Establishing a Business and the Balance Sheet

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Chapter 2

Establishing a Business and the Balance Sheet

ANSWERS TO QUESTIONS

1. (a) An asset is a probable future economic benefit owned by the business as a result of past transactions.

(b) A current asset is an asset that will be used up or turned into cash within the next 12 months.

(c) A liability is a debt or obligation arising from past transactions or events, which the company is likely to pay, settle, or fulfill by sacrificing resources in the future.

(d) A current liability is a debt or obligation that will be paid, settled, or fulfilled within one year.

(e) Owner’s capital includes the amount of financing (cash and sometimes other assets) provided to the company by the owners plus cumulative undistributed profits.

2. A business transaction is (a) an exchange of resources (assets) and obligations (debts) between a business and one or more outside parties, and (b) certain events that directly affect the entity such as a storm loss and the wearing out of equipment used to operate the business. An example of the first situation is (a) the sale of goods or services. An example of the second situation is (b) a loss incurred due to a fire.

3. An account is a standardized format used by organizations to accumulate the dollar effects of transactions on each financial statement item. Accounts are necessary to keep track of all increases and decreases in the basic accounting equation.

4. The basic accounting equation is:

Assets = Liabilities + Owner’s Equity

5. Debit is the left side of a T-account and credit is the right side of a T-account. A debit is an increase in assets and a decrease in liabilities and owner’s equity. A credit is the opposite -- a decrease in assets and an increase in liabilities and owner’s equity.

6. Transaction analysis is the process of studying a transaction to determine its economic effect on the business in terms of the basic accounting equation:

Assets = Liabilities + Owner’s Equity

The two concepts underlying the process are:

* Dual effects: every transaction affects at least two accounts.

* The accounting equation (A=L+OE) must remain in balance after each

transaction.

The two steps in transaction analysis are:

(1) identify and classify accounts and the direction and amount of the

effects.

(2) determine that the accounting equation (A = L + OE) remains in
balance.

7. The accounting equalities in transaction analysis are:

(a) Assets = Liabilities + Owner’s Equity

(b) Debits = Credits

8. A journal entry is a method for expressing the effects of a transaction on accounts in a debits equal credits format. The title of the account(s) to be debited is (are) listed first. The title of the account(s) to be credited is (are) listed underneath the debited accounts and usually indented to the right. Amounts are then recorded in the debit and credit columns.

9. T-accounts are a simplified version of the ledger, which summarizes transaction effects for each account. T-accounts show increases on the left (debit) side for assets, which are on the left side of the accounting equation. T-accounts show increases on the right (credit) side for liabilities and stockholders’ equity, which are on the right side of the accounting equation. The T-account is a tool for summarizing transaction effects for each account and determining balances.

10. All assets possess the key feature of having probable future economic benefits. All liabilities share the key feature of requiring a future sacrifice of resources.

11. (a) The separate entity assumption indicates that transactions affecting the business are separate from transactions affecting the owners.

(b) Conservatism is the requirement to use the least optimistic measures when uncertainty exists about the value of an asset or liability.

Authors' Recommended Solution Time

(Time in minutes)

Mini-exercises / Exercises / Problems / Skill Development Cases
No. / Time / No. / Time / No. / Time / No. / Time
1 / 3 / 1 / 6 / PA2-1 / 45 / 1 / 15
2 / 3 / 2 / 10 / PA2-2 / 45 / 2 / 15
3 / 3 / 3 / 6 / PA2-3 / 50 / 3 / *
4 / 4 / 4 / 8 / PA2-4 / 50 / 4 / 20
5 / 4 / 5 / 8 / PA2-5 / 50 / 5 / 20
6 / 4 / 6 / 10 / PA2-6 / 60 / 6 / 10
7 / 4 / 7 / 8 / PB2-1 / 45 / 7 / 30
8 / 3 / 8 / 10 / PB2-2 / 45
9 / 5 / 9 / 20 / PB2-3 / 50
10 / 6 / 10 / 20 / PB2-4 / 50
11 / 6 / 11 / 12 / PB2-5 / 50
12 / 6 / 12 / 25 / PB2-6 / 60
13 / 6 / 13 / 8
14 / 20

* Due to the nature of this project, it is very difficult to estimate the amount of time students will need to complete the assignment. As with any open-ended project, it is possible for students to devote a large amount of time to these assignments. While students often benefit from the extra effort, we find that some become frustrated by the perceived difficulty of the task. You can reduce student frustration and anxiety by making your expectations clear. For example, when our goal is to sharpen research skills, we devote class time discussing research strategies. When we want the students to focus on a real accounting issue, we offer suggestions about possible companies or industries.

MINI-EXERCISES

M2–1

Debit / Credit
Assets / Increases / Decreases
Liabilities / Decreases / Increases
Owner’s Equity / Decreases / Increases

M2–2

Increase / Decrease
Assets / Debit / Credit
Liabilities / Credit / Debit
Owner’s Equity / Credit / Debit

M2–3 (1) D

(2) C

(3) A

(4) I

(5) F

(6) B

M2–4

(1) / Wages Payable / CL
(2) / Accounts Payable / CL
(3) / Accounts Receivable / CA
(4) / Buildings / NCA
(5) / Cash / CA
(6) / “Owner’s Name,”Capital / OE
(7) / Land / NCA
(8) / Merchandise Inventory / CA
(9) / Sales Taxes Payable / CL
(10) / Equipment / NCA
(11) / Notes Payable (due in six years) / NCL
(12) / Notes Receivable (due in six months) / CA
(13) / Prepaid Rent (for three months) / CA
(14) / Investments (held for five months) / CA
(15) / Supplies / CA
(16) / Utilities Payable / CL

M2–5

Req. 1 / Req. 2
a) / Accounts Receivable / CA / Debit
b) / Short-term Loan (payable) / CL / Credit
c) / “Owners’” Capital / OE / Credit
d) / Long-term Debt (payable) / NCL / Credit
e) / Income Taxes Payable / CL / Credit
f) / Property, Plant, and Equipment / NCA / Debit
g) / Accounts Payable / CL / Credit
h) / Cash / CA / Debit
i) / Accrued Liabilities (e.g., Wages Payable) / CL / Credit
j) / Inventories / CA / Debit

M2–6

Req. 1 / Req. 2
a) / Income Taxes Payable / 1) CL / Credit
b) / Accounts Receivable / 2) CA / Debit
c) / Movie Rental Supplies / 3) CA / Debit
d) / “Owners’” Capital / 4) OE / Credit
e) / Long-term Debt / 5) NCL / Credit
f) / Property and Equipment / 6) NCA / Debit
g) / Prepaid Rent / 7) CA / Debit
h) / Intangibles / 8) NCA / Debit
i) / Accounts Payable / 9) CL / Credit
j) / Long-term Liabilities / 10) NCL / Credit
k) / Cash / 11) CA / Debit
l) / Accrued Liabilities (e.g., Wages Payable) / 12) CL / Credit
m) / Merchandise Inventories / 13) CA / Debit

M2–7

1) Yes

2) No -- This event is between an owner and another company, not Toro.

3) Yes

4) No – This event involves a promise to pay for a promise to deliver.

5) Yes

6) Yes

M2–8

1) Yes

2) Yes

3) No – This event involves only a written promise to rent the building. No exchange of cash, goods, or services has occurred.

4) Yes

5) No – Although this may improve the company’s reputation, there is no exchange that is measurable.

M2–9

Assets / = / Liabilities / + / Owner’s Equity
a. / Cash / +3,940 / = / Notes Payable / +3,940
b. / Cash / +4,630 / = / R. Terlecki, Capital / +4,630
c. / Cash
Equipment / –190
+920 / = / Notes Payable / +730
d. / Cash
Supplies / –372
+372 / = / No change
e. / Supplies / +700 / = / Accounts Payable / +700

M2–10

a. / Cash (+A) / 3,940
Notes Payable (+L) / 3,940
b. / Cash (+A) / 4,630
R. Terlecki, Capital (+OE) / 4,630
c. / Equipment (+A) / 920
Cash (-A) / 190
Notes Payable (+L) / 730
d. / Supplies (+A) / 372
Cash (-A) / 372
e. / Supplies (+A) / 700
Accounts Payable (+L) / 700

M2–11

Cash (A) / Supplies (A) / Equipment (A)
Beg. / 0 / Beg. / 0 / Beg. / 0
(a) / 3,940 / 190 / (c) / (d) / 372 / (c) / 920
(b) / 4,630 / 372 / (d) / (e) / 700
8,008 / 1,072 / 920
Accounts Payable (L) / Notes Payable (L) / R. Terlecki, Capital (OE)
0 / Beg. / 0 / Beg. / 0 / Beg.
700 / (e) / 3,940 / (a) / 4,630 / (b)
730 / (c)
700 / 4,670 / 4,630

M2–12

Spotlighter Company

Balance Sheet

At January 31, 2009

Assets / Liabilities
Current assets: / Current liabilities:
Cash / $ 8,008 / Accounts Payable / $ 700
Supplies / 1,072 /

Notes Payable

/ 4,670
Total current assets / 9,080 /

Total current liabilities

/ 5,370
Owner’s Equity
Equipment / 920 /

R. Terlecki, Capital

/ 4,630
Total Assets / $ 10,000 / Total Liabilities & Owner’s Equity / $ 10,000

M2–13

Req. 1

Trump Entertainments Resorts, Inc.

Balance Sheet

At December 31, 2006

(in thousands)

Assets / Liabilities
Current assets: / Current liabilities:
Cash / $ 127,382 / Accounts Payable / $ 30,495
Accounts Receivable / 54,342 /

Salaries Payable

/ 28,099
Inventories / 10,816 /

Other Current Liabilities

/ 98,138
Other Current Assets / 23,400 /

Total current liabilities

/ 156,732
Total current assets / 215,940 /

Long-term Note Payable

/ 1,690,996
Property and Equipment / 1,535,852 /

Owners’ Equity

Other Assets / 508,704 /

Owners’ Capital

/ 412,768
Total Assets / $2,260,496 / Total Liabilities & Owners’ Equity / $2,260,496

Req. 2

The total assets of Trump Entertainment Resorts, Inc. were financed primarily by debt.

EXERCISES

E2–1

(1) / E
(2) / G
(3) / B
(4) / N
(5) / J
(6) / A
(7) / L
(8) / M
(9) / O
(10) / D

E2–2

Req. 1

Received / Given
(a) / Equipment (A) [or Computer Equipment] / Notes Payable (L)
(b) / Equipment (A) [or Delivery Truck] / Cash (A)
(c) / Not a transaction of the company / —
(d) / Cash (A) / Owner’s Capital (OE)
(e) / Land (A) / Cash (A)
(f) / Not a transaction of the company / —
(g) / Cash (A) / Notes Payable (L)
(h) / Notes Payable (L) [reduced its promise to pay] / Cash (A)

Req. 2

The truck in (b) would be recorded as an asset of $21,000. The land in (e) would be recorded as an asset of $50,000. These are applications of the cost principle.

Req. 3

The agreement in (c) involves no exchange or receipt of cash, goods, or services and thus is not a transaction. Because transaction (f) occurs between the owner and others, the separate entity assumption implies this transaction does not affect the business.

E2–3

Account / Balance Sheet Classification / Debit or Credit
Balance
1. Land / NCA / Debit
2. Wages Payable / CL / Credit
3. Notes Payable (due in three years) / NCL / Credit
4. Accounts Receivable / CA / Debit
5. Supplies / CA / Debit
6. “Owners’” Capital / OE / Credit
7. Machinery and Equipment / NCA / Debit
8. Accounts Payable / CL / Credit
9. Cash / CA / Debit
10. Taxes Payable / CL / Credit

E2–4

Assets / = / Liabilities / + / Owner’s Equity
a. / Cash / +10,000 / = / J. Favata, Capital / +10,000
b. / Cash / +7,000 / = / Notes Payable / +7,000
c. / Land
Cash / +12,000
–1,000 / = / Notes Payable / +11,000
d. / Supplies / +800 / = / Accounts Payable / +800
e. / Equipment
Cash / +3,000
–1,000 / = / Notes Payable / +2,000

E2–5

Req. 1

Assets / = / Liabilities / + / Owners’ Equity
a. / Property, Plant & Equipment
Cash / +216.3
–211.3 / = / Notes Payable / +5.0
b. / Cash / +21.1 / = / Owners’ Capital / +21.1
c. / No change / = / No change

Req. 2

The separate entity assumption states that transactions of the business are separate from transactions of the owners. Because transaction (c) occurs between the owners and external banks, there is no effect on the business.

E2-6

a. / Cash (+A) / 10,000
J. Favata, Capital (+OE) / 10,000
b. / Cash (+A) / 7,000
Notes Payable (+L) / 7,000
c. / Land (+A) / 12,000
Cash (-A) / 1,000
Notes Payable (+L) / 11,000
d. / Supplies (+A) / 800
Accounts Payable (+L) / 800
e. / Equipment (+A) / 3,000
Cash (-A) / 1,000
Notes Payable (+L) / 2,000

E2-7

Req. 1

a. / Property, Plant & Equipment (+A) / 216.3
Cash (-A) / 211.3
Notes Payable (+L) / 5.0
b. / Cash (+A) / 21.1
Owners’ Capital (+OE) / 21.1

c. No journal entry required.

Req. 2

E2–8

Req. 1

Cash / Equipment
Beg. / 0 / Beg. / 0
(a) / 60,000 / 3,000 / (b) / (b) / 12,000
57,000 / 12,000
Notes Payable / J. Estella, Capital
0 / Beg. / 0 / Beg.
9,000 / (b) / 60,000 / (a)
9,000 / 60,000

Req. 2