Bus 22 Do. MorsNote: This is a new case for the Twelfth Edition. Approach This is an introductory case and it should be taught as an introductory case. There will be plenty of time in the course for the students to leam the correct form of financial statements and details of accounting standards. In short, the instructor should be prepared to allow a variety of formats for the financial statements and tolerate some “not quite correct” accounting. The instructor may want to have students discuss Carmen's March 31 statement, but the bulk of the class should focus on the three case questions. Any discussion of the March 31 statement should deal with the nature of the various accounts (ie. prepaid rent is rent paid in advance of using the property and it is an asset because it has future economic benefits for the company, ete), rather than the format of the statement, It is better to leave the beginning of the course’s instruction in financial statement formats to the assigned case question discussions. Comments on Information Gathered and Carmen’s Concerns 1. The three month sales total is the sum of the cash sales ($7,400) and credit sales ($320). 2. Cost of sales is derived from the following equation Beginning merchandise inventory Plus Purchases Equals Total available merchandise Less Ending merchandise inventory Equals Cost of sales 3. Rent expense is $1,800 of $600 per month times three months. Paid in cash, 4, Part-time employee expenses ($1600) is the sum of cash paid ($1510) plus amount owed ($90). 5. Supplies expense ($80) is beginning supplies inventory ($100) less supplies inventory on hand on March 31 ($20), 6. The prepaid advertising ($150) was run by the local paper on April 2, The benefit of the asset expired so the asset became an expense, 7. The commercial sewing machine purchase led to an $1800 asset being recorded (a future benefit), The asset’s benefit was partly consumed during May and June resulting in a $60 depreciation charge ($1800/ 5 years/ 12 months x 2 months ~ straight line depreciation.) 8. Some of the future benefits of the computer and related software asset were consumed during the three month period. A $250 depreciation charge must be recognized ($2000/ 2/ 12/ x 3 - straight line depreciation.) 9. Cash balance at the end of period lower than beginning balance. See Question | discussion. 10. Four month’s interest must be recorded on the cousins’ $10,000 loan. ($10,000 x .06 x 4/ 12). Carmen has “rented” the cousins’ money for four months, (She forgot to include the March rent in her March 31 balance sheet.) 11. No depreciation is recorded on the cash register loaned by the local credit-card charge processor and the furniture left by the former tenant, These “assets” were not recognizedon the financial statement because they were neither donated nor acquired in business transactions. 12, The uncle’s legal work is neither an asset nor an expense of the business. It did not result in a business transaction. 13. Carmen’s potential salary payment in July is neither an expense nor a liability as of March 31. The company does not have an obligation on March 31 to pay her any compensation, Question 1 Exhibit 1 presents the company’s initial three month income statement. It does not contain a provision for taxes, since Carmen at this early date did not know if income taxes would be due on the annual results, The principal reasons why the cash balance declined during the three month profitable operating period are: 1. The commercial sewing machine purchase reduced cash by $1,800 while the related depreciation charge only reduced income by $90, 2. Ending inventory was higher than beginning inventory and the increase was paid for with cash, That is, more inventory was bought for cash ($2,900) than the cost of goods sold ($2,100), Exhibit 2 present a cash flow analysis for the three month operating period Question 2 Exhibit 3 presents the company’s June 30 balance sheet. Question 3 ess is off to a good start, but it will have to do better over the rest of the .gful compensations and repay the cousins’ loan at Carmen's bu year if Carmen plans to pay herself any meani the end of the year. When discussing Question 3 some students believe that Carmen should include a consideration of an imputed compensation expense in deciding how well she has done. Students accept the non recognition of her compensation in the income statement, but believe she should recognize that personally she has incurred an opportunity cost for lost wages (at least four months x $1300). In addition, students believe Carmen’s nonrecognition of any cost associated with using the abandoned counters and display equipment overstates how well she is doing from an economic point of view. These students would include some depreciation cost based on the asset's fair value in their evaluation of how “successful” the business has been to date.Some students advocate including the free legal advice’s value ($600) in their assessment of the company’s success to date The instructor may challenge the class to consider why the imputed salary and depreciation) are not included in the company’ ¢ items (free legal advice, income statement. Exhibit 1 Ribbons an’ Bows Income Statement for the Period April I to June 30, 2006 Sales $7,720 Cost of Sales (2,100) Gross Margin $5,620 Employee wages (1,600) Rent (1,800) Office Supplies (80) Depreciation — Computer (250) Depreciation ~ Sewing Machine (60) Interest (200) Advertising (150) Profit before Taxes $1,480 Exhibit 2 Ribbons an’ Bows Analysis of Cash Flows for the Period April 1 to June 30, 2006 Beginning Cash $4,000 Sales 7.400 Wages (1,510) Rent (1,800) Merchandise Inventory (2,900) Sewing Machine (1,800) Ending Cash $3,390Exhibit 3 Ribbons an’ Bows Balance Sheet as of June 30, 2006 sets Liabilities Cash $3,390 Wages owed $90 Accounts receivable 320 Interest owed 200 Merchandise Inventory 4,100 Cousins’ loan 10.000 Supplies 20 $10,290 Prepaid rent 1,200 Owner's Equity Computer (net) 1,750 Carmen's equity $1,000 Sewing machine (net) 1,740 1,480 Cash register deposit 250 2,480, Total 312.770 Total $12.70 Case 1-2: Kim Fuller Note I: This case is updated from the Kim Fuller case in the Eleventh Edition. Note 2: The instructor should be aware that the name, Kim Fuller, could refer either to a male or a female, The case uses no pronouns that indicate gender to refer to Kim Fuller; the gender of Kim Fuller has been left open to interpretation by the students andor the instructor. Approach ‘This case is not, as it may appear to be, an “armchair” case. It isa real situation-the case writer is one of “Kim Fuller's” (disguised name) sisters who invested in the business. The intent of the case is to get students to begin thinking about the financial information needs of a business and what kinds of underlying records must be maintained in order to support those needs. Some instructors may even wish to discuss the nature of the required source documents, since we often tend to ignore that important matter in accounting courses. Finally, the case can be used to begin introducing at an intuitive level some of the 11 basic concepts that will be presented in Chapters 2 and 3. Comments on Questions An opening question might be, “What information does Kim Fuller need to maintain in order to operate this business?” Then, as students begin to identify information needed, the instructor can press for, “Who needs that information? What do they need it for?” The information needed, as well as the users and uses can be recorded on the blackboard, The diagram in Illustration 1-1 of the text can be used to summarize for students the variety of information and purposes they have identified. As suggested in the text, this information includes such things as detailed payroll records for Fuller's employees, records of deliveries (which are sales) to Puller's customer and former employer, the chemical firm, and the amounts awed for these sales, records concerning purchases of used plastic bottles and the amounts owed to the sources of 10Exhibit 3 Ribbons an’ Bows Balance Sheet as of June 30, 2006 Assets Liabilities Cash $3,390 Wages owed 390 Accounts receivable 320 Interest owed 200 Merchandise Inventory 4,100 Cousins” loan 10.000 Supplies 20 $10,290 Prepaid rent 1,200 Owner’s Equity Computer (net) 1,750 Carmen’s equity $1,000 Sewing machine (net) 1,740 Earnings Cash register deposit 250 Total Total Case 1-2: Kim Fuller Note fi This case is updated from the Kim Fuller case in the Eleventh Edition. Note 2: The instructor should be aware that the name, Kim Fuller, could refer either to a male or a female, The case uses no pronouns that indicate gender to refer to Kim Fuller; the gender of Kim Fuller has been left open to interpretation by the students and/or the instructor. Approach This case is not, as it may appear to be, an “armchair case. It is a real situation-the case writer is one of “Kim Fuller's” (disguised name) sisters who invested in the business. The intent of the case is to get students to begin thinking about the financial information needs of a business and what kinds of underlying records must be maintained in order to support those needs. Some instructors may even wish to discuss the nature of the required source documents, since we often tend to ignore that important matter in accounting courses. Finally, the case can be used to begin introducing at an intuitive level some of the II basic concepts that will be presented in Chapters 2 and 3, Comments on Questions An opening question might be, “What information does Kim Fuller need to maintain in order to operate this business?” Then, as students begin to identify information needed, the instructor can press for, “Who needs that information? What do they need it for?” The information needed, as well as the users and uses can be recorded on the blackboard. The diagram in Illustration 1-1 of the text ean be used to summarize for students the variety of information and purposes they have identified. As suggested in the text, this information includes stich things as detailed payroll records for Fuller's employees, records of deliveries (which are sales) to Pullers customer and former employer, the chemical firm, and the amounts owed for these sales, records conceming purchases of used plastic bottles and the amounts owed to the sources of 10MARVIN COMPANY, BALANCE SHEET AS OF JANUARY 31, ~ Assets Liabilities Cash Accouints payable. Accounts receivable, Total current liabilities. Inventory sons Current assets Notes payable Land. Total liabilities Prepaid insurance. Owner’s Equity Capital Retained earnings... Total assets. ‘585,200 Total liabilities and owners’ equity. Problem 2-6 BRIAN COMPANY CURRENT ASSETS AND LIABILITIES AS OF DECEMBER 31, —- Current Assets Current Liabilities Cash oe $ 2,000 Accounts payable. Marketable securities... 3,500 Wages payable... Accounts receivable, 7,000 Bonds due ~ current portion . Current assets . Current liabilities. Current ratio =... $12,500 +$8,50 The current ratio is an indication of an entity’s ability to meet its current obligations, Cases Case 2-1: Maynard Company (Aj Note: This case is unchanged from Eleventh Edition, Answers to Questions Question 1 ‘Two suggested balance sheets as required by Question 1 are shown below. Question 2 $5,000 1,500 2,000 $8,500 This question provides an opportunity for students to step back and think about the information in a financial statement, rather than focusing on the details of constructing a financial statement. Students can begin to analyze and use the information that the financial statements contain, Students can be asked to identify which accounts have changed significantly between the beginning and ending balance sheets, ‘These would include accounts receivable, note receivable, equipment, accounts payable, taxes payable, and the bank note payable, in addition to the cash account. The only ratio explained in Chapter 2 of the text is the current ratio, so students should be encouraged to ascertain what has happened to the current ratio between June 1 and June 30, Cash has increased largely due to increased accounts and notes payable, as well as eash generated by operations. Cash appears to have been inereased by the collection of 20 oe,the note receivable, but as explained in Question 3 below, this was offset by the declaration of an identical dividend, so that the net effect on cash of these two transactions was zero. Equipment purchases were a major use of cash, As a result of these events, the June 30 current ratio has fallen to 2.15 from its June | level of 4.35. Even though the leverage ratios have not yet been introduced in the text, the instructor might want fo encourage students to observe that the proportion of liabilities on the right-hand side of the balance sheet has increased, with a complementary decrease in the proportion of equities. The capitalization ratio Total Liabilities/Total Liabilities + Equities has increased from 4% on June 1 to 9% on June 30. While these ratios are still very low, students can be made aware of the importanee of identifying trends early Question 3 Retained Eamings has not increased by the amount of net income for the month, $19,635, since Diane Maynard as the sole shareholder declared a dividend of $11,700, which she then used to cancel her loan of $11,700 from the company. Hence, Retained Earnings increased by $7,935 during the month of June Question 4 This question is intended to emphasize early in the course that shareholder's equity does not necessarily reflect what the entity is worth, Time permitting, the instructor can have students estimate the cash proceeds of piecemeal sale of the assets by a liquidation company, which, net of liabilities, will certainly be less than $619,446. Then the value of the company as a going concern can be discussed; if June's $19,635 net income is typical, the firm would be worth more than $619,446 as a going concem. Capitalizing June's net income on an annual basis ($19,635 x 12) at 10 times earning gives the company a value in excess of $2 million. The company’s return on equity is very high. On an annual basis it may be as high as 32%. This figure is 12 months" income ($19,635 x 12) divided by projected year-end equity (8619,446 + $19,635 x 6). This is not a typical business. It is better. Gere! MAYNARD COMPANY BALANCE SHEETS AS OF JUNE 1 AND JUNE 30 Assets Current Assets: As of June I As of June 30: Cash... vs al $ 34,983 $ 66,660 Accounts receivable .. 21,798 26,505 Note receivable..... 11,700, 0 Merchandise inventory 26,520 Supplies on hand 6,630 Prepaid insurance 2.826 Total current assets... $107,025 $129,141 Noncurrent assets: Land. : : 89,700 89,700 Building. : 585,000 585,000 Less: Accumulated depreciation.. (156,000) 429,000 (157,950) 427,050 ae Equipment. 13,260 36,660 Less: Accumulated depreciation... 5.304) 7,956 5,928) 30,732 Other noncurrent assets : 4.85 es65 Total noncurrent assets a "531,513 352.747 SO8LB8S, Total assets“ Liabilities cand Shareholders’ Equity Current liabilities Accounts payable. : $8,517 Bank notes payable. : . 8,385 ‘Taxes payable . — 5,700 Accrued wages payable sos _1.974 Total current liabilities. Other noncurrent liabilities Total liabilities nnn Shareholders” Equity Capital 00K oneness = 390,000 390,000 Retained earnings . 221,511 2 Total shareholder's equity a 61S Total liabilities and shareholders? equity 1038.538 Case 2- Musie Mart, Ine. Note: This case is mchanged from the Eleventh Edition. Approach This is a valuable type of problem. The student is in effect analyzing, journalizing, and posting transactions without knowing the technicalities, and hence without being encumbered by them. Some instructors prefer to make up similar transactions and give them in class, rather than, or in addition to, using the set given in this problem. If students can handle these events comfortably, they really Understand the essentials of the balance sheet and of the balance sheet equation, They are urged to cross out old balances, rather than erasing them, both because this aids in tracing errors, and because this is analogous to what is done in the ledger. Preservation of the underlying equation in each transaction and the balance sheet should be emphasized throughout For the accounts already established (¢.g., Notes Payable), students should use the identical wording. This helps avoid sloppy habits when they start to joumnalize lafer on. For new accounts (e.g., Mortgage Payable), they should be given latitude in selecting a title, but having selected one, they must stick to it.MUSIC MART, INC. BALANCE SHEET AS OF Assets Liabilities and Owners’ Equity Current assets Current liabilities: Cash | bosece Notes payable :sercnnne sme $ 6,500 Accounts receivable 2,620 Accounts payable snes 0 Inventory 4,700 ‘Total current liabilities... 11,500 Prepaid insurance nuenennnennns 1,224 Total eurrent assets... sso 34,180 Other liabilities: Mortgage payable. 9,000 Total liabilities 20,500 Owners’ equity Property: ie 25,000 Land 12,000 Retained earnings. 680 ‘Total assets $46,180 Total liabilities and owners’ equity... $46,180 Answers to Questions 1. Increase Inventory, $5,000; increase Accounts Payable, $5,000 2. Decrease Inventory, $1,500; increase Cash, $2,300; increase Retained Earnings, $800 3. Decrease Inventory, $1,700; increase Accounts Receivable, $2,620; increase Retained Eamings, $920. (Note that Retained Earnings increases whether or not the proceeds of the sale are received in cash.) 4. Increase Prepaid Insurance (or similar), $1,224; decrease Cash, $1,224 (Note that current practice is to treat this as a current asset even though the policy is in effect three years; the basis is materiality.) Increase Land, $24,000; decrease Cash, $6,000; increase Mortgage payable (noncurrent), $18,000 (In view of what happens subsequently, it can be argued that the land is a current asset, or that $12,000 of it is. It depends on whether Smith plans to retain or to sell it. This point should be brought out, to avoid the tendency to classify land as a fixed asset without thinking.) 6. Increase Cash, $3,000; decrease Mortgage Payable, $9,000; decrease Land, $12,000 Note the decrease in the liability even though it was not “paid off” in cash.) 7. No entry. Goodwill is recognized only when it is paid for. 8, Decrease Retained Earnings, $1,000; decrease Cash, $1,000, 9. Decrease Retained Earnings, $750; decrease Inventory, $750. (Note the basic similarity between #8 and #9; the equity of Smith in the business decreases whenever he, as an individual, takes out assets of the business. Students can of course handle this with a drawing account if they wish to get fancy.) 23 1,with the basic principle of value. I think students who argue for appreciation are on weak ground. They have no support from the text. This, together with #6 may be used to contrast accounting with what some would say is the “common sense” ot “logical” way to record the events, although it is too much to expect that the arguments in favor of the cost basis of valuation will be fully comprehended at this point. 10. No enuy, in accordan 11. Decrease Notes Payable, $6,000; decrease Cash, $6,000, 12, No entry, This is not a transaction of the corporation, but rather a transaction between two outside parties, Note also that the book value of the equity is not changed, even though there is clear evidence that book value is less than market value or “real” value. 13. Decrease Inventory, $850; increase Cash, $1,310; increase Retained Earnings, $460, The final balance sheet is shown on the previous page, classified in perhaps more detail than is warranted for this simple set of items. Lone Pine Cafe (A, Note: This case and its sequel in Chapter 3 are unchanged from the Eleventh Edition. PINE CAFE, BALANCE SHEET AS OF NOVEMBER 2, 2005 Assets Current assets: Cash... $10,172 Inventory 2,800 Prepaid expense L428 Total current assets. $14,440 Cafe equipment. 54,600 Total assets — ‘869.000 Liabilities and Owners' Equity Note payable... $21,000 Owners” equity Mrs. Landers. $16,000 Mr. Antoine... 16,000 Mrs. Antoine... eee 16,000 _48,000 Total liabilities and owners” equity’... 369,000 24 18,Next, prepare balance sheet: Assets Liabilities Current assets (850,000 x 1.6)... $80,000 Current liabilities $50,000 Other assets Long term debt 40,000 ($218,182 - $50,000) 138,182 Total liabilities nee $90,000 Owners’ equity Beginning balance nn $120,000 Plus net income Ending balance Total liabilities Total assets $218,182" and owners’ equity Total assets = Total liabilities and Owner"s equity. Problem 3-9 Sales LC 26,666,667 [LC 20,000,000 x (200/ 150)] January cash LC 1,000,000 [LC 500,000 x (200 / 100)] December cash LC 600,000 At year-end the company was more liquid in terms of nominal currency (LC 600,000 versus LLC 500,000) but in terms of the purchasing power of its cash it was worse off (LC 1,000,000 versus LC 600,000). Cases ard Company (B) May Note: This case is unchanged from the Eleventh Edition. as Question 1 See below. Question 2 This question brings out the difference between cash accounting and accrual accounting, Cash increased by $31,677 whereas net income was $19,635. Explaining the exact difference may be too difficult at this stage, but students should see that 1. The bank loan, a financing transaction, increased cash by $20,865 but did not affect net income. Cash collected on credit sales made last period ($21,798) also increased cash, but did not affeet net income this period. (The same is true of the collection of the $11,700 note receivable from Diane Maynard, but it was offset by the payments of the $11,700 dividend to Diane Maynard, the sole shareholder.)MAYNARD COMPANY. INCOME STATEMENT, JUNE Sales (844,420 cash sales + $26,505 credit sales) $70,925 Less: Cost of sales * 39,345, Gross Margin 31,580 Expenses Wages($5,660+$2,202-$1,974) $5,888 Utilities... = : 900 Supplies (§5,5591S1,671-86,630) 600 Insurance($3, 150-$2,826) wun» 324 Depreciation (8157,950-8156, 000) (85.926 -$5,304). 2,574 Miscellaneous 1. = 135 Income before income tax Trcome tx expense (57,224 $5,700). ‘Net Income Less: Dividends, Increase in retained earnings *Cost of sales: ‘Merchandise purchased for cash... $14,715 ‘Merchandise purchased on credit. 21,315 [821,315+($8,517-$8,517)] Inventory, June 1... 29,835 Total goods available during JUMC....esnn 65,865 Inventory, June 30... ee 26,520 Cost of Sales. $39,345 3. The purchase of equipment (823,400) and other assets ($408) decreased cash but did not affect net income (at least not by this full amount) this period, 4, Credit sales made this period ($26,505) increased net income, but did not affect cash. 5. Noncash expenses such as depreciation ($2,574) and insurance ($324) decreased net income but did not affect cash as they relate largely, if not wholly, to eash outflows made for asset acquisition in prior petiods. (Exception: such expenses on an entity’s first income statement are not related to prior period expenditures but they will be a much smaller amount than the frst accounting period’s expenditures. Question 3 (a) $14,715 is incorrect because it is the amount of eash purchases rather than the cost of sales. ‘The cost of cash purchases and cost of sales amounts would be equal for a period in which all purchases were for cash, and in which the dollar amount of beginning inventory was the same as the dollar amount of ending inventory, since Cost of Sales = Beginning Inventory + Purchases - Ending Inventory. (b) $36,030 is the sum of cash purchases ($14,715) and credit purchases ($21,315). As explained above, purchases equal cost of sales for the period only if beginning and ending inventory amounts are the same. 21Case 3-2: Lone Pine Café (By Note: This cave is updated front the Eleventh Edition. Approach This ease introduces students to preparation of an income statement based on analyzing transactions, At this stage, students are not expected to set up accounts in the formal sense. However, in effect they do so for those income statement items that did not coincide exactly with cash flows. Question I A suggested income statement as required by Question 1 is shown below. The following notes apply to the income statement. The student needs to refer back to Lone Pine Café (A) in order to construct the income statement fn the acerual basis. Amounts for sales on credit, purchases on credit, beginning and ending inventory, beginning and ending prepaid operating license, and depreciation expense are to be found there. Specifically: a. Sales revenues = $43,480 cash sales + $870 credit sales to ski instructors = $44,350, b. Food and beverage expense credit purchases - $2,430 ending inventory $2,800 beginning inventory + $10,016 cash purchases + $1,583 11,969. 2. Since the entity is unincorporated, it is also correct (though less meaningful for evaluative purposes) to treat the $23,150 partners’ salaries as owners” drawings. This treatment would result in an income of $12,296 and a decrease in equity (after drawings) of $10,854, LONE PINE CAFE (B) INCOME STATEMENT FOR NOVEMBER 2, 2005, THROUGH MARCH 30, 2006 Sales $44,350 Expense Salaties to partners . - $23,150 Part-time employee wages.. 5,480 Pood and beverage supplies 1,969 Telephone and electricity... 3,270 Rent expense. 7.500 Depreciation 2,445 Operating license expense 595 Interest 540 Miscellaneous ex; 255 Total expenses. (Loss).CALE 4-1 Comments on Questions Question 1 Students should describe each transaction along the Lines: ‘Barbara Thompson started PC Depot by investing $65,000 of her own money and $160,000 borrowed from the bank, so her initial cash balance ‘was $165,000." Question 2 (These accounts are shown under question 3.) Question 3 9) (10) qi) (2) 3) (4) as) (16) ay (18) a9) 20) General Journal (cont'd) Cash Sales Accounts Receivable. Sales. Cash : Accounts Receivable Accounts Payable. Cote Merchandise Inventory . ‘Accounts Payable.. Cost of Sales... ‘Merchandise Inventory. Wages Expense... Cash. Wages Expense Accrued Wages Prepaid Rent Cash, Prepaid Insurance. Cash, . Utilities Expense... Accounts Payable, Furniture and Fixtures. Cash. Accounts Payable. 55 38,000 14,850 3.614 96,195 49,940 38,140 688 440 1,485 2,310 226 1,760 38,000 14,850 3,614 96,195 49,940 38,140 688 440 1,485 2,310 226 660 1,100PC DEPOT Balance Sheet as of September 30 Assets Cash oe $84,661 Accounts receivable. 11,236 Merchandise inventory 149,300 Prepaid insurance, - 2.117 Prepaid rent. — . : so 1,485 Furniture and fixtures nn vee $17,260 Accumulated depreciation Total Assets C144) 17,16 Liabilities ant Owners? Accounts payable. : — $92,571 Accrued wages .. - — = 440 Bank loan payable 100,000 Interest payable. 1,250 Proprietor’s capital 65,000 Retained earnings .. 6.654 Total Liabilities and Owners’ Equity PC DEPOT. Income Statement for September $52,850 38.140 SAleS scene Cost of sales. Gross margin... 14,710 Expenses: Wares. $2,063 Advertising 1,320 Office supplies 1,100 Utilities. 501 Rent... 1.485 Insurance. 193, Interest 1,250 Depreciation... 44 _ 8.056 Net income 56LEDGER — Cash Merchandise Inventor a) 165,000 | (2) @ 137,500 | (14) 38,140 O) 38,000 | (4) (3) 49,940 | a 3,614 | (5) 6) a : Accouits Payable 8) (2) 96,195 | G) 137,500 (12) 96,195 (3) 49,940 (3) 688 (9) 226 1,485 (20) 1,100 2.310 660 Accrued Wages (6) 440 Prepaid Insurance - a8) 2,310 | (23) 193 Bank Loan Payable Furniture and Fixtures o 100,000 Capital @ 5,500 a 20) 1,760 w@ 65,000 Accounts Receivable : (0) 14,850 | (11) 3614 id Rent a7) ——___Rent Expenses @ 1,485 les = 4) 32,850 | (9) 38,000 Advertising Expense (10) 14,850 @ 1,320 Cost of Sales Wages Expense i) 38,140 © 935 (is) 688 Depreciation Expense (16) 440 @D 144 Office Supplies Expense Accumulated Depreciation @M 1,100 | Ql) 144 Utilities Expense Interest Payable - (8) 215 (22) 1,250 (9) 226 | 31Insurance Expense ___ Interest Expense 3) 193] 2) 1,250 | Retained Earnings Income Summa i (25) 6,654] 4) «52,850 I (other closing entries i not shown here) Question 4 Other adjusting entries: (21) Depreciation Expense (($15,500 + $1,760) / 10]/ 12. 144 | ‘Accumulated Depreciation .. : M44 (22) Interest Expense ($100,000 x 15%) / 12).. 1,250 | Interest Payable 1,250 | (23) Insane: Expense § 2310/12). 193 Prepaid Insurance 193 | Postings to the ledger are shown under Question 3. Note that five additional T accounts, not required for | entries (1) - (20), must be created in order to post these adjusting entries. | Question 5 For reasons of space, we shall illustrate only one of the entries closing the temporary accounts, plus the final closing entry: | (24) Sales. 52,850 | Income Summary 52,850 (25) Income Summary’... 6,654 i Retained Earnings, 6,654 Note that two more T accounts have been created for the closing process, Question 6 ' ‘The statements appear above. | Case 4-2: Save-Mart | Note: This case is unchanged from the Eleventh Edition, | Approach This is a straightforward problem in making adjusting and closing entries, Students may raise the | Possibility of recording social security taxes on accrued sales salaries; this has not been done in the ‘accompanying solution, 58are interpretable with great precision. They are most meaningful iftcaleulated for the same company over a period of years, ¢, Days’ receivables = Net receivables / (Credit sales / 365) = $32,800 / ($323,400 x .77/ 365). = 48 days, some analysts use total sales lculation is correct. The result This ratio measures the average collection period of receivables. Althou: (often because the portion of credit sales is not disclosed), the above suggests that GRW's customers are stretching the payment period. Cases Approach This case is designed to give practice in handling the various transactions for accounts receivable and bad debts. There ean be differences of opinion, particularly about the treatment of bad debts recovered, but the objective is to understand the process, and I do not think it is important to get agreement as to the “one best method” (if there is such a thing). This is not a full assignment by itself, but is if taken together with study of the text ‘Comments on Questions Question 1 1. Accounts Receivable 9,965,575 Sales, 9,965,575 2. Cash : 9,685,420 Accounts Receivable ... . 9,685,420 3. Allowance for Doubtful Accounts 26,854 Accounts Receivable... 26,854 ts receivable, assuming that the account on the balance (Entries would also be made to speci sheet is a control account.) 4, Debit Cash $3,674 ($2,108 for one account and $1,566 as partial payment on another). The rest of the transaction could be handled in one of three different ways: (a) Credit Allowance for Doubtful Accounts $4,594 ($2,108 for account collected in full and $2,486 for account collected in part with reasonable assurance of future collection of remainder), and debit Accounts Receivables $920 (for balance of account partially collected). This is preferable, (b) Credit Bad Debt Expense $3,674 ($2,108 + $1,566). (c) Credit some “Other Income” account $3,674. The calculation of the Allowance for Doubtful Accounts and Accounts Receivable depends upon which of the alternatives was employed in handling the collection of written-off accounts in 4 above. Under (a), the Accounts Receivable remaining on the books at the end of 2006 is ealeulated as follows:Accounts Receivable, December 31, 2005 ‘Add inerease to A/R from sales on account during 2006 Less decrease to A/R for accounts for which payment was received during 2006 Less accounts written off in 2006 $1,241,5: ‘Add that portion still due on previously written-off account which was paid in part in 2006 with reasonable assurance of 920, future payment of the payment of the remainder. 31,242,478 ‘The bad debt expense is 0.3 percent * $1,242,478 = $37,274. The entry, therefore, would be: Bad Debt Expense... a 29,886 Allowance for Doubtful Accounts... 29,886 The Allowance for Doubtful Accounts remaining on the books at the end of 2006 is calculated as follows: Allowance for Doubtful Accounts, December 31, 2005 vue $29,648 Less Accounts Receivable written off in 2006. 26,854 2,794 Add increase to Allowance for Doubtfisl Accounts for previously written-off accounts which were collected du 4594 the year or deemed collectible in the future... Balance in account... S Add additional bad debt expense needed . Total allowance for Doubtful Accounts, December 31, 2006. $37,274 ‘The Allowance for Doubtful Accounts remaining on the books at the end of 2006 is calculated as follows: Under (b) or (¢), in the calculation of Accounts Receivable: the last step in the calculation above is eliminated, thus leaving an Accountings Receivable balance of $1,241,558. ‘The Bad Debt Expense is calculated and recorded the same as shown above. The Allowance for Doubtful Accounts remaining on the books as the end of 2006 is calculated as follows: Allowance for Doubtfis! Accounts, December 31, 2005... $29,648 Less Accounts Receivable written off in 2006 sure 26.854 Balance in account... $2,794 Add additional bad debt expense ...cscsnneneneneninn Total Allowance for Doubtful Accounts, December 31, 2006 Question 2 Using (a) Using (b) or (c) Balance of accounts as of December 31, 2006: Accounts Receivable . fee $1,242478 $1,241,558 Less allowance for doubtful accounts... 37,274 37.247 $1,205,204 $1,204,311 74 Bh