Basic Accounting Flashcards
(9 cards)
Taft Corp., which began business on January 1, year 1, appropriately uses the installment sales method of accounting. The following data are available for December 31, year 1 and year 2.
Balance of deferred
gross profit on
sales account Year 1 Year 2
Year 1 $300,000 $120,000
Year 2 - 440,000
Gross profit on sales 30% 40%
The installment accounts receivable balance at December 31, year 2, is
$1,500,000
When using the installment sales method, the balance of the deferred gross profit account represents the gross profit not yet recognized because the related receivable has not yet been collected. The formula below expresses this relationship.
Deferred GP = GP rate × Accounts Receivable
This equation can be rearranged as follows:
Deferred GP / GP rate = Accounts Receivable
Therefore, the installment accounts receivable balance at 12/31/Y2 can be computed as follows:
From year 1 sales:
$120,000 / 30% = $ 400,000
From year 2 sales: $440,000 / 40% = 1,100,000
Total $1,500,000
Sanni Co. had $150,000 in cash-basis pretax income for the year. At the current year-end, accounts receivable decreased by $20,000 and accounts payable increased by $16,000 from their previous year-end balances. Compared to the accrual-basis method of accounting, Sanni’s cash-basis pretax income is
Higher by $36,000
On November 1, year 2, Key Co. paid $3,600 to renew its insurance policy for 3 years and used an income statement account to record this transaction. At December 31, year 2, Key’s unadjusted trial balance showed a balance of $90 for prepaid insurance and $4,410 for insurance expense. What amounts should be reported for prepaid insurance and insurance expense in Key’s December 31, year 2 financial statements?
Prepaid insurance Insurance expense
3,400 1,100
This answer is correct. Based on the information given, Key has only one prepaid insurance policy at 12/31/Y2. The 3-year policy acquired on 11/1/Y2 has been in force for 2 months, so 34 months remain unexpired. Therefore, 12/31/Y2 prepaid insurance is $3,400 ($3,600 x 34/36). Key must make an adjusting entry to transfer $3,310 ($3,400 – $90) from insurance expense to prepaid insurance. This will leave the account balances at $3,400 for prepaid insurance ($90 + $3,310) and $1,100 for insurance expense ($4,410 – $3,310). (Apparently, Key Co. records policy payments as charges to insurance expense during the year and adjusts the prepaid insurance account at the end of the year.)
Deb Co. records all sales using the installment method of accounting. Installment sales contracts call for 36 equal monthly cash payments. According to the FASB’s conceptual framework, the amount of deferred gross profit relating to collections 12 months beyond the balance sheet date should be reported in the
Current asset section as a contra account.
Ott Company acquired rights to a patent from Grey under a licensing agreement that required an advance royalty payment when the agreement was signed. Ott remits royalties earned and due under the agreement on October 31 each year. Additionally, on the same date, Ott pays, in advance, estimated royalties for the next year. Ott adjusts prepaid royalties at year-end. Information for the year ended December 31, year 2, is as follows:
Date Amount
01/01/Y2 Prepaid royalties $ 65,000
10/31/Y2 Royalty payment (charged to royalty expense) 110,000
12/31/Y2 Year-end credit adjustment to royalty expense 25,000
In its December 31, year 2 balance sheet, Ott should report prepaid royalties of
90,000
This answer is correct. On 1/1/Y2, the balance of prepaid royalties was $65,000. Ott makes no entries to this account until year-end, so the 12/31/Y2 balance before adjustment was still $65,000. On 10/31/Y2, Ott made a $110,000 royalty payment which included payment in advance for year 3 royalties. However, under Ott’s system, all such payments are debited to royalty expense when paid, and any necessary adjustments to prepaid royalties are made at year-end. At 12/31/Y2, Ott made a credit adjustment to royalty expense:
Prepaid royalties 25,000
Royalty expense 25,000
Therefore, the 12/31/Y2 balance of prepaid royalties is $90,000 ($65,000 + $25,000).
Young & Jamison’s modified cash-basis financial statements indicate cash paid for operating expenses of $150,000, end-of-year prepaid expenses of $15,000, and accrued liabilities of $25,000. At the beginning of the year, Young & Jamison had prepaid expenses of $10,000, while accrued liabilities were $5,000. If cash paid for operating expenses is converted to accrual-basis operating expenses, what would be the amount of operating expenses?
165,000
The cash paid for operating expenses is $150,000. Because prepaid expenses increased by $5,000 (end of year of $15,000 less beginning of year $10,000), this amount is not included in accrual-basis expenses. The accrued liabilities increased from $5,000 at beginning of the year to $25,000 at the end of the year, indicating that an additional $20,000 of liabilities were incurred and not yet paid. To convert to accrual-basis operating expenses, the cash paid of $150,000 is adjusted by subtracting the increase in the prepaid expense account, and adding the increase in accrued liabilities. ($150,000 – 5,000 + 20,000 = $165,000).
Lane Company acquires copyrights from authors, paying advance royalties in some cases, and in others, paying royalties within 30 days of year-end. Lane reported royalty expense of $375,000 for the year ended December 31, year 3. The following data are included in Lane’s December 31 balance sheets:
Year 2 Year 3
Prepaid royalties $60,000 $50,000
Royalties payable 75,000 90,000
During year 3 Lane made royalty payments totaling
350,000
On December 31, year 1, Reed, Inc. authorized Foy to operate as a franchisee for an initial franchise fee of $75,000. Of this amount, $30,000 was received upon signing the agreement and the balance, represented by a note, is due in three annual payments of $15,000 each beginning December 31, year 2. The present value on December 31, year 1, of the three annual payments appropriately discounted is $36,000. According to the agreement, the nonrefundable down payment represents a fair measure of the services already performed by Reed; however, substantial future services are required of Reed. Collectibility of the note is reasonably certain. On December 31, year 1, Reed should record unearned franchise fees in respect of the Foy franchise of
36,000
This answer is correct. Franchise fee revenue shall be recognized when all material services have been substantially performed by the franchisor (i.e., the franchisor has no remaining obligation to refund any cash received and substantially all of the initial services of the franchisor have been performed). Of the initial fee of $75,000, the $30,000 down payment applies to the initial services already performed by Reed. Additionally, this amount is not refundable. Therefore, the $30,000 may be recognized as revenue in year 1. The three remaining $15,000 installments relate to substantial future services to be performed by Reed. The present value of these payments, $36,000, is recorded as unearned fees and recognized as revenue once substantial performance has occurred.
Cash 30,000
Notes Receivable 45,000
Discount on NR 9,000
Franchise revenue 30,000
Unearned franchise fees 36,000
Which of the following is an example of the expense recognition principle of associating cause and effect?
Sales commissions.
