Chapter 3, Problem 3.13E

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

At January 1 (beginning of its fiscal year). Conover. Inc., a financial services consulting firm, reported the following account balances (in thousands of dollars, except number of shares and par value per share):

Cash	$1,900	Accounts payable	$210
Short-term investments	410	Unearned revenue	1,320
Accounts receivable	3,570	Salaries payable	870
Supplies	150	Short-term note payable	780
Prepaid expenses	4,720	Common stock ($1 par value)	50
Office equipment	1,530	Additional paid-in capital	6,560
Accumulated depreciation—office equipment*	(480)	Retained earnings	2,010

  *This accoutu has a credit balance representing the portion of the cost of the equipment used in the past.

  Required:

1. 1. Create T-accounts for the balance sheet accounts and for these additional accounts: Consulting Fees Revenue. Interest Revenue. Salaries Expense, and Utilities Expense. Enter the beginning balances of the balance sheet accounts: Conover's income statement accounts had zero balances.
2. 2. Enter the following transactions for the current year into the T-accounts, using the letter of each transaction as the reference:
   1. a. Received $9,500 cash for consulting services rendered.
   2. b. Issued 10,000 additional shares of common stock at a market price of $120 per share.
   3. c. Purchased $640 of equipment, paying 25 percent in cash and owing the rest on a short-term note.
   4. d. Received $890 from clients for consulting services to be performed in the next year.
   5. e. Bought $470 of supplies on account.
   6. f. Incurred and paid $1,800 in utilities for the current year.
   7. g. Consulted for clients in the current year for fees totaling $1,620. due from clients in the next year.
   8. h. Received $2,980 from clients paying on their accounts.
   9. i. Incurred $6,210 in salaries in the current year, paying $5,300 and owing the rest (to be paid next year).
   10. j. Purchased $1,230 in short-term investments and paid $800 for insurance coverage beginning in the next fiscal year.
   11. k. Received $10 in interest revenue earned in the current year on short-term investments.
3. 3. Using the data from the T-accounts, amounts for the following at the end of the current year were

   Revenues $ _________ −Expenses $ ________ = Net Income $ __________

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

4. 4 What would net income be if Conover, Inc., 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	$1,900	(c)	$160
(a)	$9,500	(f)	$1,800
(b)	$1,200	(i)	$5,300
(k)	$10	(j)	$2,030
(d)	$890
(h)	$2,890
Ending balance	$7,190

Short-term investments account:

Short-term investments account
Beginning balance	$410
(j)	$1,230
Ending balance	$1,640

Accounts receivable account:

Accounts receivable account
Beginning balance	$3,570
(g)	$1,620	(h)	$2,980
Ending balance	$2,210

Supplies account:

Supplies account
Beginning balance	$150
(e)	$470
Ending balance	$620

Prepaid expenses account:

Prepaid expenses account
Beginning balance	$4,720
(j)	$800
Ending balance	$5,520

Office equipment account:

Office equipment account
Beginning balance	$1,530
(c)	$640
Ending balance	$2,170

Accumulated depreciation account:

Accumulated depreciation account
		Beginning balance	$480
		Ending balance	$480

Accounts payable account:

Accounts payable account
		Beginning balance	$210
		(e)	$470
		Ending balance	$680

Unearned revenue account:

Unearned revenue account
		Beginning balance	$1,320
		(d)	$890
		Ending balance	$2,210

Salaries payable account:

Salaries payable account
		Beginning balance	$870
		(i)	$910
		Ending balance	$1,780

Short-term note payable account:

Short-term note payable account
		Beginning balance	$780
		(c)	$480
		Ending balance	$1,260

Common stock account:

Common stock account
		Beginning balance	$50
		(b)	$10
		Ending balance	$60

Additional paid-in capital account:

Additional paid-in capital account
		Beginning balance	$6,560
		(b)	$1,190
		Ending balance	$7,750

Retained earnings account:

Retained earnings account
		Beginning balance	$2,010
		Ending balance	$2,010

Consulting fees revenue account:

Consulting fees revenue account
		Beginning balance	0
		(a)	$9,500
		(g)	$1,620
		Ending balance	$11,120

Interest revenue account:

Interest revenue account
		Beginning balance	0
		(k)	$10
		Ending balance	$10

Salaries expense account:

Salaries expense account
Beginning balance	0
(i)	$6,210
Ending balance	$6,210

Utilities expense account:

Utilities expense account
Beginning balance	0
(f)	$1,800
Ending balance	$1,800

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

To determine

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

Answer to Problem 3.13E

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

$\begin{array}{c}\text{Revenue}-\text{Expenses}=\text{Net income}\\ \text{\$11,130}-\$8,010=\$3,120\end{array}$

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

$\begin{array}{c}\text{Assets}=\text{Liabilities}+\text{Stockholders' equity}\\ \$18,870=\$5,930+\$12,940\end{array}$

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:

$\begin{array}{c}\text{Revenues}=\text{Consulting fees revenue}+\text{Interest revenue}\\ =\$11,120+\$10\\ =\$11,130\end{array}$ (1)

Calculate the expenses:

$\begin{array}{c}\text{Expenses}=\text{Salaries expenses}+\text{Utilities expenses}\\ =\$6,210+\$1,800\\ =\$8,010\end{array}$ (2)

Calculate the net income:

Particulars	Amount($)	Amount ($)
Revenues	(1)11,130
Less: Expenses	(2)8,010
Net income		$3,120

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
$7,190		$680		$60
$1,640		$2,210		$7,750
$2,210		$1,780		$2,010
$620		$1,260		$3,120
$5,520
$2,170
($480)
$18,870	=	$5,930	+	$12,940

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 3.13E

Net income of Incorporation C under cash basis of accounting is $5,290.

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) 14,580
Less: Cash payments	(4) 9,920
Net income		$5,290

Table (3)

Calculate the cash receipts:

$\begin{array}{c}\text{Cash receipts}=\left(\text{Consulting fees revenue}\right)+\left(\text{Common stock issued}\right)\\ +\left(\text{Consulting fees revenue}\right)+\left(\text{Accounts receivable}\right)+\left(\text{Interest revenue}\right)\\ =\$9,500+\$1,200+\$890+\$2,980+\$10\\ =\$14,580\end{array}$ (3)

Calculate the cash payments:

$\begin{array}{c}\text{Cash payments}=\left(\text{Short-term notes payable}\right)+\left(\text{Utilities expenses}\right)+\\ \left(\text{Salaries expenses}\right)+\left(\text{Purchase of short-term invenstment}\right)\\ =\$160+\$1,800+\$5,300+\$2,030\\ =\$19,760\end{array}$ (4)

• According to the cash basis of accounting, the net income is $5,290 which 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.