accounting problem, help please?

Question

Decision Making Across the Organization

BYP4-6. Swiss Valley Park was organized on April 1, 2006, by Erika Barnes. Erika is a good manager but a poor accountant. From the trial balance prepared by a part-time bookkeeper, Erika prepared the income statement shown at the top of page 213 for the quarter that ended March 31, 2007.

SWISS VALLEY PARK
Income Statement
For the Quarter Ended March 31, 2007
Revenues
Rental revenues $89,000
Operating expenses
Advertising $ 4,200
Wages 27,600
Utilities 900
Depreciation 800
Repairs 2,800
Total operating expenses 36,300
Net income $52,700








Erika knew that something was wrong with the statement because net income had never exceeded $20,000 in any one quarter. Knowing that you are an experienced accountant, she asks you to review the income statement and other data.


You first look at the trial balance. In addition to the account balances reported in the income statement, the ledger contains these selected balances at March 31, 2007.

Supplies $ 5,200
Prepaid Insurance 7,200
Notes Payable 14,000





You then make inquiries and discover the following.
1.
Rental revenues include advanced rentals for summer-month occupancy, $26,000.

2.
There were $1,300 of supplies on hand at March 31.

3.
Prepaid insurance resulted from the payment of a 1-year policy on January 1, 2007.

4.
The mail on April 1, 2007, brought the following bills: advertising for week of March 24, $110; repairs made March 10, $380; and utilities $240.

5.
There are four employees who receive wages totaling $290 per day. At March 31, 3 days' wages have been incurred but not paid.

6.
The note payable is a 3-month, 8% note dated January 1, 2007.






Instructions

With the class divided into groups, answer the following.
a.
Prepare a correct income statement for the quarter ended March 31, 2007.

b.
Explain to Erika the generally accepted accounting principles that she did not follow in preparing her income statement and their effect on her results.

Answer 1

Adjustments to be made are:
1. Dr Rental revenues 26k
Cr Advance rental revenue 26k

2. Dr Supplies expense 3,900
Cr Supplies 3900

3. Dr Insurance 1,800 (3/12 of 7,200)
Cr Prepaid insurance 1,800

4. Dr Advertising 110
Dr Repairs 380
Dr Utilities 240
Cr Accrued expenses 730

5. Dr Wages 3,480 (4 staff x 3 days x $290 per day)
Cr Wages payable 3,480

6. Dr Interest 280 (8%p.a on 14,000 for 3 mths)
Cr Interest payable 280

(a) Correct income statement
For the Quarter Ended March 31, 2007
Revenues
Rental revenues $63,000
Operating expenses
Advertising $ 4,310
Wages 31,080
Utilities 1,140
Depreciation 800
Repairs 3,180
Insurance 1,800
Interest 280
Supplies expense 3,900
Total operating expenses 46,490
Net income $16,510

(b) GAAP not followed:
(i) accrual basis of accounting
The accounting method under which revenues are recognized on the income statement when they are earned (rather than when the cash is received). The balance sheet is also affected at the time of the revenues by either an increase in Cash (if the service or sale was for cash), an increase in Accounts Receivable (if the service was performed on credit), or a decrease in Unearned Revenues (if the service was performed after the customer had paid in advance for the service).

Under the accrual basis of accounting, expenses are matched with revenues on the income statement when the expenses expire or title has transferred to the buyer, rather than at the time when expenses are paid. The balance sheet is also affected at the time of the expense by a decrease in Cash (if the expense was paid for when it incurred), an increase in Accounts Payable (if the expense will be paid in the future), or a decrease in Prepaid Expenses (if the expense was paid in advance).

(ii) Time Period Assumption
This accounting principle assumes that it is possible to report the complex and ongoing activities of a business in relatively short, distinct time intervals such as the five months ended May 31, 2007, or the 5 weeks ended May 1, 2007. The shorter the time interval, the more likely the need for the accountant to estimate amounts relevant to that period. For example, the property tax bill is received on December 15 of each year. On the income statement for the year ended December 31, 2007, the amount is known; but for the income statement for the three months ended March 31, 2007, the amount was not known and an estimate had to be used.