Accounting Answers Note #10

Question 1 Describe credit and debit. Also explain why sometimes debit is increased and sometimes credit is increased Answer Credit and debit are two fundamental terms used in accounting that represent changes in assets, liabilities, and equities. They are used to record financial transactions in an organization's accounting system. Credit is an entry made on the right side of an account, while debit is the entry made on the left side of the account. This basic principle of accounting is known as the "double-entry system". The double-entry system ensures accuracy in financial reporting and helps in identifying errors and discrepancies in the financial statements. Credit represents an increase in liabilities or a decrease in assets or equity. On the other hand, debit represents an increase in assets or a decrease in liabilities or equity. For example, when a company receives cash from a customer, the cash account is debited (increased) and the accounts receivable account is credited (decreased). In some cases, both credit and debit will increase. This occurs in situations where a company receives an asset and incurs a liability at the same time. For example, when a company purchases inventory on credit, the inventory account is debited (increased) and the accounts payable account is credited (increased). Similarly, both credit and debit can decrease. This happens when an asset decreases, and a liability increases. For instance, when a company makes a payment on accounts payable, the accounts payable account is debited (decreased) and the cash account is credited (decreased). There are various reasons why debit can increase and why credit can increase. Here are some possible scenarios: 1. When a company receives an asset such as cash, equipment, or inventory, debit will increase. 2. When a company incurs a liability such as accounts payable, debit will increase. 3. When a company makes a payment on a liability, such as paying off a loan or accounts payable, credit will increase. 4. When a company sells its products or services on credit, credit will increase. It is also essential to understand the concept of double-entry in order to understand why debit and credit can increase or decrease. As mentioned earlier, every transaction has two sides: debit and credit. This means that for every debit there must be a corresponding credit, and vice versa. In conclusion, credit and debit are two important terms in accounting that represent changes in assets, liabilities, and equity. They follow the double-entry system, which ensures accuracy in financial reporting. Both credit and debit can increase or decrease, depending on the nature of the transaction. It is crucial for high school students to have a good understanding of these terms as they continue their academic and professional journey in the field of accounting. Question 2 An account number beginning with a 4 indicates that the account: 1) Is a Revenue section account 2) Is an Expense section account 3) Is an Equity section account 4) Is an Asset section account 5) Is a Liability section account Answer According to Generally Accepted Accounting Principles (GAAP), accounts in a company's financial statements are classified into five main categories: assets, liabilities, equity, revenue, and expenses. Each of these categories has a unique account number range. An account number beginning with a 4 falls in the asset section, and hence, the correct answer is option 4. Assets are economic resources owned by a company that have future economic benefits. An asset could also be something that a company has acquired to generate future income. These can be tangible, such as cash, inventory, buildings, or intangible, such as patents or trademarks. Question 3 Assume a company has Year 1 beginning common stock of $10,000 and Year 2 ending stockholders' equity of $150,000. Which of the following is true in regards to this scenario? Multiple Choice The Company has likely incurred heavy losses over the last two years. Revenues have exceeded expenses over the last two accounting cycles. This is likely a poor investment for the stockholders of the Company. Expenses have exceeded revenues over the last two accounting cycles. Answer Based on the information provided, there are a few potential conclusions that can be drawn about the company's financial performance over the last two years. Let's explore each of the options provided and determine which one is most likely to be true. Option 1: The company has likely incurred heavy losses over the last two years. This option suggests that the company's stockholders' equity has significantly decreased from $10,000 to $150,000, indicating a potential loss of $140,000. However, this may not necessarily be the case. There are a few factors that could contribute to this significant increase in stockholders' equity without incurring heavy losses. Useful source: 1. "Stockholders' Equity." Investopedia, Investopedia, 30 Aug. 2021, www.investopedia.com/terms/s/stockholdersequity.asp. This source defines stockholders' equity as the portion of a company's balance sheet that represents the capital received from investors in exchange for stock, as well as the retained earnings of a company. It also provides a clear explanation of how the figure is calculated. Option 2: Revenues have exceeded expenses over the last two accounting cycles. This option suggests that the company's total revenues have exceeded its total expenses over the last two accounting periods. This could lead to a positive change in stockholders' equity and could explain the significant increase from $10,000 to $150,000. However, it is also important to consider other factors such as company investments, additional funding, and any potential changes in the company's assets. Useful source: 2. "Understanding Income Statements." Corporate Finance Institute, Corporate Finance Institute, 27 Mar. 2020, corporatefinanceinstitute.com/resources/knowledge/accounting/incomestatement/. This source explains the different components of an income statement, including revenues and expenses, and how they are used to determine a company's net income. Option 3: This is likely a poor investment for the stockholders of the Company. This option suggests that purchasing stock in this company would not be a wise investment decision based on the significant increase in stockholders' equity. However, it is important to note that stockholders' equity is only one aspect of a company's financial performance. Other factors such as market trends, industry competition, and company growth potential should also be considered before making any investment decisions. Useful source: 3. Brigham, Eugene F., and Michael C. Ehrhardt. Financial Management: Theory & Practice. South-Western Cengage Learning, 2013. This comprehensive source covers various topics related to financial management, including stockholders' equity and investment decisions. It also includes real-world examples and case studies to help readers better understand the concepts. Option 4: Expenses have exceeded revenues over the last two accounting cycles. This option suggests the company has experienced a decrease in stockholders' equity, with expenses exceeding revenues over the last two accounting periods. However, as mentioned earlier, it is important to consider other factors that may have contributed to this decrease, such as investments or company expansions. Question 4 Cash 400,000 Accounts receivable 800,000 Allowance for doubtful accounts 50,000 Inventories 1,000,000 Land 500,000 Building 5,000,000 Accumulated depreciation-building 2,000,000 Machinery 3,000,000 Accumulated depreciation-machinery 1,200,000 Equipment 400,000 Accumulated depreciation-equipment 100,000 Investment in associate 1,300,000 Prepaid expenses 100,000 Notes payable 750,000 Accounts payable 350,000 Income tax payable 50,000 Accrued expenses 60,000 Mortgage note payable in quarterly installments of P100,000 2,000,000 Estimated liability for damages 140,000 Retained earnings appropriated for plant expansion 1,000,000 Retained earnings appropriated for contingencies 100,000 Share capital 3,000,000 Share premium 300,000 Retained earnings unappropriated 1,250,000 Trademark 150,000 Secret processes and formulas 200,000 Bank loan payable - due June 30, 2X25 500,000 Answer Assets Liabilities Equity Cash 400,000 Notes Payable 750,000 Share Capital 3,000,000 Accounts Receivable 800,000 Accounts Payable 350,000 Share Premium 300,000 Allowance for Doubtful Accounts 50,000 Income Tax Payable 50,000 Retained Earnings Appropriated for Plant Expansion 1,000,000 Inventories 1,000,000 Accrued Expenses 60,000 Retained Earnings Appropriated for Contingencies 100,000 Land 500,000 Mortgage Note Payable 2,000,000 Retained Earnings Unappropriated 1,250,000 Building 5,000,000 Estimated Liability for Damages 140,000 Trademark 150,000 Accumulated Depreciation - Building 2,000,000 Bank Loan Payable - due June 30, 2X25 500,000 Secret Processes and Formulas 200,000 Machinery 3,000,000 Retained Earnings 1,250,000 Accumulated Depreciation - Machinery 1,200,000 Equipment 400,000 Accumulated Depreciation - Equipment 100,000 Investment in Associate 1,300,000 Prepaid Expenses 100,000 Calculation for the net book value of Property, Plant, and Equipment: Original Cost Building: 5,000,000 Machinery: 3,000,000 Equipment: 400,000 Total Original Cost: 8,400,000 Accumulated Depreciation Building: 2,000,000 Machinery: 1,200,000 Equipment: 100,000 Total Accumulated Depreciation: 3,300,000 Net Book Value of Property, Plant, and Equipment: 5,100,000 In order to classify accounts, we must first understand the difference between assets, liabilities, and equity. Assets are resources that a company owns and can use to generate future economic benefits. Liabilities are obligations that a company owes and must be settled in the future through the transfer of assets. Equity represents the residual interest in the assets of a company after deducting liabilities. Based on this, the individual asset and liability accounts in this scenario can be classified as follows: Assets: - Cash - Accounts Receivable - Allowance for Doubtful Accounts - Inventories - Land - Building - Accumulated Depreciation – Building - Machinery - Accumulated Depreciation – Machinery - Equipment - Accumulated Depreciation – Equipment - Investment in Associate - Prepaid Expenses Liabilities: - Notes Payable - Accounts Payable - Income Tax Payable - Accrued Expenses - Mortgage Note Payable - Estimated Liability for Damages - Bank Loan Payable – due June 30, 2X25 Equity: - Share Capital - Share Premium - Retained Earnings Appropriated for Plant Expansion - Retained Earnings Appropriated for Contingencies - Retained Earnings Unappropriated - Trademark - Secret Processes and Formulas - Retained Earnings Question 5 Assets 2X23 2X22 Cash and cash equivalents 750,000 950,000 Accounts receivable 1,750,000 1,100,000 Inventory 2,550,000 1,800,000 Prepaid expenses 100,000 150,000 Property, plant, and equipment 5,300,000 4,300,000 Accumulated depreciation (1,150,000) (800,000) Total Assets 9,300,000 7,500,000 Liabilities and equity Accounts payable 1,250,000 1,000,000 Accrued expenses 50,000 200,000 Share capital 4,750,000 4,250,000 Retained earnings 3,250,000 2,050,000 Total Liabilities and Equity 9,300,000 7,500,000 Additional information The statement of retained earnings for 2X23 showed net income of P1,500,000 and cash dividend paid of P300,000. During the year, the entity purchased equipment for cash and issued share capital for cash. Answer In the statement above, we can see the assets, liabilities, and equity of an entity for the years 2X23 and 2X22. From this information, we can compute for the cash flows from operating, investing, and financing activities. Net income for 2X23 is P1,500,000 while cash dividends paid during the year is P300,000. To reconcile net income to net cash provided by operating activities, we need to make adjustments for non-cash transactions such as depreciation, amortization, and deferred taxes. Assuming that these are the only non-cash transactions, we can calculate the total cash flows from operating activities by subtracting the total adjustments from net income. Thus, the total cash flow from operating activities is P1,500,000 - P350,000 = P1,150,000. For the investing activities, we can see that the entity purchased equipment for cash. Therefore, the cash flow from investing activities is P5,300,000 - P4,300,000 = P1,000,000. In the financing activities, the entity issued share capital for cash. This means that the cash flow from financing activities is P4,750,000 - P4,250,000 = P500,000. Adding the cash flows from operating, investing, and financing activities, we can determine the net change in cash which is P1,150,000 + P1,000,000 + P500,000 = P2,650,000. This means that the net change in cash for the year 2X23 is an increase of P2,650,000.