bonds.
21. What are some advantages of issuing bonds versus borrowing from a bank?
a. One primary advantage of bond financing is that the company can usually obtain
larger amounts of money over a longer term. By going directly to the public, the
company may also be able to obtain lower financing costs.
22. What are some disadvantages of issuing bonds?
a. One of the primary disadvantages of a bond issue is the restrictions that may be
placed on management. These restrictions are called debt covenants and may
restrict some actions of management.
23. Why can a company usually issue bonds at a lower interest rate than the company would
pay if the funds were borrowed from a bank?
a. A company can issue bonds at a lower interest rate than the company would pay if
the funds were borrowed from a bank for two primary reasons:
i. A company can set the term it wants – typically the terms are for much
longer time frames than banks offer. This longer time frame offsets the
higher interest rates a bank would charge.
ii. Banks earn their income by borrowing money at low interest rates and
then loaning money to consumers at higher interest rates. This spread is
what generates their profits and increases the cost of interest. A company
can issue its bonds directly to the consumer and eliminate the middleman
and therefor pay a lower interest rate.
24. If Roc Co. issued $100,000 of 5%, 10-year bonds at the face amount, what is the effect of
the issuance of the bonds on the financial statements? What amount of interest expense
will Roc Co. recognize each year?
a. The effect of the issuance on the financial statements would be that the cash
account, which is an asset, increased and the bonds payable account, which is a
liability, increased as well. This event would be an asset source. The event would
be a source of cash reflected on the financing activities section of the statement of
cash flows. It has no impact on the income statement.
b. The amount of interest expenses the company will recognize each year is $5,000.
25. What mechanism is used to adjust the stated interest rate to the market rate of interest?
a. The system that is used to adjust the stated interest rate to the market rate of
interest is the concept of effective rate of interest. The effective rate of interest
represents the interest rate that investors are willing to accept for a giving security.
This effective rate inherently equals the market rate of interest for other securities
that have similar levels of risk. Premiums and discounts come into play by
increasing or decreasing securities prices in order to have the effective rate and
market rate match.
26. When the effective interest rate is higher than the stated interest rate on a bond issue, will
the bond sell at a discount or a premium? Why?
a. When the effective interest rate is higher than the stated interest rate on a bond
issue the bond will sell at a premium. This is because investors are willing to pay
more in order to receive a return greater than what is stated.
 27. What type of transaction is the issuance of bonds by a company?
a. The issuance of bonds by a company is a financing activity reflected on the
statement of cash flows. The company first issues the bond in exchange for cash.
Next, it pays investors periodic interest payments reflected on the income
statement as an expense and on the statement of cash flows as an operating
activity. Finally, it pays investors the principal back by repaying the face amount
of the bond which is reflected on the statement of cash flows as a financing
activity.
28. What factors may cause the effective interest rate and the stated interest rate to be
different?
a. State of the economy
b. Government policy
c. Supply and demand
d. Length of time
e. Company perception in the marketplace
29. If a bond is selling at 97 ½, how much cash will the company receive from the sale of a
$1,000 bond?
a. The amount of cash the company selling the bond would receive $975.
30. How is the carrying value of a bond computed?
a. The carrying value of a bond is defined as the book value of the bond liability. It
is computed by subtracting the discount on bonds payable amount from the bonds
payable amount or by adding the premium on bonds payable amount to the bonds
payable amount
31. Gay Co. has a balance in the Bonds Payable account of $25,000 and a balance in the
Discount on Bonds Payable account of $5,200. What is the carrying value of the bonds?
What is the total amount of the liability?
a. The carrying value of the bond is $19,800.
b. The total amount of liability is $19,800.
32. When the effective interest rate is higher than the stated interest rate, will interest expense
be higher or lower than the amount of interest paid?
a. The interest expense will not differ from the amount of interest paid.
33. What is a classified balance sheet?
a. Classified Balance Sheet – balance sheet that distinguishes between current and
noncurrent items.

Chapter 8
Homework Items:

Exercise 8
When Crossett Corporation was organized in January 2018, it immediately issued 4,000
shares of $50 par, 6%, cumulative preferred stock and 50,000 shares of $20 par common stock.
Its earnings history is as follows: 2018, net loss of $35,000; 2019, net income of $125,000; 2020
net income of $215,000. The corporation did not pay a dividend in 2018.
a. How much is the dividend arrearage as of January 1, 2019?
 b. Assume that the board of directors declares a $40,000 cash dividend at the end of 2019
(remember that the 2018 and 2019 preferred dividends are due). How will the dividends
be divided between the preferred and common stock holders?

Exercise 11
Tom Yuppy, a wealthy investor, paid $20,000 for 1,000 shares of $10 par common stock
issued to him by Leuig Corp. A month later, Leuig Corp. issued an additional 2,000 shares of
stock to Yuppy for $25 per share.
Show the effect of the two stock issues on Leuig’s books in a horizontal statements model
like the following one. In the cash flow column, indicate whether the item is an operating activity
(OA), investing activity (IA) or a financing activity (FA). Use NA to indicate that an element was
not affected by the event.

Assets = Equity Rev. - Exp. = Net. Income Cash Flow

IA
Exercise 15
Beacon Corporation issued a 5% stock dividend on 30,000 shares of its $10 par common
stock. At the time of the dividend, the market value of the stock was $15 per share.
a. Compute the amount of the stock dividend
a. $22,500
Show the effects of the stock dividend on the financial statements using a horizontal
statements model like the following one.

Assets = Liabilities + Common Stock + PIC in Excess + Ret. Earn. Rev. – Exp. = Net Inc CF
NA NA 1,500 7,500 (22,500) NA. NA NA. NA

Written Assignment:
1. What are the three major forms of business organizations? Describe each.
a. Sole proprietorship – is a business owned by one individual.
b. Partnership – a business that is owned by two or more persons with the intent to
make a profit.
c. Corporation – a legal entity that is organized according to the laws of the state in
which it is formed.
2. How are sole proprietorships formed?
a. The sole proprietorship is formed when an individual decides to engage in some
activity that provides goods or services, with the intent of making a profit.
3. Discuss the purpose of a partnership agreement. Is such an agreement necessary for
partnership formation?
a. The partnership agreement is a legal agreement that defines the responsibilities of
each partner and specifies the division of profits and losses. In order to form a
partnership, there must be some type of agreement.
4. What is meant by the phrase separate legal entity? To which type of business organization
does it apply?
a. The phrase separate legal entity means that the business organization operates
separately from its owners. The corporation is referred to as a “separate legal
 entity” and conducts business with the same rights and responsibilities as a
person.
5. What is the purpose of the articles of incorporation? What information do they provide?
a. The articles of incorporation constitute a legal document that is filed with the
appropriate state agency requesting the official formation of a corporation.
b. The articles of incorporation generally set forth the name of the corporation, the
proposed date of the incorporation, the purpose for which the corporation is
formed, the expected life of the corporation, provisions for the capital stock of the
corporation, and the names and addresses of the members of the board of
directors.
6. What is the function of a stock certificate?
a. The stock certificate is issued as evidence of ownership in a corporation and
represents a certain proportionate share of the business ownership.
7. What promoted Congress to pass the Securities Act of 1933 and the Securities Exchange
Act of 1934? What is the purpose of these laws?
a. The stock market crash of 1929 and subsequent economic depression led to the
passage of the Securities and Exchange Acts of 1933 and 1934. These acts were
passed to regulate the issuance of stock and govern exchanges of publicly traded
stock. A part of this regulation extends to the formulation of certain accounting
policies for companies listed on the stock exchanges.
8. What are the advantages and disadvantages of the corporate form of business
organization?
a. Advantages:
i. Limited liability
ii. Continuity of existence
iii. Free transferability of ownership interest
iv. Ease of raising capital
b. Disadvantages:
i. Regulation
ii. Double taxation
9. What is a limited liability company? Discuss its advantages and disadvantages.
a. Limited Liability Company – organization offering many of the best features of
corporations and partnerships and with many legal benefits of corporations but
permitted by the Internal Revenue Service to be taxed as a partnership, thereby
avoiding double taxation of profits.
10. How does the term double taxation apply to corporations? Give an example of double
taxation.
a. The term double taxation as it applies to a corporation means that earnings are
taxed both at the corporate level and the shareholder level when earnings are
distributed in the form of dividends.
11. What is the difference between contributed capital and retained earnings for a
corporation?
a. Contributed capital is the capital that is acquired by the corporation from owners
of the corporation.
b. Retained earnings is the capital of a corporation that has been generated through
the earnings process of a corporation and kept in the corporation.
12. What are the similarities and differences in the equity structure of a sole proprietorship, a
partnership, and a corporation?
a. For both sole proprietorships and partnerships, contributed capital and retained
earnings are combined in one capital account for financial statement reporting.
13. Why is it easier for a corporation to raise large amounts of capital than it is for a
partnership?
a. Because corporations can be owned by millions of individuals, they are able to
pool the resources of many individuals which permits access to billions of dollars
of capital. Proprietorships and partnerships are bound by the financial condition of
a few, private investors.
14. What is the meaning of each of the following terms with respect to the corporate form of
organization:
a. Legal capital – amount of assets that should be maintained as protection for
creditors; the number of shares multiplied by the par value.
b. Par value of stock – arbitrary value assigned to stock by the board of directors.
c. Stated value of stock – arbitrary value assigned to stock by the board of directors.
d. Market value of stock – the price at which securities sell in the secondary market:
also called fair value.
e. Book value of stock – historical (original) cost of an asset minus the accumulated
depreciation; alternatively, undepreciated amount to date.
f. Authorized shares of stock – number of shares that the corporation is approved by
the state to issue.
g. Issued stock – stock sold to the public.
h. Outstanding stock – stock owned by outside parties; normally the amount of stock
issued less the amount of treasury stock.
i. Treasury stock – stock first issued to the public and then bought back by the
corporation.
j. Common stock – basic class of corporate stock that carries no preferences as to
claims on assets or dividends; certificates that evidence ownership in a company.
k. Preferred stock – stock that receives some form of preferential treatment (usually
as to dividends) over common stock; normally has no voting rights.
l. Dividends – transfer of wealth from a business to its owners.
15. What is the difference between cumulative preferred stock and noncumulative preferred
stock?
a. Cumulative preferred stock – a class of preferred stock for which the stipulated
dividend, if not paid, accumulates from one year to the next. If a corporation does
not pay dividends for one year, the unpaid dividend amount is carried forward and
when dividends are paid in later years, any unpaid portion of past dividends is
paid first, before any dividends may be paid on common stock.
b. Noncumulative preferred stock – a class of preferred stock whose unpaid
dividends is not carried forward to future years. If dividends are not declared in
one year, they are lost.
16. What is no-par stock? How is it recorded in the accounting records?
a. No-par stock – is stock for which a par value has not been established by the
corporation. May have a stated value. If so, the issuance of the stock is recorded
exactly the same way as par value stock.
17. Assume that Best Co. has issued and outstanding 1,000 shares of $100 par value, 10%,
cumulative preferred stock. What is the dividend per share? If the preferred dividend is
two years in arrears, what total amount of dividends must be paid before the common
shareholders can receive any dividends?
a. Dividends per share: $100 par X 10% = $10 per share.
b. The total dividend to be paid to preferred shareholders is $30,000, the current
year’s dividend plus that of the past two years.
18. If Best Co. issued 10,000 shares of $20 par value common stock for $30 per share, what
amount is added to the Common Stock account? What amount of cash is received?
a. The amount added to the common stock is equal to par value times the number of
shares issued or $200,000.
b. The amount of cash received is $300,000.
19. What is the difference between par value stock and stated value stock?
a. Par value is assigned in the charter at the time of the incorporation.
b. Stated value is determined by the board of directors after incorporation.
20. Why might a company repurchase its own stock?
a. To reduce the number of shares outstanding and thus increase the earnings per
share
b. To accumulate stock to use for employee bonus
c. To accumulate stock to be used in a merger or acquisition
d. To avoid a hostile takeover
e. To keep the stock price high with active trading
21. What effect does the purchase of treasury stock have on the equity of a company?
a. The purchase of treasury stock decreases total equity by increasing the treasury
stock account which is a contra-equity account.
22. Assume that Day Company repurchased 1,000 of its own shares for $30 per share and
sold the shares two weeks later for $35 per share. What is the amount of gain on the sale?
How is it reported on the balance sheet? What type of account is treasury stock?
a. Even though the stock was purchased for $30 per share and resold for $35 per
share, there is no gain on the sale.
b. It is reported on the balance sheet in the stockholders’ equity section as paid-in
capital.
c. Treasury stock is a contra equity account.
23. What is the importance of the declaration date, record date, and payment date in
conjunction with corporate dividends?
a. The declaration date is the date the dividend is officially declared by the
corporation’s board of directors. The declaration of the dividend creates a legal
liability to pay the dividend.
b. The record date is the date that establishes the ownership of the stock by the
specific shareholders to whom the dividends will be paid.
c. Payment date is the date the dividend checks are actually written and mailed to
the shareholders.
24. What is the difference between a stock dividend and a stock split?
a. Stock dividend – may be declared to give the shareholders some reward when the
corporation does not have sufficient cash to distribute. The stock dividend will
give each shareholder additional shares in proportion to their stock ownership.
 After the stock dividend, each shareholder owns exactly the same proportion of
the corporation as he owned before the dividend. The effect on the accounting
equation is to transfer the amount of the stock dividend from retained earnings to
contributed capital.
b. Stock split – is a method used to lower the market price of a share of stock. A
stock split replaces old shares with a proportionate number of new shares.
25. Why would a company choose to distribute a stock dividend instead of a cash dividend?
a. A stock dividend is declared either to compensate shareholders when cash is not
available or to lower the market price of a share of stock.
26. What is the primary reason that a company would declare a stock split?
a. The primary reason for declaring a stock split is to reduce the market value of
stock by increasing the number of shares outstanding on the market. This makes
the stock more affordable and may increase the demand for stock.
27. If Best Co. had 10,000 shares of $20 par value common stock outstanding and declared a
5-for-1 stock split, how many shares would then be outstanding and what would be their
par value after the split?
a. In a stock split, the number of shares is increased according to the amount of the
split and the par is reduced proportionately. In a five-for-one split, the new
number of shares would be five times the old: 10,000 X 5 = 50,000. The
paramount would be reduced to one-fifth of the original amount $20/5 = $4.
28. When a company appropriates retained earnings, does the company set aside cash for a
specific use?
a. When retained earnings are appropriated, an equal amount of cash is not
necessarily set aside. However, retained earnings that are appropriated are not
available to be paid out as dividends.
29. What is the largest source of financing for most U.S. businesses?
a. Equity financing.
30. What is meant by equity financing? What is meant by debt financing?
a. Equity financing refers to capital acquired from owners; usually the term refers to
the issuance of stock.
b. Debt financing refers to borrowing in the form of notes and bonds payable.
31. What is a widely held corporation? What is a closely held corporation?
a. Widely held corporation is one in which the stock is held by a large number of
investors.
b. A closely held corporation is one in which ownership is concentrated in the hands
of a few people.
32. What are some reasons that a corporation might not pay dividends?
a. In deciding whether to declare dividends, the board of directors must consider
whether the corporation has sufficient cash to cover operating requirements and
meet emergencies. The board may also wish to retain earnings in order to pay
dividends in years when cash flows are low. In addition, the board may restrict
dividends in order to finance future expansions of the business.