Accounting Chapter 7

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Questions and Answers

What is our Retained Earnings?

Twenty-eight dollars

Which method will we stick with for accounting purposes?

Weighted Average

FIFO

Cash Method

LIFO (correct)

Did the collection of five dollars impact the Income Statement?

False

How much cash did we collect on our account?

$5 Signup and view all the answers

What are the three financial statements mentioned?

Balance Sheet, Income Statement, Cash Flow Statement Signup and view all the answers

What is the beginning cash amount for this week?

$59.00 Signup and view all the answers

How much did we pay for the lemonade stand?

$10 Signup and view all the answers

What is meant by capitalizing an asset?

Adding the asset to the Balance Sheet Signup and view all the answers

What happens to the earnings when we expense the paint?

Decrease earnings Signup and view all the answers

Is the paint considered a capital improvement?

False Signup and view all the answers

How much was the expensed paint?

$2 Signup and view all the answers

What does the Cash Statement record?

Only the cash that comes in and goes out Signup and view all the answers

Why do we not expense the sink?

It provides a long-term benefit and improves the value of the stand. Signup and view all the answers

By how much did Accounts Payable increase with the sink purchase?

$2.00 Signup and view all the answers

What type of asset are the lemonade stand and land classified as?

Fixed Assets Signup and view all the answers

Is the roof shingle repair an expense?

Yes Signup and view all the answers

How much did the roof shingle repair cost?

$1.00 Signup and view all the answers

The repair affected only the left side of the Balance Sheet.

False Signup and view all the answers

To capitalize an item, it must last longer than ______.

one year Signup and view all the answers

What are the two main criteria for deciding whether to expense or capitalize an item?

Time and Cost Signup and view all the answers

How long should an item last to be capitalized?

More than a year Signup and view all the answers

If an item costs less than $500, what happens?

It is expensed Signup and view all the answers

What kind of lemonade did you purchase?

Pre-made lemonade from Truman's Own Signup and view all the answers

How much did you sell the lemonade for?

$50 Signup and view all the answers

Did cash go out when you purchased the pre-made lemonade?

Yes Signup and view all the answers

How much cash went out when paying Pappy for sugar?

$4.00 Signup and view all the answers

What was the interest expense when repaying the bank?

$2.00 Signup and view all the answers

Can land be depreciated?

False Signup and view all the answers

What is the total depreciable amount for the stand and sink?

$10.00 Signup and view all the answers

Depreciation affects cash flow.

False Signup and view all the answers

What method of depreciation is used?

Straight Line Depreciation Signup and view all the answers

How much did we collect?

$45.00 Signup and view all the answers

How much did we spend?

$63.00 Signup and view all the answers

What is the change in cash?

-$18.00 Signup and view all the answers

If we started with $59, what should be our ending cash?

$41.00 Signup and view all the answers

How much cash do we have according to the Cash Statement?

$41.00 Signup and view all the answers

What were the total sales for the week?

$50 Signup and view all the answers

What was the beginning inventory?

$10 Signup and view all the answers

What were the total expenses for the week?

$6 Signup and view all the answers

What is the net profit for the week?

$24 Signup and view all the answers

What was the cost of goods sold?

$20 Signup and view all the answers

What is the total available for sale?

$30 Signup and view all the answers

What is the total cost of the assets being purchased?

$10.00 Signup and view all the answers

How are the stand and lot classified on the Balance Sheet?

Fixed Assets Signup and view all the answers

What is the likely reason for specifying the cost allocation between the stand and the land?

For tax deduction purposes Signup and view all the answers

Which of the following would NOT typically be classified as a Fixed Asset?

Inventory for sale Signup and view all the answers

Why are Fixed Assets considered 'fixed'?

They are not intended for sale and used repeatedly Signup and view all the answers

How should the $5 collected from Accounts Receivable be recorded on the Cash Statement?

As an addition under Collections Signup and view all the answers

What is the correct amount to enter under the Beginning Cash line for this week?

$59.00 Signup and view all the answers

What is the primary purpose of the Cash Statement?

To record the cash inflow and outflow over a specified time Signup and view all the answers

In what line would you categorize the $10 spent on the land and lemonade stand?

As a Fixed Asset Investment Signup and view all the answers

What line reflects the net result of cash flows at the end of the week?

Change in Cash Signup and view all the answers

What is the primary function of the Cash Flow Statement?

To track cash movements in and out of the business Signup and view all the answers

Why is it stated that the $5 collected from Accounts Receivable will not impact the Income Statement?

The sale was already recognized in a prior accounting period Signup and view all the answers

What are the implications of using the Accrual Method of accounting regarding cash transactions?

All transactions are recorded as they occur, regardless of cash flow Signup and view all the answers

What can be considered the 'third leg' required for financial stability in business record-keeping?

Cash Flow Statement Signup and view all the answers

Which of the following best describes the concept behind financial record-keeping as illustrated in the chapter?

A three-legged structure provides better stability Signup and view all the answers

When using the Accrual Method, when is revenue recognized?

When goods or services are delivered Signup and view all the answers

In terms of financial statements, what role does a Balance Sheet play?

It presents the financial position at a specific point in time Signup and view all the answers

Why is it beneficial to keep track of cash flow as described?

To gauge the overall financial health of the business Signup and view all the answers

What effect does collecting $5 in cash have on Accounts Receivable?

Accounts Receivable decreases by $5 Signup and view all the answers

What is the total amount of Assets after the collection of $5?

$82.00 Signup and view all the answers

Which accounting method is mentioned as the one to stick with for tax purposes?

LIFO Signup and view all the answers

Which financial statement will be affected by the $5 cash collection?

Balance Sheet Signup and view all the answers

What was the initial value of Accounts Receivable before the cash collection?

$10.00 Signup and view all the answers

What is the effect of the cash collection on total Liabilities?

Liabilities remain unchanged Signup and view all the answers

Why is the LIFO method difficult for some companies to maintain?

It requires more detailed records. Signup and view all the answers

What remains as Retained Earnings after receiving the payment of $5?

$28.00 Signup and view all the answers

What determines whether a business should capitalize or expense an item?

The time and how long the item lasts Signup and view all the answers

If a company has a policy to capitalize items costing $500 or more, what happens to a $400 item?

It is expensed immediately Signup and view all the answers

What happens to the accounting equation when an asset is capitalized?

Only assets increase without affecting liabilities Signup and view all the answers

What must occur for a roof repair to be classified as a capital improvement?

The roof must be replaced entirely Signup and view all the answers

What effect does a maintenance expense have on the financial statements?

It is recorded as an expense in the Income Statement Signup and view all the answers

Why is an item that costs $500 but is deemed insignificant typically expensed?

It is below the capitalization threshold Signup and view all the answers

Which of the following items would most likely be capitalized?

A new computer costing $800 Signup and view all the answers

How does an ongoing maintenance expense affect the Cash Statement?

It shows as a cash outflow Signup and view all the answers

What happens to cash when $2 is spent on paint for the lemonade stand?

Cash decreases by $2 Signup and view all the answers

How is the expense for the paint recorded on the Income Statement?

As a paint expense of $2 Signup and view all the answers

What signifies that the sink purchased for the lemonade stand will not be expensed?

It is a fixed asset Signup and view all the answers

What is the impact of capitalizing the sink instead of expensing it?

It retains value on the Balance Sheet Signup and view all the answers

By how much does Accounts Payable increase when the sink is acquired on credit?

$2.00 Signup and view all the answers

What overall effect does paying for the paint have on the financial statements?

Decreases cash and increases expenses by $2 Signup and view all the answers

What classification is the sink added to the lemonade stand if it improves its functionality?

Fixed asset Signup and view all the answers

What statement is true about the cash flow related to the paint purchase?

Cash outflow for expenses paid Signup and view all the answers

What is the impact of paying $4.00 to Pappy on the cash balance?

Cash decreases by $4.00 Signup and view all the answers

What gets reduced on the right side of the Balance Sheet when the payment is made?

Accounts Payable Signup and view all the answers

When was the sugar purchase accounted for using the Accrual Method?

During Week 2 Signup and view all the answers

Will the $4.00 payment for sugar show up on the Income Statement this week?

No, it was already accounted for Signup and view all the answers

What is the total cash effect of collecting $40 and paying $4.00?

$36.00 Signup and view all the answers

What can be inferred about the relationship with Pappy Parker after making the cash payment?

It likely improved due to payment Signup and view all the answers

What does the payment for sugar not affect on the Income Statement this week?

Cost of goods sold Signup and view all the answers

The payment made to Pappy was for which specific item?

Sugar Signup and view all the answers

Study Notes

Financial Record-Keeping Basics

LIFO accounting method used to roll up weekly earnings; beneficial for tax savings.
Maintaining LIFO records is complex and costly, typically adopted by companies with extensive inventory.
Retained Earnings for week three equals $28.
Accounts Receivable collection recorded when a customer pays $5 for lemonade.

Balance Sheet Updates

Update Balance Sheet to reflect cash increase and Accounts Receivable decrease due to the $5 payment.
The accrual method confirms that the $5 collection does not affect current Income Statement; it was already recorded as a sale.

Introduction of Cash Flow Statement

The Cash Flow Statement complements the Balance Sheet and Income Statement, capturing cash inflows and outflows.
Key components of the Cash Flow Statement include Collections, Inventory Paid, Fixed Asset Investment, and Expenses Paid.
Beginning Cash recorded at $59; cash collections from Accounts Receivable are added.

Fixed Asset Acquisition

Purchase of a lemonade stand and land for a total of $10; assets capitalized on the Balance Sheet.
Identification of fixed assets: property, plant, and equipment not intended for sale.
Capitalizing means adding the asset to the Balance Sheet rather than expensing it; affects only the Balance Sheet.

Expense Recognition

Purchase of paint for $2 to improve the stand debated between capitalizing or expensing.
Decided to expense paint due to its low enduring value, reducing current earnings by $2.
All three financial statements impacted: Balance Sheet, Income Statement (paint expense), and Cash Statement (tracked cash outflow).

Further Asset Developments

Purchase of a $2 sink on credit; increases Accounts Payable but does not affect cash immediately.
Added sink seen as a capital improvement to the lemonade stand, not an expense, impacting only the Balance Sheet.

Maintenance vs. Capital Improvement

Repair of a cracked shingle costs $1 and is treated as an expense, reflecting normal maintenance costs.
Capital improvements enhance the asset’s value and are recorded as new assets, while maintenance expenses reflect costs to keep an asset functional.
Transactions ideally keep the Balance Sheet in equilibrium, confirming stable financial health.

Key Takeaways

Financial transactions adhere to the principles of accrual accounting, emphasizing timing and proper recording.
Understanding the distinction between capitalizing and expensing is crucial for accurate financial reporting.
Regular updates to all three financial statements ensure comprehensive tracking of business performance.### Cash Statement and Financial Transactions
Cash statement remains unaffected if no cash outflow occurs, as in the decision to capitalize or expense items.
Criteria for deciding to capitalize or expense an item include:
- Time: Items lasting over one year are capitalized; those under one year are expensed.
- Cost: Items below a company's set threshold (e.g., $500) are expensed, while those above are capitalized.

Business Decisions and Purchases

Purchasing pre-made lemonade for $20 impacts the cash statement as it reduces cash by that amount.
Sales of lemonade generated 50revenue(50 revenue (50revenue(40 cash, 10onaccount),leadingtoagrossearningsincreaseof10 on account), leading to a gross earnings increase of 10onaccount),leadingtoagrossearningsincreaseof30 after deducting the cost of goods sold ($20).

Balance Sheet Adjustments

Updated balance sheets reflect:
- Cash decreases with each purchase, affecting accounts payable and Total Assets.
- Earnings calculations require reflecting sales and costs, ensuring balance on both sides of the balance sheet.

Managing Accounts and Repayments

Payments made to suppliers (e.g., $4 for sugar) do not affect current Income Statement but reduce cash and accounts payable on the balance sheet.
Loan repayments include principal and interest, impacting both cash and the Notes Payable on the balance sheet.

Depreciation and Fixed Assets

Depreciation: Non-cash expense reflecting the decrease in value of fixed assets over time due to wear and tear, calculated as an expense on the Income Statement.
Fixed assets (e.g., stand and sink) are depreciated over time (straight-line method: 10over10years=10 over 10 years = 10over10years=1 per year).
Only the stand can be depreciated; land cannot due to it having an indefinite lifespan.

Income Statement and Expenses

Non-cash expenses like depreciation reduce profits without affecting cash flow.
Compilation of expenses for the week includes costs related to paint, repairs, interest, and depreciation.
Example expenses include:
- Paint: $2
- Roof repair: $1
- Interest: $2
- Depreciation: $1

Summary of Financial Weeks

Weekly collections and expenditures summarized to track cash changes and ensure balanced statements.
Overall cash flow illustrates the business's financial health through careful management of assets and liabilities.

Initial Sales Contract and Assets

Purchase breakdown: 8forthelemonadestand,8 for the lemonade stand, 8forthelemonadestand,2 for the land, totalling $10.
Cash transaction of $10 results in acquiring a Fixed Asset, which consists of the stand and the land.
Fixed Assets are items not intended for sale and used repeatedly in business operations.

Balance Sheet Overview

Assets include the lemonade stand (8)andtheland(8) and the land (8)andtheland(2).
To reflect transactions, both cash outflow and asset acquisition must be balanced on the Balance Sheet.
Need to track liabilities such as Accounts Payable and Notes Payable post transactions for accurate accounting.

Cash Statement Details

Cash Statement tracks cash inflows and outflows over a defined time period.
Starting cash balance noted as 59.00;59.00; 59.00;5 was collected from Accounts Receivable.
Cash outflows included paying off accounts payable, bank loan principal, and interest.

Fixed Assets and Depreciation

Fixed Assets examples include office furniture, vehicles, computers, etc.
Depreciation is the decrease in asset value over time due to wear and tear; applicable to the stand and sink but not the land.
Land cannot be depreciated as it does not wear out and lasts indefinitely.

Depreciation Methodology

Straight Line Depreciation method applies (cost divided by useful life).
In this case, the total depreciation over a 10-year span for the stand and improvements is 10,equatingto10, equating to 10,equatingto1 per year.

Income Statement Essentials

Weekly sales totalled 50,with50, with 50,with40 in cash and $10 on account.
Expenses accounted for: Paint (2),roofrepair(2), roof repair (2),roofrepair(1), Interest (2),andDepreciation(2), and Depreciation (2),andDepreciation(1) amounted to $6 in total.
Net Profit calculated as $24, after deducting total expenses from Gross Profit.

Summary of Transactions

Weekly transactions recorded include cash collections, asset purchases, repairs, and loan repayments.
Final accounting week resulted in balancing the financial statements—Assets equalled Liabilities + Owner's Equity.

Earnings and Accounting Methods

Weekly earnings are rolled up to assess financial performance, using the LIFO (Last In, First Out) method for tax advantages.
LIFO can be complex and is typically adopted by companies with large inventories.
Retained earnings for the period stand at $28, with no earnings reported for the new week.

Cash Transactions Overview

A $5 collection from a friend for past lemonade purchases is recorded, affecting both cash and accounts receivable.
The Accrual Method of accounting necessitates that previous sales are not recorded again upon collection; cash flow management is essential.

Financial Statements

Three crucial financial statements: Balance Sheet, Income Statement, and Cash Flow Statement.
Cash Flow Statement tracks cash movements, crucial for business survival and stability.
A recent expense of $2 for paint is recorded, affecting the Cash Flow Statement.

Capitalizing vs. Expensing

Criteria for capitalizing or expensing items:
- Time: Items lasting longer than one year may be capitalized, while shorter-lived items are expensed.
- Cost: Items costing below a company-defined threshold (e.g., $500) are expensed.

Transactions Impacting Assets and Liabilities

A used sink purchased for $2 is added to Accounts Payable, which increases liabilities and improves asset value.
Repair expenses, such as restoring a roof without adding significant value, are classified as maintenance expenses.

Managing Cash Flow

The importance of relationships in business is highlighted through the timely payment of a $4 account for sugar, enhancing supplier relations.
Transactions are analyzed to ensure consistency in financial statements; accounts payable reduction reflects cash payments.

Implications for Income Statement

Payments made do not impact the Income Statement for the current week as previous purchases are recognized at the time of transaction, not upon payment.
The interplay between cash management and accounting methods demonstrates the need for clarity in financial reporting.

By keeping track of these critical aspects, businesses can maintain proper financial health and enhance operational efficiency.

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Description

This chapter focuses on the LIFO inventory method and its practical implications for businesses. It highlights the importance of rolling up earnings and offers insights into the cost implications of maintaining LIFO records. Gain a better understanding of how inventory methods affect tax savings and accounting decisions.