Financial Accounting

ACCT 5011, Fall A 2014

Tom Fields
Here are about 20 inference problems similar to those in Notes 4 that we covered in class on August
18th. These are NOT assigned as homework, and are NOT required. They are available as
additional problems for any student who would like more practice. There are four sections; section
1 has missing data (Type I) inference problems; sections 2 & 3 have missing transaction (Type II)
inference problems - the problems in section 3 are significantly more difficult than those in section
2. Finally, section four has a few alternate accounting (Type III) problems similar to the AOL or
Microsoft cases (which we will cover in classes 6 and 7 respectively). For the quiz, focus on the
first three sections, and dont worry about revenue recognition issues; all four sections will be
relevant for the midterm.
In section 1, the key is to know all of the items which affect a given account, and the use the Taccount approach to solve for what you do not know. In sections 2 & 3, the key is to understand the
journal entries both as actually done, and as they should have been done. Once youve done that,
determining the effect on the financial statements should be relatively straightforward. In section 4,
you again want to write out the journal entries under both the actual and the alternate approach;
possibly use the techniques in section 1 to solve for any missing data, and then adjust the financial
statements as needed. Solutions to all problems are included at the end of the handout.
You can also see the sample quizzes for a few more examples of questions similar to those in
Section 1 and Section 3.
Section 1: Missing Data. Use the balance sheet and income statement for Walgreens (year ended
August 31, 2013). DO NOT use information from any other statements.
a. Determine the total cash collected from credit customers during 2013 - these are insurance
companies paying for prescription drugs. Assume that 63% of net sales were made on credit.
Assume that there are no write-offs for uncollectible accounts (something well discuss later in the
course).
b. Assume that the entire balance of Other current assets represents prepaid rent. If rent expense
during 2013 was $2,571, how much rent did Walgreens PAY during 2013?
c. Assume that Walgreens purchased $1,212 worth of Property and Equipment during 2013, and
did not sell any. What was their depreciation expense for the year (note that you cant determine the
solution directly from the income statement because depreciation is buried in Selling, general and
administrative expenses)?
d. Assume that the account accrued expenses and other liabilities includes a liability for
dividends payable that totals 354 at the end of 2013, and 282 at the end of 2012. We know from the
example that we did in the notes (see slide 11 from Notes 4) that dividends declared during the year
were 1083. What were dividends paid?

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Section 2: Effect of Errors (Basic). Use the balance sheet and income statement for Walgreens
(year ended August 31, 2013). DO NOT use information from any other statements. The following
events, which occurred during the year ended August 31, 2013, were accidentally not recorded. No
adjusting entries relating to these transactions were recorded either. Treat each question
independently, and ignore income tax effects. All numbers are in millions (as are the numbers in the
financial statements).
a. In January 2013, Walgreens paid $5 cash to its suppliers, in order to settle some of its accounts
payables.
b. During March 2013 Walgreens purchased land worth $10. Walgreens paid $2 in cash and took
out a loan for the remaining amount. Assume that the entire loan is non-current.
c. On June 1, 2013, Walgreens paid $12 for insurance. The policy covers the period June 1, 2013
to May 31, 2014.
d.

In June 2013, Walgreens issued (i.e., sold) $20 in common stock for cash.

e. Total credit sales on July 4, 2013 were $22. The cost of the inventory sold was $18.
f. In August 2013, Walgreens declared (but did not pay) a $354 dividend on its common stock.
The payment will be made in September 2013.
g. For the month of August 2013, there were electric utility bills of $2, which were not paid until
September 2013.
h. During August 2013, $1 was received from an insurance company as payment for prescriptions
which would not be filled (and thus recorded as revenues) until September 2013.
For each part (a-h) answer the following questions. If the appropriate adjustment were made to
correct for the omission, what would be
i)
ii)
iii)
iv)

Walgreens total assets at August 31, 2013?

Walgreens total current liabilities at August 31, 2013?
Walgreens total shareholders equity at August 31, 2013?
Walgreens net earnings for the year ended August 31, 2013?

ACCT 5011 Financial Accounting

3
Section 3: Effect of Errors (Advanced). Use the balance sheet and income statement for America
Online (year ended June 30, 1996), which are included in the AOL (B) case (DO NOT use
information from any other statement). The following events, which occurred during the year ended
June 30, 1996, were recorded incorrectly. Treat each question independently, and ignore income tax
effects. All numbers are in thousands (as are the numbers in the financial statements).
a. In June, 1995, AOL correctly accrued for wages earned during fiscal 1995, but not to be paid
until July 1995. In July, 1995, AOL paid these wages (totaling $5,000) but recorded them using the
following entry:
Wage Expense (+E, -SE)
5,000
Cash (-A)
5,000
b. In December 1995, AOL collected $500 in cash on trade accounts receivable relating to sales
previously made (and correctly recorded). AOL recorded this cash receipt as:
Cash (+A)
500
Revenue (+R, +SE)
500
c. On January 1, 1996, AOL spent $4,000 cash to purchase certain license rights. These rights
have a useful life of 2 years (24 months) and no value at the end of that period. AOLs policy is to
capitalize these costs and spread them evenly over the useful life; however, AOL accidentally
expensed these costs immediately.
d. Cash subscription fees totally $800 were received on April 1, 1996, for services to be provided
between April 1, 1996 and March 31, 1997. All $800 were recorded as revenue on April 1, 1996.
Assume the all costs were recorded correctly.
e. AOL was engaged during fiscal 1996 for a two-year consulting project. Total fees were agreed
to be $10, all of which would be paid in fiscal 1997. Total costs were expected to be (and were) $6,
half paid in 1996 and half in 1997. Assume that all costs were for cash. In 1996, AOL recorded this
project using the percentage of completion method, even though corporate policy was to use the
completed contract method for such projects.

For each part (a-e) answer the following questions. If the appropriate adjustment were made to
correct for the error, what would be
i)
ii)
iii)
iv)

AOLs total assets at June 30, 1996?

AOLs total liabilities at June 30, 1996?
AOLs total stockholders equity at June 30, 1996?
AOLs net income for the year ended June 30, 1996?

ACCT 5011 Financial Accounting

4
Section 4: Alternate Accounting. We did (or will do) two of these problems in class (AOL and
Microsoft). In both of these examples, the firm is using accrual accounting to separate the effect of
cash flows and income. The problem is then to undo this accrual in order to restate the financial
statements as if the firm had never used this method. As we saw in the two key slides from Notes 4
and Notes 5, there are only 4 possibilities here:
1.
2.
3.
4.

Pay cash now, but record expense later (AOL Case)

Record expense now, but pay cash later
Receive cash now, but record revenue later (Microsoft Case)
Record revenue now, but receive cash later

In each of these cases the careful way to do it is to follow the three steps first laid out in Notes 4
(slide 15): prepare the journal entries under each method; solve for any missing data; determine the
effect of the difference.
Roughly speaking, what we end up doing in each case is:
1) adjusting the I/S by the change in the balance sheet accrual account and
2) adjusting the balance sheet by the cumulative amount in the balance sheet account.
a. Refer to the 2013 Walgreens balance sheet and income statement. From footnote 16, we can see
that the accrued expenses and other liabilities line on the balance sheet includes $928 and $772 in
accrued salaries for August 31, 2013 and August 31, 2012, respectively. These represent salaries
already earned by employees at those dates (and therefore expensed) but not yet paid by Walgreens.
If Walgreens had always used cash basis accounting for salaries, what would their 2013 net income
have been? Here, cash basis accounting means that the expense would be recorded when cash was
actually paid, regardless of when the work is performed.
If you cant solve the problem as given, try adding the additional assumption that Walgreens paid
$772 in 2013 for salaries earned in 2012 and that they paid $928 in 2014 for salaries earned in 2013.
This assumption is reasonable, but it is NOT necessary.
b. Refer to the AOL financial statements for the year ended June 30, 1996 (included in the course
packet with the AOL case). Assume that prepaid expenses and other current assets refers to
entirely to prepaid rent. If AOL had always used a cash basis for its rent expense (i.e., if AOL
simply expensed rent when paid, rather than when incurred), what would have been their 1996 net
income? What would have been their total assets, total liabilities and total shareholders equity at
the end of 1996?
c. Refer to the 2013 Walgreens balance sheet and income statement. Walgreens records revenue for
prescription sales at the time of sale, even though cash is received later. If Walgreens had always
used a cash basis for recording such revenue (i.e., if they recorded revenue only when cash was
actually received), what would have been their net income for the year ended August 31, 2013, and
their total assets, total liabilities, and total shareholders equity at the end of 2013? Assume, in
violation of the matching principle, that the cost of goods sold was still recorded at the time of sale,
and assume that there are no write-offs for uncollectible accounts. You should be able to do the
problem without referring to problem a) from section 1.
ACCT 5011 Financial Accounting

Solutions Section 1: Missing Data

a. The journal entries for credit customers look like:
A/R (+A)
X
Sales (+R, +SE)
X
When sales on account are made (there will also
be a cost of sales entry here, which does not
affect our problem)

Cash (+A)
Y
A/R (-A)
When cash is collected

We want to solve for Y, and since Cash wont be much help, we will analyze Accounts Receivable.
BB
Sales
EB

Accounts Receivable (A)

2,167
X Y
2,632

Collections

Thus, 2,167+XY=2,632, or Y = 2167+X2632.

We can compute X as 63% x 2013 Net Sales = 0.63 x 72,217 = 45,497.
Then Y (our answer) = 2167+454972632 = 45,032.
b. The journal entries for rent look like:
Prepaid Rent (+A)
Cash (-A)
When cash is paid

Rent Expense (+E, -SE)

Y
Prepaid Rent (-A)
When the expense is incurred

We want to solve for X, and since Cash wont be much help, we will analyze Prepaid Rent.
BB
Pymt
EB

Prepaid Rent (A)

260
X Y=2571
284

Expense

Thus, 260+XY=284, or X = 284+Y260.

Then X (our answer) = 284+2571260 = 2595.

ACCT 5011 Financial Accounting

6
c. The journal entries for PE (Property & equipment) look like:
Property and Equipment (+A)
Cash (-A)
When PPE is purchased

X
X

Depreciation Expense (+E, -SE)

Property and Equipment (-A)
When depreciation is recorded

Y
Y

There is no sales entry as none was sold. We want to solve for Y, and since Cash wont be much
help, we will analyze Property and Equipment. Note that this account is reported net, i.e., net of
accumulated depreciation.
BB
Purch
EB

Property & Equipment (A)

12,038
X=1,212 Y
12,138

Depreciation

Thus, 12,038+XY =12,138, or Y=12,038+X12,138.

Then Y (our answer) = 12038+121212138 = 1,112.
d. The journal entries for dividends look like:
Retained Earnings (-SE)
X
Dividends Payable (+L)
When dividends are declared

Dividends Payable (-L)

Cash (-A)
When dividends are paid

We want to solve for Y, and since Cash wont be much help, we will analyze Dividends Payable.

Paid

Dividends Payable (L)

282
Y X = 1,083
354

BB
Declared
EB

Thus, 282+XY=354, or Y=282+X354.

Then Y (our answer) = 282+1083354 = 1011.

ACCT 5011 Financial Accounting

Solutions - Section 2: Effect of Errors (Basic)

In all of the cases in this section, the actual journal entry is NONE, and so the adjustment is just
the correct entry.
a.

Accounts Payable (-L)

Cash (-A)

5
5

Assets decrease by 5:
35481 5 =
Current Liabilities decrease by 5:
8883 5 =
Shareholders Equity is not changed: 19454 =
Net Earnings are not changed:
2450 =
b.

Land (+A)
Cash (-A)
Mortgage (+L)

2450

2
8

Insurance Expense (+E, -SE)

Prepaid Insurance (+A)
Cash (-A)

3
9

Cash (+A)
Common Stock (+SE)

35489
8883
19454
2450

(June, July and August, 2013)

(September 2013 through May 2014)
12

Assets decrease by 12-9 = 3:

Current Liabilities are not changed:
Shareholders Equity decreases by 3:
Net Earnings decrease by 3:
d.

19454

10

Assets increase by 10-2:

35481 + 8 =
Current Liabilities are not changed:
8883 =
Shareholders Equity is not changed: 19454 =
Net Earnings are not changed:
2450 =
c.

35476
8878

35481 3 =
8883 =
19454 3 =
2450 3 =

35478
8883
19451
2447

20

Assets increase by 20:

Current Liabilities are not changed:
Shareholders Equity increases by 20:
Net Earnings are not changed:

20
35481 + 20 =
8883 =
19454 + 20 =
2450 =

ACCT 5011 Financial Accounting

35501
8883
19474
2450

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e.

Accounts Receivable (+A)

Sales Revenue (+R, +SE)
Cost of Goods Sold (+E, -SE)
Inventory (-A)

22
22
18
18

Assets increase by 22-18=4:

35481 + 4 =
Current Liabilities are not changed:
8883 =
Shareholders Equity increases by 22-18=4: 19454 + 4 =
Net Earnings increase by 22-18=4:
2450 + 4 =
f.

g.

Retained Earnings (-SE)

Dividends Payable (+L)

282
282

Assets are not changed:

Current Liabilities increase by 354:
Shareholders Equity decreases by 354:
Net Earnings are not changed:

35481 =
8883 + 354 =
19454 354 =
2450 =

Utilities Expense (+E, -SE)

Utilities Payable (+L)

Cash (+A)
Deferred Revenue (+L)
Assets increase by 1:
Current Liabilities increase by 1:
Shareholders Equity is not changed:
Net Earnings are not changed:

35481
9237
19100
2450

Assets are not changed:

Current Liabilities increase by 2:
Shareholders Equity decreases by 2:
Net Earnings decrease by 2:
h.

35485
8883
19458
2454

35481 =
8883 + 2 =
19454 2 =
2450 2 =

35481
8885
19452
2448

1
1
35481 + 1 =
8883 + 1 =
19454 =
2450 =

ACCT 5011 Financial Accounting

35482
8884
19454
2450

Solutions - Section 3: Effect of Errors (Advanced)

In this section, it helps to write out both the actual journal entry and the correct journal entry. The
difference between the two is then the adjustment.
a. ACTUAL:
CORRECT:
ADJUST:

Wage Expense (+E, -SE)

Cash (-A)
Wage Payable (-L)
Cash (-A)
Wage Payable (-L)
Wage Expense (-E, +SE)

Assets are not changed:

Liabilities decrease by 5000:
Stockholders Equity increases by 5000:
Net Income increases by 5000:
b. ACTUAL:
CORRECT:
ADJUST:

Cash (+A)
Revenue (+R, +SE)
Cash (+A)
Accounts Receivable (-A)
Revenue (-R, -SE)
Accounts Receivable (-A)

Assets decrease by 500:

Liabilities are not changed:
Stockholders Equity decreases by 500:
Net Income decreases by 500:
c. ACTUAL:
CORRECT:
ADJUST:

Expense (+E, -SE)

Cash (-A)
License Rights (+A)
Expense (+E, -SE)
Cash (-A)
License Rights (+A)
Expense (-E, +SE)

Assets increase by 3000:

Liabilities are not changed:
Stockholders Equity increases by 3000:
Net Income increases by 3000:

5,000
5,000
5,000
5,000
5,000
5,000
958754 =
446252 - 5000 =
512502 + 5000 =
29816 + 5000 =

958,754
441,252
517,502
34,816

500
500
500
500
500
500
958754 500 =
446252 =
512502 500 =
29816 500 =

958,254
446,252
512,002
29,316

4,000
4,000
3,000
1,000

(18 months)
(6 months)
4,000

3,000
3,000
958754 + 3000 =
446252 =
512502 + 3000 =
29816 + 3000 =

ACCT 5011 Financial Accounting

961,754
446,252
515,502
32,816

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d. ACTUAL:
CORRECT:
ADJUST:

Cash (+A)
Revenue (+R, +SE)
Cash (+A)
Revenue (+R, +SE)
Deferred Revenue (+L)
Revenue (-R, -SE)
Deferred Revenue (+L)

Assets are not changed:

Liabilities increase by 600:
Stockholders Equity decreases by 600:
Net Income decreases by 600:
e. ACTUAL:

CORRECT:
ADJUST:

800
800
800
200
600
600
600
958754 =
446252 + 600 =
512502 600 =
29816 600 =

Receivable (+A)
Revenue (+R, +SE)
Cost of Goods Sold (+E, -SE)
Cash (-A)
Inventory (+A)
Cash (-A)
Revenue (-R, -SE)
Receivable (-A)
Inventory (+A)
Cost of Goods Sold (-E, +SE)

Assets decrease by 5-3 = 2:

Liabilities are not changed:
Stockholders Equity decreases by 5-3=2:
Net Income decreases by 5-3=2:

(3 months)
(9 months)

958,754
446,852
511,902
29,216

5
5
3
3
3
3
5
5
3
3

958754 2 =
446252 =
512502 2 =
29816 2 =

ACCT 5011 Financial Accounting

958,752
446,252
512,500
29,814

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Solutions - Section 4: Alternate Accounting

a. Accrued Salaries at Walgreens.
Under the existing accounting, there are three transactions relating to Salaries. During fiscal year
2013:
Accrued Salaries (-L)
X
Cash (-A)
X
X represents salaries paid for in 2013, even though the work was actually done (and thus the
expense was recorded) in 2012. That is, the expense is recognized before cash is paid.
Salaries Expense (+E, SE)
Y
Cash (-A)
Y
Y represents salaries paid for in 2013, for work done in 2013. That is, the expense is recognized
and cash is paid in the same period. As well see momentarily, this could actually be skipped
without changing our answer.
Salaries Expense (+E SE)
Z
Accrued Salaries (+L)
Z
Z represents work done in 2013, but that will not be paid for until 2014. That is, the expense is
recognized before cash is paid.
Under cash basis accounting, no transaction would be made in 2013 for the salaries paid in 2014
(Z), but the other two transactions would be recorded as:
Salaries Expense (+E, SE)
Cash (-A)

Salaries Expense (+E, SE)

Cash (-A)

X
Y

In moving from the first set of transactions to the second, we see that Walgreens avoids expense of
Z and incurs an additional expense of X. The expense of Y is paid under both methods and so does
not cause a change. Under the existing accounting, Walgreens income statement shows net income
of 2450. Thus, Walgreens 2013 net income under the alternate accounting would have been:
2450 + Z X. In order to get a specific number, we need to know Z X.

ACCT 5011 Financial Accounting

12
But this can be obtained by analyzing the Accrued Salaries liabilities account under the actual
method:
Beginning Balance
Ending Balance

Accrued Salaries (L)

772
X
Z
928

The beginning and ending balance are obtained from the problem.
Solving the equation: 772 + Z X = 928 tells us that Z X = $156. Thus, the alternate net income
would have been: 2450+156 = $2,606.
The question did not ask for the balance sheet effect, but it isnt hard. Under the alternate method,
Accrued Expenses and Other Liabilities would be lower by $928, and thus total liabilities would
be lower by the same amount. Retained Earnings (and thus total shareholders equity) would be
higher by $928, in order to keep the balance sheet in balance.

ACCT 5011 Financial Accounting

13
b. Prepaid rent at AOL
Under the existing accounting, there are two transactions relating to prepaid rent. During fiscal year
1996:
Prepaid Rent (+A)
X
Cash (-A)
X represents rent paid during 1996.

Rent Expense (+E, -SE)

Y
Prepaid Rent (-A)
Y
Y represents rent used, and therefore expensed during 1996.
Under cash basis accounting, the rent expense would be the same as the rent paid:
Rent Expense (+E, -SE)
Cash (-A)

X
X

In moving from the first set of transactions to the second, we see that AOL avoids expense of Y and
incurs an additional expense of X. Under the existing accounting, AOLs income statement shows
net income of 29,816. Thus, AOLs 1996 net income under the alternate accounting would have
been: 29,816 + Y X. In order to get a specific number, we need to know Y X. But this can be
obtained by analyzing the Prepaid Rent account under the actual method:
Prepaid Rent (A)
Beginning Balance
25,527
X
Y
Ending Balance
68,832
The beginning and ending balance are obtained from the balance sheet (using the assumption that
the prepaid expenses and other current assets account refers entirely to prepaid rent).
Solving the equation: 25,527 + X Y = 68,832 tells us that X Y = $43,305. Thus, the alternate net
income would have been: 29,816 43,305 = ($13,489).
We can also adjust the balance sheet, by writing off the entire (cumulative) amount of capitalized
prepaid rent on the balance sheet, and balancing this against a reduction of retained earnings.
This gives us a summary balance sheet at 6/30/1996 of
Assets
Liabilities
SE

958,754 68,832
446,252
512,502 68,832

=
=
=

889,922
446,252
443,670

ACCT 5011 Financial Accounting

14
c. Accounts Receivable at Walgreens
First, make sure we understand the journal entries. If we do not use problem a) from section 1, the
best we can do is:
ACTUAL:
Accounts Receivable (+A)
Net Sales (+R, +SE)

X
X

Cash (+A)
Accounts Receivable (-A)

Y
Y

ALTERNATE:
No entry at delivery
Cash (+A)
Net Sales (+R, +SE)

Y
Y

Starting with the income statement, we see that as we move from the actual to the alternate,
revenues increase by Y and decrease by X. Thus revenues (and NI) increase by Y-X.
Now set up the T-account and solve for the difference between X and Y.
BB
EB

Accounts Receivable (A)

2,167
X Y
2,632

Thus, 2,167 + X Y = 2,632 or X Y = 465.

Net income under actual is 2,450 (from the income statement). Alternate net income is 2,450 + Y X = 2,450 465 = 1,985.
We can also adjust the balance sheet, by writing off the entire (cumulative) amount of accounts
receivable on the balance sheet, and balancing this against a reduction of retained earnings.
This gives us a summary balance sheet at 8/31/13 of
Assets
Liabilities
SE

35,481 2,632
16,027
19,454 2,632

=
=
=

32,849
16,027
16,822

ACCT 5011 Financial Accounting