Learning Questions and Answers for Financial Accounting, Lesson 4.2 – Mastery Level

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1

When I teach Introduction to Financial Accounting to a live class, I always believe transactional analysis is a vitally important topic for my students to learn. Consequently, one day in class, I put the students into groups of two and ask them to read the following information and determine what accounts are affected by each transaction and whether each change is an increase or a decrease. When the students can get 80 or 90 percent of these transactions correct, then I am comfortable with them moving forward. Try these same transactions and see how well you can do. In preparation, make sure you have spent an adequate amount of time on the first two sections of Chapter Four in the textbook.

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Assume that Ace Paint Company starts operations on January 1, Year One. The company sells paint (inventory) but also paints houses (a service). The company does not do much work during Year One. At the start of Year Two, the company has a cash balance of $40,000. It also has a contributed capital balance of $30,000, and a retained earnings balance of $10,000. For simplicity, let’s assume those are the only account balances at the start of the second year. I assume you know that the $10,000 retained earnings balance includes all the revenues, expenses, and dividends for all previous years (which, in this case, is only Year One).

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Ace Paint Company has the following transactions during the second year. For each of these transactions, tell me what accounts (if any) go up and what accounts go down. Remember that at least two accounts must be affected by every transaction.

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1 – New owners put in another $20,000 of their own cash into the business to buy more new shares of the ownership (the company’s capital stock). For this question and the ones that follow indicate what accounts changed and whether they went up or down. 2 – The company buys $30,000 in inventory on credit with payment to be made in a few weeks. 3 – The company buys a parcel of land for $10,000 in cash. 4 – The company performs painting services for $19,000 with cash of $5,000 collected then and the remaining $14,000 to be collected later. All the required work is completed.

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5 – The company has rented a building for a total of $3,000 during the previous three months. No payment has yet been made. For this type of expense, the company’s accounting system records the expense immediately as it occurs (let’s assume that after each day, the computer system automatically makes a recording of the small amount for that day – computers can do that without complaining. Read this carefully – you can understand what it says.). 6. The company now pays the first $2,000 of the $3,000 in rent owed in (5).

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7 – The company’s employees worked for the previous two months and earned $4,000 but no payment has yet been made. For this type of expense, the company does not record any expense UNTIL payment is made (or until financial statements are prepared if that happens before the payment is made). (In 5 and 7, I’m demonstrating the two different ways that companies do these kinds of events. These are known as “accrued” expenses – they grow over time. You can record them as they grow [as in 5] or you can do nothing and wait until payment is made or financial statements are prepared [as in 7].)

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8 – The company now pays all of the salaries in (7). 9 – Cash of $5,000 is collected from the sale in (4) above with the rest to come in later. 10 – Cash of $13,000 is paid on the amount owed on the inventory bought in number (2) above. 11 – The company sells 60 percent of the inventory that it bought in number (2). The sale is made on credit for $33,000.

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12 – Company issues a $4,000 cash dividend to the company’s owners as a reward for a successful year of operations. 13 – The company buys a truck for $70,000. It pays $30,000 in cash and signs a long-term note for the remainder. 14 – The company sells 80 percent of the land that was bought in (3) above for 15,000 in cash. Hint: this is not inventory like in (11) above so you don’t use two separate entries but rather just one – increase what you got, decrease what you gave up, and the difference is either a gain (you got more than you gave up) or a loss (you got less than you gave up).

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15 – Assume we have gotten to the end of the fiscal year and the company wants to make financial statements. Can you do that?

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Now, you have the chance to see how you did. Once you can get 80-90 percent correct, then you are doing great and should be ready to move on.

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1 – New owners put in another $20,000 of their own cash into the business in order to buy more new shares of the ownership (the company’s capital stock). For this question and the ones that follow indicate what accounts changed and whether they went up or down.

Cash goes up $20,000 (from $40,000 to $60,000). Contributed capital (or capital stock) goes up $20,000 (from $30,000 to $50,000).

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2 – The company buys $30,000 in inventory on credit with payment to be made in a few weeks.

Inventory goes up $30,000 (to $30,000) Accounts payable goes up $30,000 (to $30,000).

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3 – The company buys a parcel of land for $10,000 in cash.

Land goes up $10,000 (to $10,000). Cash goes down $10,000 (from $60,000 in [1] to $50,000).

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4 – The company performs painting services for $19,000 with cash of $5,000 collected then and the remaining $14,000 to be collected later. All the required work is completed.

Cash goes up $5,000 (from $50,000 in [3] to $55,000). Accounts receivable goes up $14,000 (to $14,000). Sales revenue goes up $19,000 (to $19,000). Because this is the sale of a service, there is no cost of goods sold. Note also that “Sales Revenue” could have been labelled as “Sales” or as “Sales Revenue-Services”.

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5 – The company has rented a building for a total of $3,000 during the previous three months. No payment has yet been made. For this type of expense, the company’s accounting system records the expense immediately as it occurs (let’s assume that after each day, the computer system automatically makes a recording of the small amount for that day – computers can do that without complaining. Read this carefully – you can understand what it says.).

The following was recorded by the company’s accounting system over the previous three months: Rent expense goes up $3,000 (to $3,000). Rent payable goes up $3,000 (to $3,000).

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6 – The company now pays the first $2,000 of the $3,000 in rent owed in (5).

The payable was established in [5] and is now being partially paid. Rent payable goes down $2,000 (from $3,000 in [5] to $1,000). Cash goes down $2,000 (from $55,000 in [4] to $53,000).

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7 – The company’s employees worked for the previous two months and earned $4,000 but no payment has yet been made. For this type of expense, the company does not record any expense UNTIL payment is made (or until financial statements are prepared if that happens before the payment is made). (In 5 and 7, I’m demonstrating the two different ways that companies do these kinds of events. These are known as “accrued” expenses – the expense grows over time. You can record them as they grow [as in 5] or you can do nothing and wait until payment is made or financial statements are prepared [as in 7].)

Nothing will be reported until either the amount is paid or financial statements are prepared.

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8 – The company now pays all of the salaries in (7).

Neither the salary expense nor the salary payable has been recorded previously. Salary expense goes up $4,000 (to $4,000). Cash goes down by $4,000 (from $53,000 in [6] to $49,000).

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9 – Cash of $5,000 is collected from the sale in (4) above with the rest to come in later.

Cash goes up $5,000 (from $49,000 in [8] to $54,000). Accounts receivable goes down $5,000 (from $14,000 in [4] to $9,000). Notice here that the revenue was recorded in (4) at the time of the sale and should not be recorded again here. Revenue is only recorded once and that is when the seller’s performance obligation is satisfied.

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10 – Cash of $13,000 is paid on the amount owed on the inventory bought in number (2) above

Cash goes down $13,000 (from $54,000 in [9] to $41,000). Accounts payable goes down $13,000 (from $30,000 in [2] to $17,000).

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11 – The company sells 60 percent of the inventory that it bought in number (2). The sale is made on credit for $33,000.

Note that the textbook shows the sale of inventory as two entries: the first for the sale and the second for the conveyance of inventory to the customer. Note also that the inventory bought in (2) had a cost of $30,000 so 60 percent of it would be inventory of $18,000. Accounts receivable goes up $33,000 (from $9,000 in [9] to $42,000). Sales revenue goes up $33,000 (from $19,000 in [4] to $52,000). Cost of goods sold goes up $18,000 (to $18,000). Inventory goes down by $18,000 (from $30,000 in [2] to $12,000. Note also that “Sales Revenue” could have been labelled as “Sales” or “Sales Revenue—Inventory”.

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12 – Company issues a $4,000 cash dividend to the company’s owners as a reward for a successful year of operations.

Dividends distributed goes up $4,000 (to $4,000). Cash goes down $4,000 (from $41,000 in [10] to $37,000).

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13 – The company buys a truck for $70,000. It pays $30,000 in cash and signs a long-term note for the remainder.

Truck goes up $70,000 (to $70,000). Cash goes down $30,000 (from $37,000 in [12] to $7,000). Notes payable goes up $40,000 (to $40,000).

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14 – The company sells 80 percent of the land that was bought in (3) above for 15,000 in cash. Hint: this is not inventory like in (11) above so you don’t use two separate entries but rather just one – increase what you got, decrease what you gave up, and the difference is either a gain (you got more than you gave up) or a loss (you got less than you gave up).

Note that the land in (3) had a cost of $10,000. 80 percent of that land would have a cost of $8,000. Cash goes up $15,000 (from $7,000 in [13] to $22,000). Land goes down $8,000 (from $10,000 in [2] to $2,000). Gain on sale of land goes up $7,000 (to $7,000).

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Okay, how did you do? On your first attempt, what percentage of these did you get correct? On your second attempt, how much did you improve? Can you get to the point where you can get 100 percent correct and understand each one?

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Now, take the final balances listed for each account above (cash is $22,000, land is $2,000, gain on sale of land is $7,000, and so on). Produce your very own income statement, statement of retained earnings, and balance sheet for this company. Review Table 3.1, Table 3.4, and Table 3.6 before you begin.

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If you click on the “ANSWER” button immediately following these Learning Questions and Answers, you will find a typical set of financial statements using these account balances. See how close you can come to producing the same financial statements. There is some flexibility that is allowed but your statements should resemble these statements in most ways.

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