What is Accounting?

Accounting consists of three basic activities:

(1) Identification of Transactions → identifies the economic events relevant
to its business.
(2) Recording of Transactions → keeping a systematic, chronological diary of
economic events.
(3) Communications → Communicates the collected information to interested
users by means of accounting reports.

Related Users: There are two broad groups of users of financial information:
(1) Internal users are managers who plan, organize, and run the business.
*Two conditions: (1) Take Decisions, and (2) Withdraws Salary.
[Managerial Accounting provides internal reports]
(2) External users are those outside of a company who want financial information
about the company.
Two most common types of External Users are: Investors and Creditors.
Investors (owners) use accounting information to make decisions to buy, hold,
or sell ownership shares of a company.
Creditors (such as suppliers and bankers) use accounting information to
evaluate the risks of granting credit or lending money.
[Financial Accounting provides economic and financial information for
investors, creditors, and other external users]
*Owner of an organization is an external user.

Definition of Accounting:
Accounting is an information system that identifies transactions, records transactions
according to accounting rules and regulations, and communicates those recorded
information to the related users/stakeholders on time.

Input System Output

Transactions Accounting Financial Statement or
Accounting Information
Concept Check:
Stockholder → Shareholder
Stakeholder → Any interested party
*All stockholders are stakeholders, but not all stakeholders are shareholders.

Elements of Accounting:

1. Assets
“Balance Sheet” items.
2. Liabilities
Real Accounts

3. Owner’s Equity

4. Revenues
“Income Statement” items.
Nominal Accounts
5. Expenses

1. Assets: Assets are resources a business owns from which future economic benefit
will be received.
2. Liabilities: Liabilities are third party’s claims on total assets – that is, existing debts
and obligations.
3. Owner’s Equity: The ownership claim on total assets is owner’s equity.
Since the claims of the creditors/liabilities must be paid before ownership claims,
owner’s equity is often referred to as Residual Equity.
4. Revenues: Revenues are gross increase in owner’s equity resulting from business
activities.
5. Expenses: Expenses are decreases in owner’s equity that result from operating the
business.

▪ In Indian Accounting, Liabilities are referred to as External Liabilities, and Owner’s

Equity as Internal Liabilities.
Assumptions:
Two main assumptions are the monetary unit assumption and the economic entity
assumption.

Monetary Unit Assumption:

The monetary unit assumption requires that companies include in the accounting records
only transaction data that can be expressed in money terms.

This assumption enables accounting to quantify (measure) economic events. It is vital to

applying the cost principle.

Economic Entity Assumption:

The economic entity assumption requires that the activities of an economic entity be kept
separate and distinct from the activities of its owner and all other economic entities. An
economic entity can be any organization or unit in society.

Accrual Basis of Accounting:

Accrual basis accounting is about recognizing business revenues and matching expenses
when they are generated – not when money actually changes hands.

This means companies record revenue when it is earned, not when the company
receives/collects the money, and this is same for expenses.

**This is why revenues do not always equal the cash in hand.

Basic Accounting Equation:
A = L + OE

Assets = Liabilities + Owner’s Equity

Balance-Sheet (B/S) of a company:

Assets Liabilities + Owner’s Equity

Long-term/Non-current Assets: Long-term Liabilities:

- Property, Plant, Land, - Bank Loans, Mortgage

Third Party s claim

Equipment etc. Loans etc.

Liabilities (L)
- Intangible assets.
Ex. Goodwill, Brand Value Current Liabilities:
etc. - Accounts Payable (A/P)
- Unearned Revenues
Current Assets: - Accrued Expenses
- Cash & Bank
- Inventory
Owner s Equity (OE)

- Accounts Receivable (A/R) Ownership Claim

Capital (+)
- Prepaid Expenses Withdrawals (-)
- Accrued Revenues Net Profit (+)

▪ A Balance-Sheet reports the assets, liabilities, and owner’s equity at a specific date.
It is the augmented representation of accounting.
▪ Balance-Sheet Statement of Financial Position.

Accounting Period is any time frame used for financial reporting, determined by the
organization/management – that is, it can be daily, weekly, monthly, quarterly, semi-
annually, annually, or any period of time.
Assets:
Long-term/Non-current Assets are those assets that put benefits for more than one
accounting period.

Intangible Assets → Goodwill, Brand Recognition, Brand Value, Intellectual Properties

such as Patents, Trademarks, Copyrights etc.
Goodwill means the value of the loyalty of the firm's customers.

Current Assets are those assets that can be liquidated quickly and used for a company's
immediate needs.

Inventory is the stock of items that a company sells or uses in production.

Closing/Ending Inventory refers to the amount of inventory a business has left in stock
at the end of an accounting period.

Accounts Receivable (A/R) are the payments that are yet to be received/collected from
the customers for delivered products or performed services.

Prepaid Expenses are the advance payments that are paid for future services/goods.

Accrued Revenues are the accounts receivable which are earned from activities outside
of mainstream business.
For example: A hospital rents it’s unused space to a medicine store and the rent
payment is due. Renting space is not the main-stream business of the hospital, so it is
recorded as Accrued Revenue.
Liabilities:
Unearned Revenues also known as Deferred Revenues, refer to the advance payments
received by a business for products/services that are to be delivered/performed in the
future.
*Why unearned revenue is a liability?
Unearned Revenue refers to the advance payments received by a business for
products/services that are to be delivered/performed in the future. It is recorded as a
liability because the revenue has still not been earned and represents products/services
owed to the customer.
For example: Advance bus tickets sold by transport agencies are example of
unearned revenue. The tickets represent the service owed to the customer and the
money is not earned until the customer receives the transport service. So, it is a liability
for the business.

Accounts Payable (A/P) is the money owed by a business to its creditors for goods or
services that are already received. It refers to short-term debts that a company owes to
its suppliers and creditors.

Notes Payable are debts created by formal legal instrument documents.

Accrued Expenses are the liabilities that refer to the expenses that have not yet been
paid or logged under accounts payable during an accounting period.

Accounts Payable Accrued Expense

Liabilities that will be paid in the near Liabilities that build-up over time and due
future. to be due paid.
Accounts payable comes at a fixed price. Accrued expense can change as it may be
an estimate.
Account Name Payment Status Service Status
Prepaid Expense Paid Not Received
Accrued Revenue Not Received Performed
Unearned Revenue Received Not Performed
Accrued Expense Not Paid Received

Owner’s Equity:
Capital refers to those assets that a business gains from the owner.
Drawings/Withdrawals refers to the cash or other assets that the owner withdraws from
the business for personal use.

Opening OE + Additional Investments – Drawings + Revenues – Expenses = Closing OE

Alternative Terminologies: Individual Proprietorship → Owner’s Equity

Partnership ---------------- → Partner’s Equity
Corporation ---------------- → Shareholder’s Equity

Capital Expenditure → Purchase of fixed assets that generate revenue for more than one
accounting period.
Revenue Expenditure → Short-term purchases, referred to as ongoing operating
expense.

Extended Accounting Equation:

Assets = Liabilities + Owner’s Capital – Owner’s Drawings + Revenues – Expenses

Determine the missing amounts:

Brent Lillibridge Omar Vizquel

Company Company Company Company
January 1, 2012

Assets $ 80,000 $ 90,000 (g) $150,000

Liabilities 48,000 (d) 80,000 (j)

Owner’s equity (a) 40,000 49,000 90,000

December 31, 2012

Assets (b) 112,000 180,000 (k)

Liabilities 60,000 72,000 (h) 100,000

Owner’s equity 50,000 (e) 82,000 151,000

Owner’s equity changes in year

Additional investment (c) 8,000 10,000 15,000

Drawings 15,000 (f) 12,000 10,000

Total revenues 350,000 410,000 (i) 500,000

Total expenses 333,000 385,000 350,000 (l)

Solution:

(a) A = L + OE or, OE = A – L = 80,000 – 48,000 = 32,000.

(b) A = L + OE = 60,000 + 50,000 = 110,000.
(c) Opening OE + Add. Investment + Total Revenues – Drawings – Total Expenses =
Closing OE
or, 32,000 + Add. Investment + 350,000 – 15,000 – 333,000 = 50,000
or, Add. Investment = 16,000.
(d) A = L + OE or, L = A – OE = 90,000 – 40,000 = 50,000.
(e) A = L + OE or, OE = A – L = 112,000 – 72,000 = 40,000.
(f) Opening OE + Add. Investment + Total Revenues – Drawings – Total Expenses =
Closing OE
or, 40,000 + 8,000 + 410,000 – Drawings – 385,000 = 40,000
or, Drawings = 33,000.
(g) A = L + OE = 80,000 + 49,000 = 129,000.
(h) A = L + OE or, L = A – OE = 180,000 – 82,000 = 98,000.
(i) Opening OE + Add. Investment + Total Revenues – Drawings – Total Expenses =
Closing OE
or, 49,000 + 10,000 + Total Revenues – 12,000 – 350,000 = 82,000
or, Total Revenues = 385,000.
(j) A = L + OE or, L = A – OE = 150,000 – 90,000 = 60,000.
(k) A = L + OE = 100,000 + 151,000 = 251,000.
(l) Opening OE + Add. Investment + Total Revenues – Drawings – Total Expenses =
Closing OE
or, 90,000 + 15,000 + 500,000 – 10,000 – Total Expenses = 151,000
or, Total Expenses = 444,000.
Income Statement (I/S) of a Business:

Expense Revenue

Cost of Goods Sold (COGS) Sales Revenue

Administrative Expense: Service Revenue

Operating Expense

- Rent, Salary, Utility Bill, Commission

- Depreciation Commission
- Bad Debt Rent
Interest
Sales Related Expense:
- Advertisement
- Commission

▪ An income statement presents the revenues and expenses and resulting net income
or net loss for a specific period of time.
▪ Income Statement Statement of Financial Performance.

Revenue is recorded after ownership is transferred or service is performed. Completion

of payment is not necessary. Same goes for Expense.

COGS → Cost of Goods Sold is the total amount a business has paid as a cost directly
related to the sold products.

For example: 10 units of pen each bought for 10tk., Out of them 6 units sold for 30tk.
each. 4 units remained unsold.
Sales Revenue = 6 × 30 = 180 tk.
COGS = 6 × 10 = 60 tk.
Gross Profit = 120 tk.

▪ Gross Profit = Sales Revenue – COGS

▪ Operating Cost = Administrative Cost + Sales Related Cost
▪ Net Profit = Gross Profit – Operating Cost
Depreciation:

Depreciation is the reduction of the value of a long-term asset due to usage.

It represents how much of an asset’s value has been used.

Alternative Terminologies:

Tangible ----------→ Depreciation

Long-term Assets -------→ Intangible ----------→ Amortization
Natural Resources ----------→ Depletion

*Exception → “Land” → does not get depleted over time → Appreciation

Accumulated Depreciation:
The total amount an asset has been a depreciated up until a certain point of time is
called accumulated depreciation.

Cost – Accumulated Depreciation = Book Value

For example: A long-term asset is bought for $5,000 and it has a depreciation value of
$1,000 per year.
Accumulated
Asset Depreciation Depreciation Book Value
Initial 5,000 5,000
After 1st year 5,000 1,000 1,000 4,000
After 2nd year 5,000 1,000 2,000 3,000
After 3rd year 5,000 1,000 3,000 2,000
Transaction:
Transactions (business transactions) are those economic events that can change the
financial position of an organization.

* Transaction ∆ Financial Position

Change (1) Net Change / Quantitative Change
(2) Structural Change / Qualitative Change

* Financial Position Accounting Equation (or B/S)

* Each transaction must have a dual effect on the accounting equation, A = L + OE.

For example, if an asset is increased, there must be a corresponding:

1. decrease in another asset; or
2. increase in a specific liability; or
3. increase in owner’s equity.

If a transaction has effect on both sides of the accounting equation A = L + OE, then
the change is Net/Quantitative change.
If a transaction has effect on one side of the accounting equation A = L + OE, then
the change is Structural/Quantitative change.

* Transactions may be external or internal –

External transactions involve economic events between the company and some
outside enterprise.
For example, Campus Pizza’s purchase of cooking equipment from a supplier, payment
of monthly rent to the landlord, and sale of pizzas to customers are external transactions.

Internal transactions are economic events that occur entirely within one company.
For example, the use of cooking and cleaning supplies are internal transactions for
Campus Pizza.
Transaction Analysis:

Problem 1:
Ray Neal decides to open a computer programming service which he names Softbyte.

Transaction 1: On September 1, 2012, he invests $15,000 cash in the business.

Transaction 2: Softbyte purchases computer equipment for $7,000 cash.

Transaction 3: Softbyte purchases for $1,600 from Acme Supply Company computer
paper and other supplies expected to last several months. Acme agrees to
allow Softbyte to pay this bill in October.

Transaction 4: Softbyte receives $1,200 cash from customers for programming services it
has provided.

Transaction 5: Softbyte receives a bill for $250 from the Daily News for advertising but
postpones payment until a later date.

Transaction 6: Softbyte provides $3,500 of programming services for customers. The

company receives cash of $1,500 from customers, and it bills the balance of
$2,000 on account.

Transaction 7: Softbyte pays the following expenses in cash for September: store rent
$600, salaries and wages of employees $900, and utilities $200.

Transaction 8: Softbyte pays its $250 Daily News bill in cash.

Transaction 9: Softbyte receives $600 in cash from customers who had been billed for
services [in Transaction (6)].

Transaction 10: Ray Neal withdraws $1,300 in cash from the business for his personal use.

Instruction:
Illustrate the summarized September transactions of Softbyte to show their
cumulative effect on the basic accounting equation.
 1. Tabular Analysis:

Assets Liabilities + Owner’s Equity

Tr.
SL. + Accounts = Accounts + Owner’s - Owner’s
No. Cash + Supplies + Equipment + Revenue - Expense
Receivable Payable Capital Drawings
1 +15,000 +15,000
2 -7,000 +7,000
3 +1,600 +1,600
4 +1,200 +1,200
5 +250 -250
6 +1,500 +2,000 +3,500
7 -600 -600
-900 -900
-200 -200
8 -250 -250
9 +600 -600
10 -1,300 -1,300
8,050 + 1,400 + 1,600 + 7,000 = 1,600 + 15,000 - 1,300 + 4,700 - 1,950

18,050 = 1,600 + 16,450

Assets Liabilities Owner’s Equity

Problem 2:
Carla Quentin started her own consulting firm, Quentin Consulting, on May 1, 2012. The
following transactions occurred during the month of May.
May 1 Carla invested $7,000 cash in the business.
2 Paid $900 for office rent for the month.
3 Purchased $600 of supplies on account.
5 Paid $125 to advertise in the County News.
9 Received $4,000 cash for services provided.
12 Withdrew $1,000 cash for personal use.
15 Performed $5,400 of services on account.
17 Paid $2,500 for employee salaries.
20 Paid for the supplies purchased on account on May 3.
23 Received a cash payment of $4,000 for services provided on account
on May 15.
26 Borrowed $5,000 from the bank on a note payable.
29 Purchased office equipment for $4,200 on account.
30 Paid $275 for utilities.

Instructions:
Show the effects of the previous transactions on the accounting equation
using the following format.

Date Assets Liabilities Owner’s Equity

+ Accounts
= Notes + Accounts
+ + Owner’s - Owner’s
May Cash + Supplies + Equipment + Revenue - Expense
Receivable Payable Payable Capital Drawings
 2. Tabular Analysis:

Date Assets Liabilities + Owner’s Equity

+ Accounts = Notes + Accounts + Owner’s - Owner’s

May Cash + Supplies + Equipment + Revenue - Expense
Receivable Payable Payable Capital Drawings
1 +7,000 +7,000
2 -900 -900
3 +600 +600
5 -125 -125
9 +4,000 +4,000
12 -1,000 -1,000
15 +5,400 +5,400
17 -2,500 -2,500
20 -600 -600
23 +4,000 -4,000
26 +5,000 +5,000
29 +4,200 +4,200
30 -275 -275
14,600 + 1,400 + 600 + 4,200 = 5,000 + 4,200 + 7,000 - 1,000 + 9,400 - 3,800

20,800 9,200 11,600

= +
Assets Liabilities Owner’s Equity
Financial Statements:
Companies prepare four financial statements from the summarized accounting data:
1. Income Statement: An income statement presents the revenues and expenses and
resulting net income or net loss for a specific period of time.
- The income statement lists revenues first, followed by expenses. Finally, the
statement shows net income (or net loss).
- Note that the income statement does not include the investment and withdrawal
transactions between the owner and the business in measuring net income.
[Owner’s withdrawal of cash from business is not regarded as a business expense,
similarly, Owner’s investment is not regarded as revenue]
- The income statement is sometimes referred to as the statement of operations,
earnings statement, or profit and loss statement.

2. Owner’s Equity Statement: An owner’s equity statement summarizes the changes in

owner’s equity for a specific period of time.
- The first line of the statement shows the beginning owner’s equity amount. Then
come the owner’s investments, net income (or loss), and the owner’s drawings.

3. Balance Sheet: A balance sheet reports the assets, liabilities, and owner’s equity at
a specific date.
- The balance sheet lists assets at the top, followed by liabilities and owner’s equity.
- Total assets must equal total liabilities and owner’s equity.
- The balance sheet is a snapshot of the company’s financial condition at a specific
moment in time (usually the month-end or year-end).

4. Statement of Cash Flows: A statement of cash flows summarizes information about

the cash inflows (receipts) and outflows (payments) for a specific period of time.
▪ The statement of cash flows reports – (1) the cash effects of a company’s operations
during a period, (2) it’s investing transactions, (3) it’s financing transactions, (4) the
net increase or decrease in cash during the period, and (5) the cash amount at the
end of the period.

These statements provide relevant financial data for internal and external users.
*Note that the income statement, owner’s equity statement, and statement of cash
flows are all for a period of time, whereas the balance sheet is for a point in time.
The Account:
An account (or party) is an individual accounting record of increases and decreases in
a specific asset, liability, or owner’s equity item.
For example, a company have separate accounts for Cash, Accounts Receivable,
Accounts Payable, Service Revenue, Salaries and Wages Expense, and so on.
[Note: Capitalize the name, whenever referring to a specific account]

Debits and Credits:

The term debit indicates the left side of an account, and credit indicates the right side.
They are commonly abbreviated as Dr. for debit and Cr. for credit. They do not mean
increase or decrease, as is commonly thought. The terms debit and credit are
repeatedly used in the recording process to describe where entries are made in
accounts.

For example,

Every positive item in the tabular summary represents a receipt of cash; every
negative amount represents a payment of cash. Notice that in the account form we
record the increases in cash as debits, and the decreases in cash as credits. For
example, the $15,000 receipt of cash (in red) is debited to Cash, and the –$7,000
payment of cash (in blue) is credited to Cash.
Debit-Credit Rules:

Elements If Increase If Decrease

Assets Debit Credit
Liabilities Credit Debit
Owner’s Equity Credit Debit
Revenue Credit Debit
Expense Debit Credit

Each transaction must affect two or more accounts to keep the basic accounting
equation in balance. In other words, for each transaction, debits must equal credits.
The equality of debits and credits provides the basis for the double-entry system of
recording transactions.

▪ Under the double-entry system, the dual (two-sided) effect of each transaction is
recorded in appropriate accounts.
▪ This system provides a logical method for recording transactions.
▪ The double-entry system also helps ensure the accuracy of the recorded amounts
and helps to detect errors. If every transaction is recorded with equal debits and
credits, the sum of all the debits to the accounts must equal the sum of all the credits.
▪ The double-entry accounting system is the basis of accounting systems worldwide.

Steps in determining Debit/Credit in Accounts:

Step 1: Identify the Accounts/Parties.

Step 2: Determine the Accounting Elements.

Step 3: Analyze the effects on the elements; Increased (+)/Decreased (–).

Step 4: Analyze Debit/Credit in the specific accounts.

Examples:

a. Owner Invested TK. 5,000 in the business.

1. Two accounts/parties: Cash Account, Owner’s Capital Account.
2. Elements: Cash [Asset], Owner’s Capital [Owner’s Equity].
3. Increased (+)/Decreased (–): A [+], OE [–].
4. Debit/Credit: Cash Account Debit, Owner’s Capital Account Credit.

b. Received TK. 10,000 from accounts receivable.

1. Two accounts/parties: Cash Account, A/R Account.
2. Elements: Cash [Asset], A/R [Asset].
3. Increased (+)/Decreased (–): A [+], A [–].
4. Debit/Credit: Cash Account Debit, A/R Account Credit.

c. Paid TK. 10,000 to A/P.

1. Cash Account, A/P Account.
2. Asset, Liability.
3. A [–], L [–].
4. A/P Debit, Cash Credit.

d. Provided services of TK. 10,000 on cash.

1. Cash, Service Revenue.
2. Asset, Revenue.
3. A [+], R [+].
4. Cash Dr., Service Revenue Cr.

e. Paid salaries to employees TK. 5,000 cash.

1. Cash, Salary Expense.
2. Asset, Expense.
3. A [–], E [+].
4. Salary Expense Dr., Cash Cr.
The Journal:
Companies initially record transactions in chronological order (the order in which they
occur). Thus, the journal is referred to as the book of original entry. For each
transaction the journal shows the debit and credit effects on specific accounts.

The journal makes several significant contributions to the recording process:

1. It discloses in one place the complete effects of a transaction.
2. It provides a chronological record of transactions.
3. It helps to prevent or locate errors because the debit and credit amounts
for each entry can be easily compared.

▪ Companies may use various kinds of journals, but every company has the most basic
form of journal, a general journal.
▪ Typically, a general journal has spaces for dates, account titles and explanations,
references, and two amount columns.
▪ Entering transaction data in the journal is known as journalizing.
▪ An entry involving only two accounts (one debit and one credit) is called a simple
entry. Some transactions require more than two accounts in journalizing. An entry
that requires three or more accounts is a compound entry.
▪ The journal is also referred to as the primary book of accounts.
The Ledger:
The entire group of accounts maintained by a company is the ledger. The ledger keeps
in one place all the information about changes in specific account balances.

Companies may use various kinds of ledgers, but every company has a general ledger.
A general ledger contains all the asset, liability, and owner’s equity accounts.

▪ Companies arrange the ledger in the sequence in which they present the accounts
in the financial statements, beginning with the balance sheet accounts. First in
order are the asset accounts, followed by liability accounts, owner’s capital,
owner’s drawings, revenues, and expenses. Each account is numbered for easier
identification.
▪ The ledger provides the balance in each of the accounts.
For example: The Cash account shows the amount of cash available to meet
current obligations, the Accounts Receivable account shows amounts due from
customers, Accounts Payable shows amounts owed to creditors.
▪ Transferring journal entries to the ledger accounts is called posting. Posting
should be performed in chronological order.
▪ The ledger is also referred to as the permanent book of accounts.
The Trial Balance:
A trial balance is a list of accounts and their balances at a given time. Customarily,
companies prepare a trial balance at the end of an accounting period.

▪ Accounts are listed in the order in which they appear in the ledger.
▪ Debit balances appear in the left column and credit balances in the right column.
▪ The trial balance proves the mathematical equality of debits and credits after
posting. Under the double-entry system, this equality occurs when the sum of the
debit account balances equals the sum of the credit account balances.
▪ A trial balance may also uncover errors in journalizing and posting.
▪ A trial balance is useful in the preparation of financial statements.
▪ Note that dollar signs do not appear in journals or ledgers. Dollar signs are
typically used only in the trial balance and the financial statements. Generally, a
dollar sign is shown only for the first item in the column and for the total of that
column.
▪ Total amounts are double underlined to indicate they are final sums.

Limitations of a Trial Balance:

A trial balance does not guarantee freedom from recording errors. Numerous errors
may exist even though the trial balance columns agree.
For example, the trial balance may balance even when:
1. a transaction is not journalized,
2. a correct journal entry is not posted,
3. a journal entry is posted twice,
4. incorrect accounts are used in journalizing or posting, or
5. offsetting errors are made in recording the amount of a transaction.
As long as equal debits and credits are posted, even to the wrong account or in the
wrong amount, the total debits will equal the total credits.
The trial balance does not prove that the company has recorded all transactions or that
the ledger is correct.
Problem P2-1A:
Frontier Park was started on April 1 by H. Hillenmeyer. The following selected events
and transactions occurred during April.

Apr. 1 Hillenmeyer invested $35,000 cash in the business.

4 Purchased land costing $27,000 for cash.

8 Incurred advertising expense of $1,800 on account.

11 Paid salaries to employees $1,500.

12 Hired Park manager at a salary of $4,000 per month, effective May 1.

13 Paid $1,650 cash for a one-year insurance policy.

17 Withdrew $1,000 cash for personal use.

20 Received $6,800 in cash for admission fees.

25 Sold 100 coupon books for $25 each. Each book contains 10 coupons that
entitle the holder to one admission to the park.

30 Received $8,900 in cash admission fees.

30 Paid $900 on balance owed for advertising incurred on April 8.

Hillenmeyer uses the following accounts: Cash, Prepaid Insurance, Land, Accounts
Payable, Unearned Service Revenue, Owner’s Capital, Owner’s Drawings, Service
Revenue, Advertising Expense, and Salaries and Wages Expense.

Instructions:
1. Journalize the April transactions.
2. Post to the Ledger Accounts.
3. Prepare Trial Balance on April 30.
Solution to P2-1A:
1. Journal

Date Particulars Ref. Debit Credit

Apr. 1 Cash – Dr. 35,000
Owner’s Capital – Cr. 35,000
(Owner invested cash in the business)
Apr. 4 Land – Dr. 27,000
Cash – Cr. 27,000
(Purchased land for cash)
Apr. 8 Advertising Expense – Dr. 1,800
Accounts Payable – Cr. 1,800
(Incurred advertising expense on account)
Apr. 11 Salaries and Wages Expense – Dr. 1,500
Cash – Cr. 1,500
(Paid salaries to employees)
Apr. 13 Prepaid Insurance – Dr. 1,650
Cash – Cr. 1,650
(Paid for one-year insurance policy)
Apr. 17 Owner’s Drawings – Dr. 1,000
Cash – Cr. 1,000
(Owner withdrew cash for personal use)
Apr. 20 Cash – Dr. 6,800
Service Revenue – Cr. 6,800
(Received cash for admission fees)
Apr. 25 Cash – Dr. 2,500
Unearned Service Revenue – Cr. 2,500
(Sold coupon books for future services)
Apr. 30 Cash – Dr. 8,900
Service Revenue – Cr. 8,900
(Received cash as admission fees)
Apr. 30 Accounts Payable – Dr. 900
Cash – Cr. 900
(Paid creditor on account)
 2. Ledger
Cash:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 1 Owner’s Capital 35,000 35,000
Apr. 4 Land 27,000 8,000
Apr. 11 Salaries and Wages Expense 1,500 6,500
Apr. 13 Prepaid Insurance 1,650 4,850
Apr. 17 Owner’s Drawings 1,000 3,850
Apr. 20 Service Revenue 6,800 10,650
Apr. 25 Unearned Service Revenue 2,500 13,150
Apr. 30 Service Revenue 8,900 22,050
Apr. 30 Accounts Payable 900 21,150

Prepaid Insurance:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 13 Cash 1,650 1,650

Land:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 4 Cash 27,000 27,000

Accounts Payable:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 8 Advertising Expense 1,800 1,800
Apr. 30 Cash 900 900
Unearned Service Revenue:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 25 Cash 2,500 2,500

Owner’s Capital:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 1 Cash 35,000 35,000

Owner’s Drawings:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 17 Cash 1,000 1,000

Service Revenue:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 20 Cash 6,800 6,800
Apr. 30 Cash 8,900 15,700

Advertising Expense:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 8 Accounts Payable 1,800 1,800

Salaries and Wages Expense:

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 11 Cash 1,500 1,500
 3. Trial Balance:

April 30

Serial Accounts Ref. Debit Credit

1 Cash $ 21,150

2 Prepaid Insurance 1,650

3 Land 27,000

4 Accounts Payable $ 900

5 Unearned Service Revenue 2,500

6 Owner’s Capital 35,000

7 Owner’s Drawings 1,000

8 Service Revenue 15,700

9 Advertising Expense 1,800

10 Salaries and Wages Expense 1,500

$ 54,100 $ 54,100
Problem P2-2A:
Desiree Clark is a licensed CPA. During the first month of operations of her business, the
following events and transactions occurred.

May 1 Clark invested $20,000 cash in her business.

2 Hired a secretary-receptionist at a salary of $2,000 per month.
3 Purchased $2,500 of supplies on account from Read Supply Company.
7 Paid office rent of $900 cash for the month.
11 Completed a tax assignment and billed client $3,200 for services provided.
12 Received $3,500 advance on a management consulting engagement.
17 Received cash of $1,200 for services completed for C. Desmond Co.
31 Paid secretary-receptionist $2,000 salary for the month.
31 Paid 60% of balance due Read Supply Company.

Desiree uses the following chart of accounts: No. 101 Cash, No. 112 Accounts
Receivable, No. 126 Supplies, No. 201 Accounts Payable, No. 209 Unearned Service
Revenue, No. 301 Owner’s Capital, No. 400 Service Revenue, No. 726 Salaries and
Wages Expense, and No. 729 Rent Expense.

Instructions:
1. Journalize the transactions.
2. Post to the Ledger Accounts.
3. Prepare a Trial Balance on May 31.
Solution to P2-2A:
1. Journal

Date Particulars Ref. Debit Credit

May 1 Cash – Dr. 101 20,000
Owner’s Capital – Cr. 400 20,000
(Owner invested cash in the business)

May 3 Supplies – Dr. 126 2,500

Accounts Payable – Cr. 201 2,500
(Purchased supplies on account)

May 7 Rent Expense – Dr. 729 900

Cash – Cr. 101 900
(Paid office rent)

May 11 Accounts Receivable – Dr. 112 3,200

Service Revenue – Cr. 400 3,200
(Billed client for services provided)

May 12 Cash – Dr. 101 3,500

Unearned Service Revenue – Cr. 209 3,500
(Received payment for future services)

May 17 Cash – Dr. 101 1,200

Service Revenue – Cr. 400 1,200
(Received cash for services provided)

May 31 Salaries and Wages Expense – Dr. 726 2,000

Cash – Cr. 101 2,000
(Paid salaries)

May 31 Accounts Payable – Dr. 201 1,500

Cash – Cr. 101 1,500
(Paid creditor on account,
60% of $2,500 = $1,500)
 2. Ledger

Cash (Account No. 101):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
May 1 Owner’s Capital 400 20,000 20,000
May 7 Rent Expense 729 900 19,100
May 12 Unearned Service Revenue 209 3,500 22,600
May 17 Service Revenue 400 1,200 23,800
May 31 Salaries and Wages Expense 726 2,000 21,800
May 31 Accounts Payable 201 1,500 20,300

Accounts Receivable (Account No. 112):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
May 11 Service Revenue 400 3,200 3,200

Supplies (Account No. 126):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
May 3 Accounts Payable 201 2,500 2,500

Accounts Payable (Account No. 201):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
May 3 Supplies 126 2,500 2,500
May 31 Cash 101 1,500 1,000
Unearned Service Revenue (Account No. 209):
Balance
Date Particulars Ref. Debit Credit
Debit Credit
May 12 Cash 101 3,500 3,500

Owner’s Capital (Account No. 301):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
May 1 Cash 101 20,000 20,000

Service Revenue (Account No. 400):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
May 11 Accounts Receivable 112 3,200 3,200
May 17 Cash 101 1,200 4,400

Salaries and Wages Expense (Account No. 726):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
May 31 Cash 101 2,000 2,000

Rent Expense (Account No. 729):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
May 7 Cash 101 900 900
 3. Trial Balance

May 31

Serial Accounts Name Ref. Debit Credit

1 Cash 101 $ 20,300

2 Accounts Receivable 112 3,200

3 Supplies 126 2,500

4 Accounts Payable 201 $ 1,000

5 Unearned Service Revenue 209 3,500

6 Owner’s Capital 301 20,000

7 Service Revenue 400 4,400

8 Salaries and Wages Expense 726 2,000

9 Rent Expense 729 900

$ 28,900 $ 28,900
Problem P2-3A:
Jay Cutler owns and manages a computer repair service, which had the following trial
balance on December 31, 2011 (the end of its fiscal year).
MEGA REPAIR SERVICE
Trial Balance
December 31, 2011
Cash $ 8,000
Accounts Receivable 15,000
Supplies 13,000
Prepaid Rent 3,000
Equipment 20,000
Accounts Payable $ 19,000
Owner’s Capital 40,000
$59,000 $59,000

Summarized transactions for January 2012 were as follows.

1 Advertising costs, paid in cash, $1,000.
2 Additional supplies acquired on account $4,200.
3 Miscellaneous expenses, paid in cash, $2,000.
4 Cash collected from customers in payment of accounts receivable $14,000.
5 Cash paid to creditors for accounts payable due $15,000.
6 Supplies used during January $4,000.
7 Repair services performed during January: for cash $6,000; on account
$9,000.
8 Wages for January, paid in cash, $3,500.
9 Jay’s drawings during January were $3,000.

Instructions:
1. Prepare journal entries to record each of the January transactions.
2. Prepare Ledger Accounts for the month of January.
3. Prepare Trial Balance on January 31, 2012.
Solution to P2-3A:
1. Journal

Serial Particulars Ref. Debit Credit

1 Advertising Expense – Dr. 1,000

Cash – Cr. 1,000
(Paid for advertisement in cash)
2 Supplies – Dr. 4,200
Accounts Payable – Cr. 4,200
(Purchased supplies on account)
3 Miscellaneous Expense – Dr. 2,000
Cash – Cr. 2,000
(Paid for miscellaneous expenses in cash)
4 Cash – Dr. 14,000
Accounts Receivable – Cr. 14,000
(Cash collected in payment of accounts receivable)
5 Accounts Payable – Dr. 15,000
Cash – Cr. 15,000
(Paid creditor on accounts payable)
6 Supplies Expense – Dr. 4,000
Supplies – Cr. 4,000
(Supplies used during January)
7 Cash – Dr. 6,000
Accounts Receivable – Dr. 9,000
Service Revenue – Cr. 15,000
(Services performed for cash and on account)
8 Wages Expense – Dr. 3,500
Cash – Cr. 3,500
(Paid wages in cash)
9 Owner’s Drawings – Dr. 3,000
Cash – Cr. 3,000
(Owner’s Drawings during January)
 2. Ledger
Cash:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
Balance 8,000
1 Advertising Expense 1,000 7,000
3 Miscellaneous Expense 2,000 5,000
4 Accounts Receivable 14,000 19,000
5 Accounts Payable 15,000 4,000
7 Service Revenue 6,000 10,000
8 Wages Expense 3,500 6,500
9 Owner’s Drawings 3,000 3,500

Accounts Receivable:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
Balance 15,000
4 Cash 14,000 1,000
7 Cash 9,000 10,000

Supplies:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
Balance 13,000
2 Accounts Payable 4,200 17,200
6 Supplies Expense 4,000 13,200
Prepaid Rent:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
Balance 3,000

Equipment:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
Balance 20,000

Accounts Payable:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
Balance 19,000
2 Supplies 4,200 23,200
5 Cash 15,000 8,200

Owner’s Capital:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
Balance 40,000

Owner’s Drawings:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
9 Accounts Payable 3,000 3,000
Service Revenue:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
7 Cash 6,000 6,000
7 Accounts Receivable 9,000 15,000

Advertising Expense:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
1 Cash 1,000 1,000

Supplies Expense:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
6 Supplies 4,000 4,000

Wages Expense:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
8 Cash 3,500 3,500

Miscellaneous Expense:
Balance
Serial Particulars Ref. Debit Credit
Debit Credit
3 Cash 2,000 2,000
 3. Trial Balance
January 31, 2012

Serial Accounts Name Ref. Debit Credit

1 Cash $ 3,500

2 Accounts Receivable 10,000

3 Supplies 13,200

4 Prepaid Rent 3,000

5 Equipment 20,000

6 Accounts Payable $ 8,200

7 Owner’s Capital 40,000

8 Owner’s Drawings 3,000

9 Service Revenue 15,000

10 Advertising Expense 1,000

11 Supplies Expense 4,000

12 Wages Expense 3,500

13 Miscellaneous Expense 2,000

$ 63,200 $ 63,200
Problem P2-5A:
The Chicago Theater is owned by Rashied Davis. All facilities were completed on March
31, 2012. At this time, the ledger showed: No. 101 Cash $4,000, No. 140 Land $10,000,
No. 145 Buildings (concession stand, projection room, ticket booth, and screen) $8,000,
No. 157 Equipment $6,000, No. 201 Accounts Payable $2,000, No. 275 Mortgage
Payable $8,000, and No. 301 Owner’s Capital $18,000.
During April, the following events and transactions occurred.

Apr. 2 Paid film rental of $1,100 on first movie.

3 Ordered two additional films at $1,000 each.
9 Received $2,800 cash from admissions.
10 Made $2,000 payment on mortgage and $1,000 for accounts payable due.
11 Chicago Theater contracted with Virginia McCaskey to operate the
concession stand. McCaskey is to pay 17% of gross concession receipts
(payable monthly) for the rental of the concession stand.
12 Paid advertising expenses $500.
20 Received one of the films ordered on April 3 and was billed $1,000. The film
will be shown in April.
25 Received $5,200 cash from admissions.
29 Paid salaries $2,000.
30 Received statement from Virginia McCaskey showing gross concession
receipts of $1,000 and the balance due to The Chicago Theater of $170
($1,000 × 17%) for April. McCaskey paid one-half of the balance due and
will remit the remainder on May 5.
30 Prepaid $1,200 rentals on special film to be run in May.
In addition to the accounts identified above, the chart of accounts shows: No. 112
Accounts Receivable, No. 136 Prepaid Rent, No. 400 Service Revenue, No. 429 Rent
Revenue, No. 610 Advertising Expense, No. 726 Salaries and Wages Expense, and No.
729 Rent Expense.

Instructions:
a) Journalize the April transactions.
b) Post the April journal entries to the ledger.
c) Prepare a trial balance on April 30, 2012.
Solution to P2-5A:
a) Journal

Date Particulars Ref. Debit Credit

Apr. 2 Rent Expense – Dr. 729 1,000
Cash – Cr. 101 1,000
(Paid for film rental in cash)
Apr. 9 Cash – Dr. 101 4,200
Service Revenue – Cr. 400 4,200
(Received cash from admission services)
Apr. 10 Mortgage Payable – Dr. 275 2,000
Accounts Payable – Dr. 201 1,000
Cash – Cr. 101 3,000
(Made payment on mortgage and accounts
payable)
Apr. 12 Advertising Expense – Dr. 610 500
Cash – Cr. 101 500
(Paid advertising expenses)
Apr. 20 Rent Expense – Dr. 729 1,000
Accounts Payable – Cr. 201 1,000
(Rented film on account)
Apr. 25 Cash – Dr. 101 5,200
Service Revenue – Cr. 400 5,200
(Received cash from admission services)
Apr. 29 Salaries and Wages Expense – Dr. 726 2,000
Cash – Cr. 101 2,000
(Paid salaries)
Apr. 30 Cash – Dr. 101 85
Accounts Receivable – Dr. 112 85
Rent Revenue – Cr. 429 170
(Received rent revenue $1,000 × 17% = 170,
half in cash and half on account)
Apr. 30 Prepaid Rent – Dr. 136 1,200
Cash – Cr. 101 1,200
(Prepaid rentals for future films)
 b) Ledger
Cash (Account No. 101):
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Balance 4,000
Apr. 2 Rent Expense 729 1,000 3,000
Apr. 9 Service Revenue 400 4,200 7,200
Apr. 10 Mortgage Payable 275 2,000 5,200
Apr. 10 Accounts Payable 201 1,000 4,200
Apr. 12 Advertising Expense 610 500 3,700
Apr. 25 Service Revenue 400 5,200 8,900
Apr. 29 Salaries and Wages Expense 726 2,000 6,900
Apr. 30 Rent Revenue 429 85 6,985
Apr. 30 Prepaid Rent 136 1,200 5,785

Accounts Receivable (Account No. 112):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 30 Rent Revenue 429 85 85

Prepaid Rent (Account No. 136):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 30 Cash 101 1,200 1,200

Land (Account No. 140):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Balance 10,000
Buildings (Account No. 145):
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Balance 8,000

Equipment (Account No. 157):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Balance 6,000

Accounts Payable (Account No. 201):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Balance 2,000
Apr. 10 Cash 101 1,000 1,000
Apr. 20 Rent Expense 729 1,000 2,000

Mortgage Payable (Account No. 275):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Balance 8,000
Apr. 10 Cash 101 2,000 6,000

Owner’s Capital (Account No. 301):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Balance 18,000
Service Revenue (Account No. 400):
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 9 Cash 101 4,200 4,200
Apr. 25 Cash 101 5,200 9,400

Rent Revenue (Account No. 429):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 30 Cash 101 85 85
Apr. 30 Accounts Payable 112 85 170

Advertising Expense (Account No. 610):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 12 Cash 101 500 500

Salaries and Wages Expense (Account No. 726):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 29 Cash 101 2,000 2,000

Rent Expense (Account No. 729):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Apr. 2 Cash 101 1,000 1,000
Apr. 20 Accounts Payable 201 1,000 2,000
 c) Trial Balance

April 30, 2012

Serial Accounts Name Ref. Debit Credit

1 Cash 101 $ 5,785

2 Accounts Receivable 112 85

3 Prepaid Rent 136 1,200

4 Land 140 10,000

5 Buildings 145 8,000

6 Equipment 157 6,000

7 Accounts Payable 201 $ 2,000

8 Mortgage Payable 275 6,000

9 Owner’s Capital 301 18,000

10 Service Revenue 400 9,400

11 Rent Revenue 429 170

12 Advertising Expense 610 500

13 Salaries and Wages Expense 726 2,000

14 Rent Expense 729 2,000

$ 35,570 $ 35,570
Problem P2-1B:
Forte Disc Golf Course was opened on March 1 by Matt Forte. The following selected
events and transactions occurred during March.

Mar. 1 Invested $20,000 cash in the business.

3 Purchased Heeren’s Golf Land for $15,000 cash. The price consists of land
$12,000, shed $2,000, and equipment $1,000. (Make one compound entry)

5 Paid advertising expenses of $700.

6 Paid cash $600 for a one-year insurance policy.

10 Purchased golf discs and other equipment for $1,050 from Innova
Company payable in 30 days.

18 Received $1,100 in cash for golf fees earned (Forte records golf fees as
service revenue).

19 Sold 150 coupon books for $10 each. Each book contains 4 coupons that
enable the holder to play one round of disc golf.

25 Withdrew $800 cash for personal use.

30 Paid salaries of $250.

30 Paid Innova Company in full.

31 Received $2,100 cash for fees earned.

Matt Forte uses the following accounts: Cash, Prepaid Insurance, Land, Buildings,
Equipment, Accounts Payable, Unearned Service Revenue, Owner’s Capital, Owner’s
Drawings, Service Revenue, Advertising Expense, and Salaries and Wages Expense.
Requirements:
1. Prepare Journal for the month of March.
2. Prepare Ledger Accounts for the month of March.
3. Prepare Trial Balance for the month ending March.
 Solution to P2-1B:
1. Journal
Date Particulars Ref. Debit Credit
Mar. 1 Cash – Dr. 20,000
Owner’s Capital – Cr. 20,000
(Owner invested cash in the business)
Mar. 3 Land – Dr. 12,000
Buildings – Dr. 2,000
Equipment – Dr. 1,000
Cash – Cr. 15,000
(Purchased Golf Land for cash)
Mar. 5 Advertising Expense – Dr. 700
Cash – Cr. 700
(Paid cash for advertising expense)
Mar. 6 Prepaid Insurance – Dr. 600
Cash – Cr. 600
(Paid cash for one-year Insurance)
Mar. 10 Equipment – Dr. 1,050
Accounts Payable – Cr. 1,050
(Purchased equipment on account)
Mar. 18 Cash – Dr. 1,100
Service Revenue – Cr. 1,100
(Received cash for golf fees earned)
Mar. 19 Cash – Dr. 1,500
Unearned Service Revenue – Cr. 1,500
(Received cash for future services)
Mar. 25 Owner’s Drawings – Dr. 800
Cash – Cr. 800
(Owner withdrew cash)
Mar. 30 Salaries and Wages Expense – Dr. 250
Cash – Cr. 250
(Paid Salaries)
Mar. 30 Accounts Payable – Dr. 1,050
Cash – Cr. 1,050
(Paid creditor on account)
Mar. 31 Cash – Dr. 2,100
Service Revenue – Cr. 2,100
(Received cash for services performed)
 2. Ledger

Cash:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 1 Owner’s Capital 20,000 20,000
Mar. 3 Land 12,000 8,000
Mar. 3 Buildings 2,000 6,000
Mar. 3 Equipment 1,000 5,000
Mar. 5 Advertising Expense 700 4,300
Mar. 6 Prepaid Insurance 600 3,700
Mar. 18 Service Revenue 1,100 4,800
Mar. 19 Unearned Service Revenue 1,500 6,300
Mar. 25 Owner’s Drawings 800 5,500
Mar. 30 Salaries and Wages Expense 250 5,250
Mar. 30 Accounts Payable 1,050 4,200
Mar. 31 Service Revenue 2,100 6,300

Prepaid Insurance:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 6 Cash 600 600

Land:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 3 Cash 12,000 12,000
Buildings:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 3 Cash 2,000 2,000

Equipment:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 3 Cash 1,000 1,000
Mar. 10 Accounts Payable 1,050 2,050

Accounts Payable:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 10 Equipment 1,050 1,050
Mar. 30 Cash 1,050 0

Unearned Service Revenue:

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 19 Cash 1,500 1,500

Owner’s Capital:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 1 Cash 20,000 20,000
Owner’s Drawings:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 25 Cash 800 800

Service Revenue:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 18 Cash 1,100 1,100
Mar. 31 Cash 2,100 3,200

Advertising Expense:
Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 5 Cash 700 700

Salaries and Wages Expense:

Balance
Date Particulars Ref. Debit Credit
Debit Credit
Mar. 30 Cash 250 250
 3. Trial Balance
March 31

Serial Accounts Name Ref. Debit Credit

1 Cash $ 6,300

2 Prepaid Insurance 600

3 Land 12,000

4 Buildings 2,000

5 Equipment 2,050

6 Accounts Payable $0

7 Unearned Service Revenue 1,500

8 Owner’s Capital 20,000

9 Owner’s Drawings 800

10 Service Revenue 3,200

11 Advertising Expense 700

12 Salaries and Wages Expense 250

$ 24,700 $ 24,700
Problem 1:

P&C Hall is a licensed dentist. During the first month of the operation of her
business, the following events and transactions occurred.

April 1 Invested $20,000 cash in her business.

1 Hired a secretary-receptionist at a salary of $700 per week payable
monthly.
2 Paid office rent for the month $1,100.
3 Purchased dental supplies on account from Smile Company $4,000.
10 Provided dental services and billed insurance companies $5,100.
11 Received $1,000 cash advance from Trudy Borke for an implant.
20 Received $2,100 cash for services completed and delivered to John
Carl.
30 Paid secretary-receptionist for the month $2,800.
30 Paid $2,400 to Smile Company for accounts payable due.

P&C uses the following chart of accounts: No. 101 Cash, No. 112 Accounts
Receivable, No. 126 Supplies, No. 201 Accounts Payable, No. 209 Unearned
Service Revenue, No. 301 Owner’s Capital, No. 400 Service Revenue, No. 726
Salaries and Wages Expense, and No. 729 Rent Expense.

Instructions:
(a) Journalize the transactions.
(b) Post to the ledger accounts.
(c) Prepare a trial balance on April 30, 2012.
 Solution to 1:
(a) Journal

Date Particulars Ref. Debit Credit

April 1 Cash – Dr. 101 20,000
Owner’s Capital – Cr. 301 20,000
(Owner invested cash in the business)
April 2 Rent Expense – Dr. 729 1,100
Cash – Cr. 101 1,100
(Paid office rent)
April 3 Supplies – Dr. 126 4,000
Accounts Payable – Cr. 201 4,000
(Purchased supplies on account)
April 10 Accounts Receivable – Dr. 112 5,100
Service Revenue – Cr. 400 5,100
(Provided services on account)
April 11 Cash – Dr. 101 1,000
Unearned Service Revenue – Cr. 209 1,000
(Received cash for future services)
April 20 Cash – Dr. 101 2,100
Service Revenue – Cr. 400 2,100
(Received cash for services provided)
April 30 Salaries and Wages Expense – Dr. 726 2,800
Cash – Cr. 101 2,800
(Paid salary)
April 30 Accounts Payable – Dr. 201 2,400
Cash – Cr. 101 2,400
(Paid creditor on account)
 (b) Ledger

Cash Account (No. 101):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
April 1 Owner’s Capital 301 20,000 20,000
April 2 Rent Expense 729 1,100 18,900
April 11 Unearned Service Revenue 209 1,000 19,900
April 20 Service Revenue 400 2,100 22,000
Salaries and Wages
April 30 726 2,800 19,200
Expense
April 30 Accounts Payable 201 2,400 16,800

Accounts Receivable (No. 112):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
April 10 Service Revenue 400 5,100 5,100

Supplies (No. 126):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
April 3 Accounts Payable 201 4,000 4,000

Accounts Payable (No. 201):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
April 3 Supplies 126 4,000 4,000
April 30 Cash 101 2,400 1,600
Unearned Service Revenue (No. 209):
Balance
Date Particulars Ref. Debit Credit
Debit Credit
April 11 Cash 101 1,000 1,000

Owner’s Capital (No. 301):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
April 1 Cash 101 20,000 20,000

Service Revenue (No. 400):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
April 10 Accounts Receivable 112 5,100 5,100
April 20 Cash 101 2,100 7,200

Salaries and Wages Expense (No.726):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
April 30 Cash 101 2,800 2,800

Rent Expense (No.729):

Balance
Date Particulars Ref. Debit Credit
Debit Credit
April 2 Cash 101 1,100 1,100
 (c) Trial Balance

April 30, 2012

Serial Accounts Name Ref. Debit Credit

1 Cash 101 $ 16,800

2 Accounts Receivable 112 5,100

3 Supplies 126 4,000

4 Accounts Payable 201 $ 1,600

5 Unearned Service Revenue 209 1,000

6 Owner’s Capital 301 20,000

7 Service Revenue 400 7,200

8 Salaries and Wages Expense 726 2,800

9 Rent Expense 729 1,100

$ 29,800 $ 29,800
Financial Statement Analysis:
• Horizontal Analysis
• Vertical Analysis
• Ratio Analysis

Ratio Analysis:
Ratio analysis expresses the relationship among selected items of financial statement
data.

▪ A ratio expresses the mathematical relationship between one quantity and another.
The relationship is expressed in terms of either a percentage, a rate, or a simple
proportion.
▪ Ratios can provide clues to underlying conditions that may not be apparent from
individual financial statement components. However, a single ratio by itself is not very
meaningful. The following types of comparisons are used –
1. Intracompany comparisons.
2. Industry average comparisons.
3. Intercompany comparisons.

To analyze the primary financial statements, we can use ratios to evaluate liquidity,
profitability, and solvency.

1. Liquidity Ratios: Measure short-term ability of the company to pay its maturing
obligations and to meet unexpected needs for cash.
2. Profitability Ratios: Measure the income or operating success of a company for a
given period of time.
3. Solvency Ratios: Measure the ability of the company to survive over a long period
of time.
Liquidity Ratios:
Measure short-term ability of the company to pay its maturing obligations and to meet
unexpected needs for cash.

Short-term creditors such as bankers and suppliers are particularly interested in

assessing liquidity. The ratios that are used to determine a company’s short-term debt-
paying ability are the current ratio, the acid-test ratio, receivables turnover, and
inventory turnover.

Current Ratio: The current ratio is a widely used measure for evaluating a company’s
liquidity and short-term debt-paying ability.

𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐀𝐬𝐬𝐞𝐭𝐬
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬

▪ Standard: 2:1 → means the company has TK. 2 to pay TK. 1 current liability/debt.

1:1 → the company do not have enough money to run business operations.
0.5:1 → the company do not have enough money to pay current liabilities.
5:1 → the company could have invested the large amount of idol money.

▪ The current ratio is sometimes referred to as the working capital ratio.

Working Capital = Current Assets – Current Liabilities

▪ The current ratio is a more dependable indicator of liquidity than working capital.
Acid-test (Quick) Ratio: The acid-test (quick) ratio is a measure of a company’s immediate
short-term liquidity.

𝐐𝐮𝐢𝐜𝐤 𝐀𝐬𝐬𝐞𝐭𝐬
𝐀𝐜𝐢𝐝 𝐭𝐞𝐬𝐭 (𝐐𝐮𝐢𝐜𝐤) 𝐑𝐚𝐭𝐢𝐨 =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬

▪ Standard: 1:1

Cash & Bank

Accounts Receivable Quick Assets/More Liquid
Current Assets/Liquid Assets
Short Investments
Inventory
Prepaid Expense

▪ Cash, short-term investments, and receivables (net) are highly liquid compared to
inventory and prepaid expenses. The inventory may not be readily saleable, and the
prepaid expenses may not be transferable to others. Thus, the acid-test ratio
measures immediate liquidity.

The formula can be rewritten as –

𝐂𝐚𝐬𝐡 + 𝐒𝐡𝐨𝐫𝐭 𝐭𝐞𝐫𝐦 𝐈𝐧𝐯𝐞𝐬𝐭𝐦𝐞𝐧𝐭𝐬 + 𝐑𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞 (𝐍𝐞𝐭)

𝐀𝐜𝐢𝐝 𝐭𝐞𝐬𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐂𝐮𝐫𝐫𝐞𝐧𝐭 𝐋𝐢𝐚𝐛𝐢𝐥𝐢𝐭𝐢𝐞𝐬
Receivables Turnover: The ratio used to assess the liquidity of the receivables is
receivables turnover. It measures the number of times, on average, the company
collects receivables during the period.

𝐍𝐞𝐭 𝐂𝐫𝐞𝐝𝐢𝐭 𝐒𝐚𝐥𝐞𝐬

𝐑𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞𝐬 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐍𝐞𝐭 𝐑𝐞𝐜𝐞𝐢𝐯𝐚𝐛𝐥𝐞𝐬

Net Credit Sales = Net Sales – Cash Sales

▪ If the question doesn’t mention Credit Sales or Cash Sales amount, then assume that
all sales are credit sales.
▪ Receivables Turnover measures liquidity by how quickly a company can convert
certain assets (the receivables) to cash. [How liquid are the receivables?]
▪ If in any ratio, the term “turnover” is mentioned, then we use the word “times”.
For example, if the receivables turnover ratio is 10.2 times, then this means that the
receivables are collected, on average, 10.2 times in a year.

▪ Average Collection Period: A popular variant of the receivables turnover ratio is to

convert it to an average collection period in terms of days.

𝟑𝟔𝟓
→ to convert the average collection period in terms of days.
𝐧 𝐭𝐢𝐦𝐞𝐬

For example, the receivable turnover (say) 10.2 times converted into an average
𝟑𝟔𝟓
collection period in terms of days gives = 36 days (approximately). This means
𝟏𝟎.𝟐
𝟓𝟐
that receivables are collected on average every 36 days, or about every ( =) 5
𝟏𝟎.𝟐

weeks.
▪ There is no standard value for Receivables Turnover [comparisons are made with
competitors and/or industry average].
▪ Analysts frequently use the average collection period to assess the effectiveness of a
company’s credit and collection policies. The general rule is that the collection period
should not greatly exceed the credit term period (the time allowed for payment).

Example: Opening A/R = 316,000; Ending A/R = 384,000; Net Credit Sales = 3,500,000.

𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠

𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑔. 𝐴/𝑅
3,500,000
= = 10 𝑡𝑖𝑚𝑒𝑠.
(316,000 + 384,000)/2

Remarks: Accounts receivables are collected, on average, 10 times in a year, or

365
Accounts receivables are collected, on average, every ( =) 36 days (approximately).
10

Accounts Payable Turnover: The accounts payable turnover ratio measures the rate at
which a company pays back its creditors or suppliers that extend lines of credit.

𝐍𝐞𝐭 𝐂𝐫𝐞𝐝𝐢𝐭 𝐏𝐮𝐫𝐜𝐡𝐚𝐬𝐞𝐬

𝐀𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐏𝐚𝐲𝐚𝐛𝐥𝐞 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐜𝐜𝐨𝐮𝐧𝐭𝐬 𝐏𝐚𝐲𝐚𝐛𝐥𝐞

▪ Accounts payable are short-term debt that a company owes to its suppliers and
creditors. The accounts payable turnover ratio shows how efficient a company is at
paying its suppliers and short-term debts.
Inventory Turnover: Inventory turnover measures the number of times, on average, the
inventory is sold during the period. Its purpose is to measure the liquidity of the
inventory. The inventory turnover is computed by.

𝐂𝐎𝐆𝐒
𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐈𝐧𝐯𝐞𝐧𝐭𝐨𝐫𝐲

▪ There is no standard for Inventory Turnover [compared with the industry average
and/or competitors].
▪ Generally, the faster the inventory turnover, the less cash a company has tied up in
inventory and the less the chance of inventory obsolescence.
▪ Inventory Turnover measures liquidity by how fast a company can convert certain
assets (the inventories) to cash. [How liquid are the inventories?]
𝟑𝟔𝟓
▪ Days in Inventory: Calculated by .
𝒏 𝒕𝒊𝒎𝒆𝒔

For example, a company’s inventory turnover of (say) 2.3 times means an average
365
selling time/period of = 159 days (approximately).
2.3

▪ Inventory turnover ratios vary considerably among industries.

For example, grocery store chains have a turnover of 17.1 times and an average selling
period of 21 days. In contrast, jewelry stores have an average turnover of 0.80 times
and an average selling period of 456 days.

▪ High Inventory Turnover Business → High-volume Business.

▪ Low Inventory Turnover Business → Low-volume Business.
 COGS = Opening Inventory + Cost of Goods Purchased (COGP) – Closing Inventory

Cost of Goods Available for Sales = Opening Inventory + COGP

Example: Opening Inventory = 25,000; Closing Inventory = 30,000; Cost of Goods

Purchased (COGP) = 245,000.

𝐶𝑂𝐺𝑆 = 25,000 + 245,000 − 30,000 = 240,000.

25,000 + 30,000
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = = 27,500.
2
𝐶𝑂𝐺𝑆 240,000
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 = = = 8.73 𝑡𝑖𝑚𝑒𝑠.
𝐴𝑣𝑔. 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 27,500

Remarks: On average, the inventory is sold 8.73 times in a year, or an average

365
selling period is ( =) 41.8 days, or almost 6 weeks.
8.73

Profitability Ratios:
Income, or the lack of it, affects the company’s ability to obtain debt and equity
financing. It also affects the company’s liquidity position and the company’s ability to
grow. Therefore, both creditors and investors are interested in evaluating profitability.
Analysts frequently use profitability as the ultimate test of management’s operating
effectiveness.
Profit Margin: Profit margin is a measure of the percentage of each dollar of sales that
results in net income.

𝐍𝐞𝐭 𝐈𝐧𝐜𝐨𝐦𝐞
𝐏𝐫𝐨𝐟𝐢𝐭 𝐌𝐚𝐫𝐠𝐢𝐧 =
𝐍𝐞𝐭 𝐒𝐚𝐥𝐞𝐬

▪ Net Income → Net Profit.

▪ Profit margin is also called the Rate of Return on Sales.
▪ There is no standard for Profit Margin; the higher the better. [comparisons are made
with industry average and/or competitors].
▪ High-volume (high inventory turnover) businesses, such as grocery stores and
discount stores, generally experience low profit margins. In contrast, low-volume
businesses, such as jewelry stores or airplane manufacturers, have high profit
margins.
For example, Boeing Co. (airplane manufacturer), a low-volume business, has higher
profit margin than Wal-Mart, a high-volume business.

Asset Turnover: Asset turnover measures how efficiently a company uses its assets to
generate sales.

𝐍𝐞𝐭 𝐒𝐚𝐥𝐞𝐬
𝐀𝐬𝐬𝐞𝐭 𝐓𝐮𝐫𝐧𝐨𝐯𝐞𝐫 =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐬𝐬𝐞𝐭𝐬

▪ The resulting number shows the total assets that are used to create sales revenue.
▪ There is no standard value for Asset Turnover; the higher the better [comparisons are
made with industry average and/or competitors].
▪ Asset turnover ratios vary considerably among industries.
For example, a large utility company like Consolidated Edison (New York) has a ratio
of 0.40 times, and the large grocery chain Kroger Stores has a ratio of 3.4 times.
Return on Assets: An overall measure of profitability is return on assets.

𝐍𝐞𝐭 𝐈𝐧𝐜𝐨𝐦𝐞
𝐑𝐞𝐭𝐮𝐫𝐧 𝐨𝐧 𝐀𝐬𝐬𝐞𝐭𝐬 =
𝐀𝐯𝐞𝐫𝐚𝐠𝐞 𝐀𝐬𝐬𝐞𝐭𝐬

▪ No standard value; the higher the better.

Payout Ratio: The payout ratio measures the percentage of earnings distributed in the
form of cash dividends.

𝐂𝐚𝐬𝐡 𝐃𝐢𝐯𝐢𝐝𝐞𝐧𝐝𝐬
𝐏𝐚𝐲𝐨𝐮𝐭 𝐑𝐚𝐭𝐢𝐨 =
𝐍𝐞𝐭 𝐈𝐧𝐜𝐨𝐦𝐞

▪ There is no standard value for Payout Ratio.

▪ Companies that have high growth rates generally have low payout ratios because they
reinvest most of their net income into the business.

Solvency Ratios:
Solvency ratios measure the ability of a company to survive over a long period of time.
Long-term creditors and stockholders are particularly interested in a company’s ability
to pay interest as it comes due and to repay the face value of debt at maturity.

Debt to Total Assets Ratio: The debt to total assets ratio measures the percentage of the
total assets that creditors provide.

𝐓𝐨𝐭𝐚𝐥 𝐃𝐞𝐛𝐭
𝐃𝐞𝐛𝐭 𝐭𝐨 𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬 𝐑𝐚𝐭𝐢𝐨 =
𝐓𝐨𝐭𝐚𝐥 𝐀𝐬𝐬𝐞𝐭𝐬

▪ Standard: Between 40% to 50%.

▪ Total Debt → Total Liabilities → Current + Long-term Liabilities.
▪ This ratio indicates the company’s degree of leverage.
▪ It also provides some indication of the company’s ability to withstand losses without
impairing the interests of creditors [How solvent is the company?].
▪ The higher the percentage of debt to total assets, the greater the risk, that the
company may not be able to meet its maturing obligations.
▪ The lower the ratio, the more equity “buffer” there is available to the creditors.
Thus, from the creditors’ point of view, a low ratio of debt to total assets is usually
desirable.
▪ The adequacy of this ratio is often judged in the light of the company’s earnings.
Generally, companies with relatively stable earnings have higher debt to total assets
ratios than cyclical companies with widely fluctuating earnings.

Times Interest Earned: Times interest earned provides an indication of the company’s
ability to meet interest payments as they come due.

𝐈𝐧𝐜𝐨𝐦𝐞 𝐛𝐞𝐟𝐨𝐫𝐞 𝐈𝐧𝐜𝐨𝐦𝐞 𝐓𝐚𝐱𝐞𝐬 𝐚𝐧𝐝 𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐄𝐱𝐩𝐞𝐧𝐬𝐞

𝐓𝐢𝐦𝐞𝐬 𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐄𝐚𝐫𝐧𝐞𝐝 =
𝐈𝐧𝐭𝐞𝐫𝐞𝐬𝐭 𝐄𝐱𝐩𝐞𝐧𝐬𝐞

▪ Times interest earned is also called Interest Coverage.

▪ A high ratio means that a company is able to meet its interest obligations because
earnings are significantly greater than annual interest obligations.
For Example, if a company’s times interest earned ratio is 10, it means that the
company's income is 10 times greater than its annual interest expense.
At the same time, if the times interest earned ratio is too high, it could indicate to
investors that the company is overly risk averse. Although it's not racking up debt, it
is not using its income to re-invest back into business development.
Summary of Ratios:
Problem 1:
The condensed financial statements of John Cully Company, for the years ended June 30,
2012 and 2011, are presented below.
Solution 1:
Problem 2:

Asset Taka Liabilities Taka

Fixed Asset 435,000 Owner’s Capital 480,000

Inventory 75,000 Long term loan 60,000

Accounts
45,000 Accounts Payable 50,000
Receivable
Notes Receivables 25,000 Salary Payable 10,000

Cash & Bank 20,000

Total 600,000 Total 600,000

Calculate:
1. Current Ratio. 2. Acid-Test Ratio.
3. Debt to Asset Ratio. 4. Debt to Equity Ratio.

Solution 2:
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑠𝑡𝑠
𝟏. 𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 + 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 + 𝑁𝑜𝑡𝑒𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 + 𝐶𝑎𝑠ℎ & 𝐵𝑎𝑛𝑘
=
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 + 𝑆𝑎𝑙𝑎𝑟𝑦 𝑃𝑎𝑦𝑎𝑏𝑙𝑒
75,000 + 45,000 + 25,000 + 20,000
=
50,000 + 10,000
= 𝟐. 𝟕𝟓 ∶ 𝟏
𝑄𝑢𝑖𝑐𝑘 𝐴𝑠𝑠𝑒𝑡𝑠
𝟐. 𝐴𝑐𝑖𝑑 𝑇𝑒𝑠𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 + 𝑁𝑜𝑡𝑒𝑠 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒 + 𝐶𝑎𝑠ℎ & 𝐵𝑎𝑛𝑘
=
𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 + 𝑆𝑎𝑙𝑎𝑟𝑦 𝑃𝑎𝑦𝑎𝑏𝑙𝑒
45,000 + 25,000 + 20,000
=
50,000 + 10,000
= 𝟏. 𝟓 ∶ 𝟏
 𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
𝟑. 𝐷𝑒𝑏𝑡 𝑡𝑜 𝐴𝑠𝑠𝑒𝑡 𝑅𝑎𝑡𝑖𝑜 =
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
𝐿𝑜𝑛𝑔 𝑡𝑒𝑟𝑚 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝐴𝑐𝑐𝑜𝑢𝑛𝑡𝑠 𝑃𝑎𝑦𝑎𝑏𝑙𝑒 + 𝑆𝑎𝑙𝑎𝑟𝑦 𝑃𝑎𝑦𝑎𝑏𝑙𝑒
=
𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠
60,000 + 50,000 + 10,000
=
600,000
= 𝟐𝟎%
𝑇𝑜𝑡𝑎𝑙 𝐷𝑒𝑏𝑡
𝟒. 𝐷𝑒𝑏𝑡 𝑡𝑜 𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 =
𝑂𝑤𝑛𝑒𝑟 ′ 𝑠 𝐸𝑞𝑢𝑖𝑡𝑦
60,000 + 50,000 + 10,000
=
480,000
= 𝟐𝟓%

Problem 3:
Net Sales 210,000, Gross Profit 42,000, Operating Expense 8,400, Opening Inventory
16,000, and Closing Inventory 32,000.

Calculate:
A. Profit Margin Ratio. B. Inventory Turnover Ratio (in both time & days)

Solution 3:
𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡 𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡 − 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐸𝑥𝑝𝑒𝑛𝑠𝑒
𝐀. 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 𝑅𝑎𝑡𝑖𝑜 = =
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠 𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
42,000 − 8,400
=
210,000

= 𝟏𝟔%

𝐶𝑂𝐺𝑆 ?
𝐁. 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 = = =?
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 16,000 + 32,000
2
Problem 4:
Debt to Equity Ratio is 2:7. If total liabilities are 140,000, what will be the total asset?

Solution 4:
𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
𝐷𝑒𝑏𝑡 𝑡𝑜 𝐸𝑞𝑢𝑖𝑡𝑦 𝑅𝑎𝑡𝑖𝑜 =
𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

2 140,000
𝑂𝑟, =
7 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

∴ 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦 = 490,000

𝐴𝑔𝑎𝑖𝑛, 𝑇𝑜𝑡𝑎𝑙 𝐴𝑠𝑠𝑒𝑡𝑠 = 𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠 + 𝑇𝑜𝑡𝑎𝑙 𝐸𝑞𝑢𝑖𝑡𝑦

= 140,000 + 490,000 = 𝟔𝟑𝟎, 𝟎𝟎𝟎

Problem 5:
Financial Statements for Andrew Industries for 2016 are shown below:
2016 2015
Assets
Cash $ 600 $ 500
Accounts Receivable 600 400
Inventory 800 600
Property, Plant and Equipment 2,000 2,100

$ 4,000 $ 3,600

Liabilities and Shareholder’s Equity

Current Liabilities 1,100 850
Bonds Payable 1,400 1,400
Paid in Capital 600 600
Retained Earnings 900 750

$ 4,000 $ 3,600
Calculate the Following Ratios for 2016:
1. Inventory Turnover Ratio 5. Asset Turnover Ratio
2. Average days in inventory 6. Profit margin on Sales
3. Receivables Turnover Ratio 7. Return on Assets
4. Average Collection Period 8. Return on Shareholders’ Equity

Solution 5:
𝐶𝑂𝐺𝑆
𝟏. 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦

?
= =? ?
800 + 600
2

365
𝟐. 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑦𝑠 𝑖𝑛 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = =? ? ? 𝑑𝑎𝑦𝑠
??
𝑁𝑒𝑡 𝐶𝑟𝑒𝑑𝑖𝑡 𝑆𝑎𝑙𝑒𝑠
𝟑. 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑁𝑒𝑡 𝑅𝑒𝑐𝑒𝑖𝑣𝑎𝑏𝑙𝑒𝑠

?
= =? ?
600 + 400
2

365
4. 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐶𝑜𝑙𝑙𝑒𝑐𝑡𝑖𝑜𝑛 𝑃𝑒𝑟𝑖𝑜𝑑 = =? ? ? 𝑑𝑎𝑦𝑠
??
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
𝟓. 𝐴𝑠𝑠𝑒𝑡 𝑇𝑢𝑟𝑛𝑜𝑣𝑒𝑟 𝑅𝑎𝑡𝑖𝑜 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑠𝑠𝑒𝑡𝑠

?
= =? ?
4,000 + 3,600
2

𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝟔. 𝑃𝑟𝑜𝑓𝑖𝑡 𝑀𝑎𝑟𝑔𝑖𝑛 𝑜𝑛 𝑆𝑎𝑙𝑒𝑠 =
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
900
= =? ?
?
 𝑁𝑒𝑡 𝑃𝑛𝑐𝑜𝑚𝑒
7. 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝐴𝑠𝑠𝑒𝑡𝑠 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐴𝑠𝑠𝑒𝑡𝑠

900
= = 𝟐𝟑. 𝟔𝟖% ?
4,000 + 3,600
2

𝐷𝑖𝑣𝑖𝑑𝑒𝑛𝑑𝑠
8. 𝑅𝑒𝑡𝑢𝑟𝑛 𝑜𝑛 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟 ′ 𝑠 𝐸𝑞𝑢𝑖𝑡𝑦 =
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑆ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟 ′ 𝑠 𝐸𝑞𝑢𝑖𝑡𝑦

?
= = ??
600 + 600
2

Problem 6:
A credit analyst is evaluating the solvency of Alcatel as of the beginning of 2015. The
following data are gathered from the company’s 2015 annual report (in € millions):

2014 2013
Assets
Total Equity 4,389 4,038
Accrued Pension 1,144 1,010
Other Reserves 2,278 3,049
Total Financial Debt 4,359 5,293
Other Liabilities 6,867 7,742
Total Assets 19,037 21,132

The analyst concludes that, as used by Alcatel in its 2005 annual report, “total financial
debt” consists of noncurrent debt and the interest-bearing, borrowed portion of current
liabilities.
i. Calculate the company’s financial leverage ratio for 2014.
ii. Interpret the financial leverage ratio calculated in requirement i.
iii. What are the company’s debt-to-assets, debt-to-capital, and debt-to-equity ratios
for the two years?
iv. Is there any discernable trend over the two years?
Solution 6:

Problem 7:
Rondo Corporation’s comparative balance sheets are presented below:
2017 2016
Assets
Cash $ 5,300 $ 3,700
Accounts Receivable 21,200 23,400
Inventory 9,000 7,000
Land 20,000 26,000
Buildings 70,000 70,000
Accumulated Depreciation – Buildings (15,000) (10,000)
Total $ 110,500 $ 120,100
Liabilities & Shareholder’s Equity:
Accounts Payable $ 10,370 $ 31,100
Common Stock 75,000 69,000
Retained Earnings 25,130 20,000
Total $ 110,500 $ 120,100

Rondo’s 2017 income statement included net sales of $120,000, cost of goods sold of
$70,000, and net income of $14,000.

Compute the following ratios for 2017:

(1) Current ratio. (2) Quick ratio.

(3) Accounts receivable turnover. (4) Inventory turnover.
(5) Profit margin. (6) Return on common stockholders’
equity.
(7) Asset turnover. (8) Return on assets.
(9) Return on common stockholders’ (10) Debt to Assets ratio.
equity.
Solution 7:

Problem 7:
External Audit Opinions:
Audit Process: An audit process is a review of the financial affairs of the business. The
purpose of the review is to allow an independent person usually a qualified or certified
auditor to express an opinion on the correctness and fairness of the presented financial
statements.

What is an audit opinion?

An auditor’s opinion is a certification that accompanies the financial statements. This

certification provides a summarized picture to the users of the financial statements that
the presented financial statements are indeed, a true and fair reflection of the financial
affairs of the business.

Kinds of audit opinion:

There are four types of audit opinions that an auditor can provide in his/her audit report:

1. Unqualified Audit Opinion, 2. Qualified Audit Opinion,

3. Disclaimer of Audit Opinion, 4. Adverse Audit Opinion.

1. Unqualified Opinion: An unqualified audit opinion is an audit report that is issued

when an auditor determines that each of the financial records provided by the business
is free of any material misrepresentations. An unqualified audit opinion is often referred
to as a clean audit opinion. This is the best type of audit opinion that a business can
receive.

2. Qualified Opinion: A qualified audit opinion is an audit report that is issued when an
auditor is not confident about the process or the transaction, that prevents them from
issuing an unqualified or clean audit opinion. This is when an auditor makes a conclusion
after the audit process that the financial statements are materially misstated and further
concludes that such misstatements are not pervasive.
3. Disclaimer of Opinion: In the event of the auditor is unable to complete the audit
report either due to the absence of financial records or insufficient cooperation from
management the auditor issues a disclaimer of opinion. This is referred to as scope
limitation and indicates that an auditor distance themselves from providing any opinion
related to the financial statements. In a way, a disclaimer of opinion is not an opinion
itself.

4. Adverse Opinion: An adverse opinion is issued when an auditor concludes that the
financial statements are materially misstated, and material errors are pervasive. It may
indicate that there are also irregularities in the financial affairs of the business. This type
of opinion is a red flag and communicates that the financial statements should not be
relied on.

In conclusion, the audit opinion is very important for the stakeholders because it lets
them know whether or not the information in the financial statements is correct, and
whether or not the financial statements can be relied on for decision making.