Chapter 3, Problem 3.10E

Analyzing the Effects of Transactions in T-Accounts and Computing Cash Basis versus Accrual Basis Net Income

Stacey’s Piano Rebuilding Company has been operating for one year. At the start of the second year, its income statement accounts had zero balances and its balance sheet account balances were as follows:

Cash	$6,400
Accounts receivable	32,000
Supplies	1,500
Equipment	9,500
Land	7,400
Building	25,300

Accounts payable	$9,600
Unearned revenue	3,840
Long-term note payable	48,500
Common stock	1,600
Additional paid-in capital	7,000
Retained earnings	11,560

Required:

1. 1. Create T-accounts for the balance sheet accounts and for these additional accounts: Rebuilding Fees Revenue, Rent Revenue. Wages Expense, and Utilities Expense. Enter the beginning balances.
2. 2. Enter the following transactions for January of the second year into the T-accounts, using the letter of each transaction as the reference:
   1. a. Rebuilt and delivered file pianos in January to customers who paid $19,000 in cash.
   2. b. Received a $600 deposit from a customer who wanted her piano rebuilt.
   3. c. Rented a part of the building to a bicycle repair shop: received $850 for rent in January.
   4. d. Received $7,200 from customers as payment on their accounts.
   5. e. Received an electric and gas utility bill for $400 to be paid in February.
   6. f. f Ordered $960 in supplies.
   7. g. Paid $2,300 on account in January.
   8. h. Received from the home of Stacey Eddy, the major shareholder, a $920 tool (equipment) to use in the business in exchange for 100 shares of $1 par value stock.
   9. i. Paid $16,500 in wages to employees who worked in January.
   10. j. Declared and paid a $2,200 dividend (reduce Retained Earnings and Cash).
   11. k. Received and paid cash for the supplies in (f).
3. 3. Using the data from the T-accounts, amounts for the following at the end of January of the second year were

   Revenues $ _________ −Expenses $ ________ = Net Income $

   Assets $ _________ = Liabilities $ _________ + Stockholders’ Equity $ ________

4. 4. What is net income if Stacey’s used the cash basis of accounting? Why does this differ from accrual basis net income (in requirement 3)?

To determine

Prepare the T- account and enter the transaction into their respective accounts for calculating the ending balance.

Explanation of Solution

T-account:

T-account is the form of the ledger account, where the journal entries are posted to this account. It is referred to as the T-account, because the alignment of the components of the account resembles the capital letter ‘T’.

The components of the T-account are as follows:

a) The title of the account

b) The left or debit side

c) The right or credit side

Prepare the T-accounts:

Cash account:

Cash account
Beginning balance	$6,400	(g)	$2,300
(a)	$19,000	(i)	$16,500
(b)	$600	(j)	$2,200
(c)	$850	(k)	$960
(d)	$7,200
Ending balance	$12,090

Accounts receivable account:

Accounts receivable account
Beginning balance	$32,000	(d)	$7,200
Ending balance	$24,800

Supplies account:

Supplies account
Beginning balance	$1,500
(k)	$960
Ending balance	$2,460

Equipment account:

Equipment account
Beginning balance	$9,500
(h)	$920
Ending balance	$10,420

Land account:

Land account
Beginning balance	$7,400
Ending balance	$7,400

Building account:

Building account
Beginning balance	$25,300
Ending balance	$25,300

Accounts payable account:

Accounts payable account
		Beginning balance	$9,600
(g)	$2,300	(e)	$400
		Ending balance	$7,700

Unearned revenue account:

Unearned revenue account
		Beginning balance	$3,840
		(b)	$600
		Ending balance	$4,440

Long-term note payable account:

Long-term note payable account
		Beginning balance	$48,500
		Ending balance	$48,500

Common stock account:

Common stock account
		Beginning balance	$1,600
		(h)	$100
		Ending balance	$1,700

Additional paid-in capital account:

Additional paid-in capital account
		Beginning balance	$7,000
		(h)	$820
		Ending balance	$7,820

Retained earnings account:

Retained earnings account
		Beginning balance	$11,560
(j)	$2,200
		Ending balance	$9,360

Rebuilding fees revenue account:

Rebuilding fees revenue account
		Beginning balance	0
		(a)	$19,000
		Ending balance	$19,00

Rent revenue account:

Rent revenue account
		Beginning balance	0
		(c)	$850
		Ending balance	$850

Wages expense account:

Wages expense account
Beginning balance	0
(i)	$16,500
Ending balance	$16,500

Utilities expense account:

Utilities expense account
Beginning balance	0
(e)	$400
Ending balance	$400

Thus, the t-accounts are prepared and the ending balances are calculated.

To determine

Determine the amount for the given equations at the end of the January.

Answer to Problem 3.10E

For the equation$\text{Revenues}-\text{Expenses}=\text{Net income}$:

$\begin{array}{c}\text{Revenue}-\text{Expenses}=\text{Net income}\\ \text{\$19,850}-\$16,900=\$2950\end{array}$

For the equation$\text{Assets}=\text{Liabilities}+\text{Stockholders' equity}$:

$\begin{array}{c}\text{Assets}=\text{Liabilities}+\text{Stockholders' equity}\\ \$82,470=\$60,640+\$21,830\end{array}$

Explanation of Solution

Accrual basis of accounting:

Accrual basis of accounting refers to recognizing the financial transactions during the period in which the event occurs, even if the cash is not exchanged.

Working note:

Calculate the revenues:

$\begin{array}{c}\text{Revenues}=\text{Rebuilding fees revenue}+\text{Rent from revenue}\\ =\$19,000+\$850\\ =\$19,850\end{array}$ (1)

Calculate the expenses:

$\begin{array}{c}\text{Expenses}=\text{Wages expenses}+\text{Utilities expenses}\\ =\$16,500+\$400\\ =\$16,900\end{array}$ (2)

Calculate the net income:

Particulars	Amount($)	Amount ($)
Revenues	(1)19,850
Less: Expenses	(2)16,900
Net income		$2,950

Table (1)

Accounting equation:

Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners. Accounting equation is expressed as shown below:

$\boxed{\text{Assets = Liabilities + Stockholders' Equity}}$

Calculate the amount for the accounting equation:

Assets	=	Liabilities	+	Stockholders’ Equity
$12,090		$7,700		$1,700
$24,800		$4,440		$7,820
$2,460		$48,500		$9,360
$10,420				$2,950
$7,400
$25,300
$82,470	=	$60,640	+	$21,830

Table (2)

To determine

Calculate the net income under cash basis of accounting and explain the reason in which manner the net income differ from accrual basis of accounting.

Answer to Problem 3.10E

Net income of Company SPR under cash basis of accounting is $7,890.

Explanation of Solution

Cash basis of accounting:

Cash basis of accounting refers to the recognition of financial transactions only when the cash is received or paid.

Calculate the net income under cash basis accounting:

Particulars	Amount($)	Amount ($)
Cash receipts	(3) 27,650
Less: Cash payments	(4) 19,760
Net income		$7,890

Table (3)

Calculate the cash receipts:

$\begin{array}{c}\text{Cash receipts}=\left(\text{Rebuilding fees revenue}\right)+\left(\text{Deposits received}\right)\\ +\left(\text{Rent revenue}\right)+\left(\text{Accounts receivable}\right)\\ =\$19,000+\$600+\$850+\$7,200\\ =\$27,650\end{array}$ (3)

Calculate the cash payments:

$\begin{array}{c}\text{Cash payments}=\text{Accounts payable}+\text{Wages expenses}+\text{Payments for supplies}\\ =\$2,300+\$16,500+\$960\\ =\$19,760\end{array}$ (4)

• According to the cash basis of accounting, the net income is higher than the accrual basis of accounting.
• The recording of the expenses and revenues differ from the accrual basis of accounting.
• Hence, the net income is different for the accrual basis of accounting and cash basis of accounting.