E2-7 (Accounting Principles—Comprehensive) Presented …



E2-7 (Accounting Principles—Comprehensive) Presented below are a number of business transactionsthat occurred during the current year for Fresh Horses, Inc.InstructionsIn each of the situations, discuss the appropriateness of the journal entries in terms of generally acceptedaccounting principles.(a) The president of Fresh Horses, Inc. used his expense account to purchase a new Suburban solelyfor personal use. The following journal entry was made.Miscellaneous Expense 29,000Cash 29,000(b) Merchandise inventory that cost $620,000 is reported on the balance sheet at $690,000, the expectedselling price less estimated selling costs. The following entry was made to record this increasein value.Merchandise Inventory 70,000Revenue 70,000(c) The company is being sued for $500,000 by a customer who claims damages for personal injuryapparently caused by a defective product. Company attorneys feel extremely confident that thecompany will have no liability for damages resulting from the situation. Nevertheless, the companydecides to make the following entry.Loss from Lawsuit 500,000Liability for Lawsuit 500,000(d) Because the general level of prices increased during the current year, Fresh Horses, Inc. determinedthat there was a $16,000 understatement of depreciation expense on its equipment and decided to record it in its accounts. The following entry was made.Depreciation Expense 16,000Accumulated Depreciation 16,000(e) Fresh Horses, Inc. has been concerned about whether intangible assets could generate cash in caseof liquidation. As a consequence, goodwill arising from a purchase transaction during the currentyear and recorded at $800,000 was written off as follows.Retained Earnings 800,000Goodwill 800,000(f) Because of a “fire sale,” equipment obviously worth $200,000 was acquired at a cost of $155,000.The following entry was made.Equipment 200,000Cash 155,000Revenue 45,000(a)This entry violates the economic entity assumption. This assumption in accounting indicates that economic activity can be identified with a particular unit of accountability. In this situation, the company erred by charging this cost to the wrong economic entity.(b)The historical cost principle indicates that assets and liabilities are accounted for on the basis of cost. If we were to select sales value, for example, we would have an extremely difficult time in attempting to establish a sales value for a given item without selling it. It should further be noted that the revenue recognition principle provides the answer to when revenue should be recognized. Revenue should be recognized when (1) realized or realizable and (2) earned. In this situation, an earnings process has definitely not taken place.(c)Probably the company is too conservative in its accounting for this transaction. The matching principle indicates that expenses should be allocated to the appropriate periods involved. In this case, there appears to be a high uncertainty that the company will have to pay. FASB Statement No. 5 requires that a loss should be accrued only (1)?when it is probable that the company would lose the suit and (2)?the amount of the loss can be reasonably estimated. (Note to instructor: The student will probably be unfamiliar with FASB Statement No.?5. The purpose of this question is to develop some decision framework when the probability of a future event must be assumed.)(d)At the present time, accountants do not recognize price-level adjust-ments in the accounts. Hence, it is misleading to deviate from the cost principle because conjecture or opinion can take place. It should also be noted that depreciation is not so much a matter of valuation as it is a means of cost allocation. Assets are not depreciated on the basis of a decline in their fair market value, but are depreciated on the basis of systematic charges of expired costs against revenues. (Note to instructor: It might be called to the students’ attention that the FASB does encourage supplemental disclosure of price-level information.)(e)Most accounting methods are based on the assumption that the busi-ness enterprise will have a long life. Acceptance of this assumption provides credibility to the historical cost principle, which would be of limited usefulness if liquidation were assumed. Only if we assume some permanence to the enterprise is the use of depreciation and amortization policies justifiable and appropriate. Therefore, it is incor-rect to assume liquidation as Fresh Horses, Inc. has done in this situation. It should be noted that only where liquidation appears imminent is the going concern assumption inapplicable.(f)The answer to this situation is the same as (b).E3-5 (Adjusting Entries) The ledger of Duggan Rental Agency on March 31 of the current year includesthe following selected accounts before adjusting entries have been prepared.Debit CreditPrepaid Insurance $ 3,600Supplies 2,800Equipment 25,000Accumulated Depreciation—Equipment $ 8,400Notes Payable 20,000Unearned Rent Revenue 9,300Rent Revenue 60,000Interest Expense –0–Wage Expense 14,000An analysis of the accounts shows the following.1. The equipment depreciates $250 per month.2. One-third of the unearned rent was earned during the quarter.3. Interest of $500 is accrued on the notes payable.4. Supplies on hand total $850.5. Insurance expires at the rate of $300 per month.InstructionsPrepare the adjusting entries at March 31, assuming that adjusting entries are made quarterly. Additionalaccounts are: Depreciation Expense; Insurance Expense; Interest Payable; and Supplies Expense. (Omitexplanations.)WATTEAU CO.TRIAL BALANCEJUNE 30, 2007Debit CreditCash $ 2,870Accounts Receivable $ 3,231Supplies 800Equipment 3,800Accounts Payable 2,666Unearned Service Revenue 1,200Common Stock 6,000Retained Earnings 3,000Service Revenue 2,380Wages Expense 3,400Office Expense 940$13,371 $16,916(L0 5)1.Depreciation Expense750Accumulated Depreciation – Equipment7502.Unearned Rent Revenue3,100Rent Revenue3,1003.Interest Expense500Interest Payable5004.Supplies Expense1,950Supplies1,9505.Insurance Expense900Prepaid Insurance900Instructions(a) Construct T-accounts and enter the balances shown.(b) Prepare adjusting journal entries for the following and post to the T-accounts. (Omit explanations.)Open additional T-accounts as necessary. (The books are closed yearly on December 31.)(1) Bad debts are estimated to be $1,400.(2) Furniture and equipment is depreciated based on a 6-year life (no salvage value).(3) Insurance expired during the year $2,550.(4) Interest accrued on notes payable $3,360.(5) Sales salaries earned but not paid $2,400.(6) Advertising paid in advance $700.(7) Office supplies on hand $1,500, charged to Office Expense when purchased.(c) Prepare closing entries and post to the accounts.(a), (b), (c)CashAccounts ReceivableAllow. for Doubtful Accts.Bal.18,500Bal.42,000Bal.700Adj.1,400InventoryFurniture & EquipmentAccum. Depr. of F. & E.Bal.80,000Bal. 84,000Bal.35,000Adj.14,000Prepaid InsuranceNotes PayableAdmin. Salaries ExpenseBal.5,100Adj.2,550Bal.28,000Bal.65,000Cls.65,000Common StockSalesInsurance ExpenseBal.80,600Cls.600,000Bal.600,000Adj.2,550Cls.2,550Sales Salaries ExpenseAdvertising ExpenseInterest ExpenseBal.50,000Cls.52,400Bal.6,700Adj.700Adj.3,360Close3,360Adj. 2,400Close6,00052,40052,4006,7006,700Bad Debt ExpenseOffice ExpensePrepaid Advertising ExpenseAdj.1,400Cls.1,400Bal.5,000Adj.1,500Adj.700Close3,5005,0005,000Interest PayableDepr. Exp.—Furn. & Equip.Income SummaryAdj.3,360Adj.14,000Cls.14,000Exp.546,210Sales600,000Inc. 53,790600,000600,000Office SuppliesSalaries PayableAdj.1,500Adj.2,400Retained EarningsCost of Goods SoldBal.10,000Bal.398,000Cls.398,000Inc.53,790Bal.63,790(b)-1-Bad Debts Expense1,400Allowance for Doubtful Accounts1,400-2-Depreciation Expense—Furniture and Equipment ($84,000 ÷ 6)14,000Accum. Depr.—Furniture and Equipment14,000-3-Insurance Expense2,550Prepaid Insurance2,550-4-Interest Expense3,360Interest Payable3,360-5-Sales Salaries Expense2,400Salaries Payable2,400-6-Prepaid Advertising Expense700Advertising Expense700-7-Office Supplies1,500Office Expense1,500(c)Dec. 31Sales600,000Income Summary600,000Dec. 31Income Summary546,210Cost of Goods Sold398,000Advertising Expense6,000Administrative Salaries Expense65,000Sales Salaries Expense52,400Office Expense3,500Insurance Expense2,550Bad Debt Expense1,400Depreciation Expense—Furniture and Equipment14,000Interest Expense3,360Dec. 31Income Summary53,790Retained Earnings53,790Instructions(a) For each plant: (2) Compute equivalent units of production for materials and for conversion costs. (b) Prepare the production cost report for Plant A for June 2005.(a)(1)Physical unitsR12RefrigeratorsF24FreezersUnits to be accounted forWork in process, June 1Started into productionTotal unitsUnits accounted forTransferred outWork in process, June 30Total units?? ??020,00020,00018,000?2,00020,000?? ??020,00020,00017,000?3,00020,000(2)Equivalent unitsR12 RefrigeratorsMaterialsConversionCostsUnits transferred outWork in process, June 30(2,000 X 100%)(2,000 X 70%)Total equivalent units18,000?2,00000,00020,00018,000?1,40019,400F24 FreezersMaterialsConversionCostsUnits transferred outWork in process, June 30(3,000 X 100%)(3,000 X 50%)Total equivalent units17,000?3,00000,00020,00017,000?1,50018,500(3)Unit costsPlant APlant BR12RefrigeratorsF24FreezersMaterials($840,000 ÷ 20,000)($700,000 ÷ 20,000)Conversion costs($620,800* ÷ 19,400)($555,000** ÷ 18,500)Total$42?32000$74$35?30$65 *$200,800 + $420,000**$236,000 + $319,000Plant A(4)R12 RefrigeratorsCosts accounted forTransferred out (18,000 X $74)$1,332,000Work in processMaterials (2,000 X $42)$84,000Conversion costs??(1,400 X $32.00)?44,800?? 128,800Total costs$1,460,800Plant BF24 FreezersCosts accounted forTransferred out (17,000 X $65)$1,105,000Work in processMaterials (3,000 X $35)$105,000Conversion costs??(1,500 X $30)? 45,000?? 150,000Total costs$1,255,000(b)STEIN CORPORATIONStamping Department—Plant AProduction Cost ReportFor the Month Ended June 30, 2007Equivalent UnitsQuantitiesPhysicalUnitsMaterialsConversionCosts(Step 1)(Step 2)Units to be accounted forWork in process, June 1Started into productionTotal unitsUnits accounted forTransferred out?? ??020,00020,00018,00018,00018,000Work in process, June 30?2,000?2,000?1,400(2,000 X 70%)Total units20,00020,00019,400CostsMaterialsConversionCostsTotalUnit costs (Step 3)Costs in JuneEquivalent unitsUnit costs [(a) ÷ (b)]Costs to be accounted forWork in process, June 1Started into productionTotal costs(a)(b)$840,000??20,000? ???$42$620,800??19,400? ???$32$1,460,800?? ??? $74$? ??? ??0?1,460,800$1,460,800Cost Reconciliation Schedule (Step 4)Costs accounted forTransferred out (18,000 X $74)Work in process, June 30Materials (2,000 X $42)Conversion costs (1,400 X $32)Total costs?$84,000??44,800$1,332,000?? 128,800$1,460,800 ................
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