Posted: April 10th, 2016

Convert the income statements for each of the three years to the accrual basis?

PROBLEM 3-5: Identification of Events With Source Documents

Many events are linked to a source document. Following is a list of events that occurred in an entity.

a. Paid a one-year insurance policy
b. Paid employee payroll
c. Provided services to a customer on account
d. Identified supplies in the storeroom destroyed by fire
e. Received payment of bills from customers
f. Purchased land for future expansion
g. Calculated Taxes Due
h. Entered into a car lease agreement and paid the tax, title, and license.

For each item, indicate if the event should be recorded. Identify one or more source documents generated from the event; which source document would be used to record the event when it produces more than one source document; and identify the information that is most useful in recoding the event in the accounts.

EXERCISE 4-26: Revenue Recognition, Cash and Accrual Basis

Hathaway Health Club sold three-year memberships at a reduced rate during its opening promotion. It sold 1,000 three-year nonrefundable memberships for $366 each. The club expects to sell 100 additional three-year memberships for $900 each over each of the next two years. Membership fees are paid when clients sign-up. The club’s bookkeeper has prepared the following income statement for the first year of business and projected income statements for Years 2 and 3. Cash-basis income statements:

Year 1 Year 2 Year 3
Sales 366000 90000 90000
Equipment* 100000 0 0
Salaries and wages 50000 50000 50000
Advertising 5000 5000 5000
Rent and utilities 36000 36000 36000
Net income (loss) 175000 -1000 -1000
*Equipment was purchased at the beginning of Year 1 for $100,000 and is expected to last for three years and then be worth $1,000.

1. Convert the income statements for each of the three years to the accrual basis.

2. Describe how the revenue recognition principle applies. Do you believe that the cash-basis or the accrual-basis income statements are more useful to management? To investors? Why?