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Case 1-1: Ribbons all' Bows, Inc.



Note: This is a nell' case/or 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 learn 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 (i.e. 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 , etc), rather than the format of the statement. It is better to leave the beginning of the course's instruction i 11 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 ofthe cash sales ($7,400) and credit sales ($320).

2. Cost of sales is derived from the following equation

Beginning merchandise inventory $3,300

Plus Purchases 2.900

Equals Total available merchandise $6,200

Less Ending merchandise inventory 4,100

Equals Cost of sales t1lQQ

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 ($18001 5 yearsl 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 ($20001 21 121 x 3 - straight line depreciation.)

9. Cash balance at the end of period lower than beginning balance. See Question 1 discussion.

10. Four month's interest must be recorded on the cousins' $10,000 loan. ($10,000 x .06 x 41 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

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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 docs 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 How analysis for the three month operating period.

Question 2

Exhibit 3 presents the company's June 30 balance sheet.

Question 3

Carmen's business is off to a good start, but it will have to do better over the rest of the year if Carmen plans to pay herself any meaningful compensations and repay the cousins' loan at 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).

Tn 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.

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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 these items (free legal advice, imputed salary and depreciation) are not included in the company's income statement.

Exhibit 1

Ribbons an' Bows Income Statement for the Period April 1 to June 30, 2006

Sales

Cost of Sales Gross Margin Employee wages Rent

Office Supplies

Depreciation - Computer Depreciation - Sewing Machine Interest

Advertising

Profit before Taxes

Exhibit 2

$7,720 (2,100) $5,620 (1,600) (1,800)

(80) (250) (60) (200) (150) $1.480

Ribbons an' Bows

Analysis of Cash Flows for the Period April 1 to June 30, 2006

Beginning Cash Sales

Wages

Rent

Merchandise Inventory Sewing Machine Ending Cash

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$4,000 7,400 (l ,510) (1,800) (2,900) (1.800)

$1,390

Exhibit 3

Ribbons an' Bows Balance Sheet as of June 30, 2006

Assets 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 Eguity
Computer (net) 1,750 Carmen's equity $1,000
Sewing machine (net) 1,740 Earnings 1,480
Cash register deposit 250 $2,480
Total 112,I2Q Total 112,270 Case 1-2: Kim Fuller

N otel: This case is updated from the Kim FIdler 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 110 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 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 I-I 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 Fuller's customer and former employer, the chemical firm, and the amounts owed for these sales, records concerning purchases of used plastic bottles and the amounts owed to the sources of

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Exhibit 3

Ribbons an' Bows Balance Sheet as of June 30, 2006

Assets 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 Eguitv
Computer (net) 1,750 Carmen's equity $1,000
Sewing machine (net) 1,740 Earnings L480
Cash register deposit ___22Q $2A&_Q
Total ~12,7IQ Total $J2,7LQ Case 1-2: lam Fuller

Note 1: This case is updated from the Kim Fuller case in/he Eleventh Edition.

Note 2: The instructor should be aware that the name, Kim Fulfer, 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 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- I 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 Fuller's customer and former employer, the chemical firm, and the amounts owed for these sales, records concerning purchases of used plastic bottles and the amounts owed to the sources of

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Assets

MARVIN COMPANY

BALANCE SHEET AS OF JANUARY 31, ----.

Liabilities

Cash .

Accounts receivable .

JnventoIY··········································

Current assets .

Land .

Prepaid insurance .

$12,500

3,400 46,500 62,400 20,000

2,800

Notes payable ~2Q.OOO

Total liabilities 27,000

Owner's Equity Capital.......................................... 55,000

Retained earnings 3,20~Q

Total liabilities

and owners' equ ity $B5~2~OQ

Accounts payable ;L7000

Total current liabilities................. S7,OOO

Total assets ..

18 .. i,200

Problem ~-6

BRIAN COMPA . .J.~Y

CURRENT ASSETS AND LIABILITIES AS OF DECEMBER 31, ----.

Current Assets

Cash $ 2,000

Marketable securities........................ 3,500

Accounts receivable.......................... 7000

Current assets ~ 12.500

Current Liabilities

Accounts payable ..

Wages payable .

Bonds due - current portion ..

Current liabilities ..

$5,000 1,500 2,000 $8.50Q

Current ratio = $ J 2,500 ;;-$8,500 = 14Z

The current ratio is an indication of an entity's ability to meet its current obligations.

Cases

Case 2-1: IHaFnard Compau)! G4)

Note: This case is unchanged front Eleventh Edition.

Answers to Questions Question J

Two suggested balance sheets as required by Question 1 are shown below.

Question 2

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 CUITcnt ratio between June 1 and June 30. Cash has increased largely due to increased accounts and notes payable, as well as cash generated by operations. Cash appears to have been increased by the collection of

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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 fallcn to 2.15 fi·om its June 1 level of 4.35. Even though the leverage ratios have not yet been introduced in the text, the instructor might want to 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 importance of identifying trends early.

Question 3

Retained Earnings 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 $11 ,700, which she then used to cancel her loan of$II,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 I iabilities, 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 finn would be worth more than $619,446 as a going concern. 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 ($619,446 + $19,635 x 6). This is not a typical business. It is better.

MAYNARD COl\1PANY

BALANCE SHEETS AS OF .JUNE 1 AND JUNE 30

Assets

Current Assets:

Cash .

Accounts receivable .

Note receivable .

Merchandise inventory .

Supplies on hand .

Prepaid insurance .

Total current assets .

Noncurrent assets:

Land .

Building .

Less: Accumulated depreciation .

Equipment .

Less: Accumulated depreciation .

Other noncurrent assets .

Total noncurrent assets .

Total assets .

As of June I

As of June 30:

$ 34,983 21,798 11,700 29,835

5,559 3 150

$ 66,660 26,505 o 26,520 6,630 2826

$107,025

$129,141

89,700

585,000 Q560(0) 13,260 5 304)

585,000 ( 157,950) 36,660

( 5,928)

429,000

427,050

7,956 __1,857 53] 513

$63&j~J~

30,732 5265 552747 $681.888

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89,700

Liabilities and Shareholders' Equity

Current liabilities:

Accounts payable .

Bank notes payable .

Taxes payable .

Accrued wages payable .

Total current liabilities .

Other noncurrent I iabil ities .

Total liabilities .

Shareholders' Eqlli()':

Capital stock .

Retained earnings .

Total shareholder's equity .

Total liabilities and shareholders' equity ..

Case 2-2: Music !lforl, Inc.

Note: 771is case is unchanged from the Eleventh Edition.

$8,517 8,385 5,700 1.974

$ 21.315 29,250 7,224 ~2,202

$ 24,576 _2451 27,027

1> 59,991 2,451 62,442

390,000 27] ,51 I

390,000 22.2,446

__ill__,_iU ~5J8.

6 19446 $681,888

---- .. -~-/

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 establ ished (e.g., Notes Payable), students should use the identical word ing. Th is helps avoid sloppy habits when they start to journalize later on. For new accounts (e.g., Mortgage Payable), they should be given latitude in selecting a title, but having selected one, they 111Ust stick to it.

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MUSIC MART, INC.

BALANCE SHEET AS OF

Assets

Current assets:

Cash .

Accounts receivable .

Inventory .

Prepaid insurance .

Total current assets .

Liabilities and (AI'17ers' Equity Current liabilities:

Notes payable ..

Accounts payable .

Total current liabilities ..

$25,636 2,620 4,700 I 224

34,180

$ 6,500 5,000 11,500

Other liabilities:

Mortgage payable ..

Total liabilities ..

Owners' equity

Paid-in capital ..

Retained earnings .

Total liabilities

and owners' equity $.4.6.,__180

9000 20,500

Property:

Land .

Total assets .

25,000 680

12,000 .$_46,ELQ

Answers to Questions

I. 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 Earnings, $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.)

5. 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 Earn ings, $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.)

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10. No entry, in accordance with the basic principle of value. I think students who argue for appreciation are 011 weak ground. They have no support fl'0111 the text. This, together with #6 may be used to contrast accounting with what some would say is the "C0I111110n sense" or "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.

I I. 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.

Case 2-3: Lone Pine Cafe (4)

Note: This case and its sequel in Chapter 3 are unchanged from the Eleventh Edition.

I_,ONE P]NE CAFE

BALANCE SHEET AS or NOVEMBER 2, 2005

Assets

Current assets:

Cash .

Inventory .

Prepa id expense .

Tota I current assets .

Cafe equipment. .

Total assets .

Liabilities and Owners' Equity

Note payable .

$10,172 2,800 1,428

$14,440 54,600 $iJ9.000

$21,000

OHJl1erS ' equity: .

Mrs. Landers .

Mr. Antoine .

Mrs. Antoine .

Total liabilities and owners' equity .

$16,000 16,000 16,000

48000 $62~000

--_._. __ .. _---

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Next, prepare balance sheet:

Assets Current assets

($50,000 x 1.6) $ 80,000

Other assets

($218,182 - $50,000) 138,182

Liabilities

Current liabilities .

Long term debt

$ 50,000 40,000

Total liabilities ..

s 90,000

Total assets $218,182+

Owners' equity

Beginning balance .

Plus net income '" .

Ending balance ..

Total liabilities

and owners' equity $2J 8,182

$120,000 8,182 ,$128,182

+ T~tal 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)]

Decem ber cash LC 600,000

At year-end the company was more I iquid in terms of nominal currency (LC 600,000 versus LC 500,0(0) but in terms of the purchasing power of its cash it was worse off (LC 1,000,000 versus LC 600,000).

Cases

Case 3-1: l11al'I1ard Compall)! (B)

Note: This case is unchanged front the Eleventh Edition.

Question I

See below.

Question 2

This question brings out the difference between cash accounting and accrual accounting. Cash increased by $3 J ,677 whereas net income was $19,635. Explaining the exact difference may be too difficult at this stage, but students should sec that:

I. The bank loan, a financing transaction, increased cash by $20,865 but cliclnot affect net income.

Cash collected on credit sales made last period ($21,798) also increased cash, but did not affect 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 tile $1 1,700 dividend to Diane Maynard, the sale shareholder.)

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MA YNARD COMPANY INCOME STATEMENT, JUNE

Sales ($44,420 cash sales + $26,505 credit sales) ..

Less: Cost of sales * .

Gross Margin .

Expenses

Wages($5,660+$2,202-$1 ,974) .

Utilities .

Supplies ($5,559+$1 ,671-$6,630) .

Insurance($3, 150-$2,826) .

Depreciation ($157,950-$156,000)+($5,928-$5,304) .

Miscellaneous .

Income before income tax .

Income tax expense ($7,224 - $5,700) .

Net JI1C0111e .

Less: Dividends .

Increase in retained earnings ..

2.

*Cost of sales:

Merchandise purchased for cash ..

Merchandise purchased on credit. ..

Inventory, June 1 .

'Total goods available during June .

Inventory, June 30 .

Cost of Sales ..

$70,925 39.345 31,580

$5,888 900 600

324 2,574 ___l_22

10,421 21,159 1.524 ]9,635 11.700 $ 7.935

$14,715 21,315 29.835 65,865 26,520

$39,345

[$21,315+($8,517 -$8,517)]

3. The purchase of equipment ($23,400) and other assets ($408) decreased cash but did not affect net income (at least 110t 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 cash outflows made for asset acquisition in prior periods. (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 first accounting period's expenditures.

Question 3

(a) $14,715 is incorrect because it is the amount of cash 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 ofbeginning 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.

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Case 3-2: Lone Pille Care eE)

Note: Thiscase is updatedfront the Eleventh Edition.

Approach

This case 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 I is shown below. The following notes apply to the income statement.

1. The student needs to refer back to Lone Pine Cafe (A) in order to construct the income statement on the accrual 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 = $43/180 cash sales + $870 credit sales to ski instructors = $44,350.

b. Food and beverage expense = $2,800 beginning inventory + $1 O,OJ 6 cash purchases + $1,583 credit purchases - $2,430 ending inventory = $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 all income of $12,296 and a decrease in equity (aftcr clrawi ngs) of $10,854.

LONE PINE CAFE (B)

INCOME STATEMENT FOR NOVEMBER 2, 2005, THROUGH MARCH 30, 2006

Sales .

Expenses:

Salaries to partners '" ..

Part-time employee wages ..

Fooel and beverage supplies ..

Telephone and electricity .

Rent expense .

Depreciation .

Operating license expense ..

J merest ..

Miscellaneous cxpenses .

Total expenses .

(Loss) ..

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$ 44,350

$23,150

5,480 11,969 3,270 7.500 2,445

595 540 255

55,204 $( I 0,8_5_il

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 $100,000 borrowed from the bank, so her initial cash balance was $165,000."

Question 2

(These accounts are shown under question 3.)

Question 3

General Journal (conr'd)

(9) Cash .

Sales .

(10) Accounts Receivable ..

Sales .

(11) Cash .

Accounts Receivable .

(12) Accounts Payable .

Cash .

(13) Merchand ise Inventory ..

Accounts Payable .

(14) Cost of Sales ,

Merchandise Inventory ..

(15) Wages Expense .

Cash .

(16) Wages Expense ..

Accrued Wages .

(17) Prepaid Rent. .

Cash "

(18) Prepaid Insurance .

Cash ..

(19) Utilities Expense ..

Accounts Payable "

(20) Furniture and Fixtures ..

Cash ..

Accounts Payable ~ "

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38,000
38,000
14,850
14,850
3,614
3,614
96,195
96,195
49,940
49,940
38,140
38,140
688
688
440
440
1,485
1,485
2,310
2,310
226
226
1,760
660
1,100 PC DEPOT

Balance Sheet as of Septcm bel' 30

Assets

Cash .

Accounts receivable ..

Merchandise inventory ..

Prepaid insurance ..

Prepaid rent .

Furniture and fixtures ..

Accumulated depreciation .

Total Assets ..

Liabilities ant Owners' Equity

Accounts payable ..

Accrued \vages .

Bank loan payable ..

Interest payable ..

Proprietor's capital .

Retained earnings ..

Total Liabilities and Owners' Equity ..

peDEPOl'

Income Statement for September

Sa les , ...

Cost of saJes ..

Gross margin ..

Expenses:

Wages ..

Advertising .

Office supplies ..

Utilities .

Rent. ..

1 nsurance ..

Interest ..

Depreciation ..

Net income ..

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$17,260 L_144)

$2,063 ],320 1,100 501 1,485 193 J,250 _J±1

$84,661 11,2J6 149,300 2,117 1,485

17 116 .$_26c.5,9 I 5

$92,571 440 100,000 1,250 65,000 __ 6.654 $265.915_

$52,850 38.140 ]4,710

__jLQ56 o 6.654.

LEDGER
Cash Merchandise Inventory
(1 ) 165,000 (2) 1,485 (3) 137,500 1(14) 38,140
(9) 38,000 (4) 15,500 (13 ) 49,940
(11 ) 3,614 (5) 1,320
! (6) 935
(7) 1,100 Accounts Payable
(8) 275 (12) 96,195 (3) 137,500
(12) 96,195 (13) 49,940
( 15) 688 ( 19) 226
( 17) 1,485 (20) 1,100
(18) 2,310
I (20) 660 Accrued Wages
I (16) 440
Pre~aid Insurance
( 18) 2,310 I (23) 193 Bank Loan Payable
I (1) 100,000
Furniture and Fixtures
(4) ] 5,500 I Pro~rictor's CaIJital
(20) I (1) 65,000
1,760
Accounts Receivable
(10) 14,850 I (II) 3,614 PI'e~aid Rent
(17) 1,485 I
Rent EXEenses
(2) ],485 I Sales
(24) 52,850 I (9) 38,000
Advertising EXEense (10) 14,850
(5) 1,320 I
Cost of Sales
(14) 38,140 I
(6)
(15) DCJ.~reciation Ex~ense
( 16) (21) 144 I
Office Su~pIies Expense Accumulated De~reciation
(7) ],100 I (21 ) 144
Utilities Expense Interest ~~_yable
(8) ---;i~ I (22) 1,250
(] 9) 57

Insurance Expense

193 I

__ ~ ~_I~n~t~l'est lEXIJense

(22) 1,250

(23)

____ ~~I_Ilcome Summary _

6,654 (24) 52,850

_____ R_c"-t_ai ned Ram iogs

~(25)

6,654

(25)

(other closing entries not shown here)

Question 4

Other adjusting entries:

(21) Depreciation Expense [($15,500 + $1,760) / 10] / 12 ..

Accurnulated Depreciation .

(22) I ntcrest Expense ($100,000 x 15%) / 12) ..

Interest Payable ..

(23) Insurance Expense ($ 2,310/ 12) ..

Prepaid I nsurance .

144
144
1,250
1,250
193
193 Postings to the ledger are shown under Question 3. Note that five additional T accounts, not required for entries (I) - (20), must be created in order to post these adjusting entries.

Question 5

For reasons of space, we shall illustrate on Iy one of the entries closing the tern porary accounts, pi us the final closing entry:

(24) Sales .

Income Summary .

(25) Income Summary .

Retained Earnings .

Note that two more T accounts have been created for the closing process.

52,850

52,850

6,654

6,654

Question 6

The statements appear above.

Case 4-2: SaFe-Mart

N otc: This case is unchanged front 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 if calculated for the same company over a period of years.

c. Days' receivables Net receivables / (Credit sales /365) = $32,800 / ($323,400 x.77 / 365). = 48 days.

This ratio measures the average collection period of receivables. Although some analysts lise total sales (often because the portion of credit sales is not disclosed), the above calculation is correct. The result suggests that CJRW's customers are stretching the payment period.

Cases

Case 5-1: Stern Corporation (A) Note: The case has been updated.

Approach

This case is designed to give practice in handling the various transactions for accounts receivable and bad debts. There can 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 ofthe text.

Comments on Questions

Question 1

] . Accounts Receivable ..

Sales .

2. Cash .

Accounts Receivable .

3. Allowance for Doubtful Accounts ..

Accounts Receivable ..

9,965,575

9,965,575

9,685,420

9,685,420

26,854

26,854

(Entries would also be made to specific accounts receivable, assuming that the account on the balance 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.

5. The calculation of the Allowance for Doubtful Accounts and Accounts Receivable depends upon wh ich 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 0[2006 is calculated as follows:

73

Accounts Receivable, December 31,2005 ..

Add increase to AIR from sales on account during 2006 .

Less decrease to AIR for accounts for which payment was

received during 2006 .

Less accounts written off in 2006 ..

Ad d that portion sti II due on prev iously written-off account which was paid in part in 2006 with reasonable assurance of

future payment of the payment of the rernainder.. ..

$ 988,257 9,965.5"75. 10,953,832

9.685,4)0 1,268,412 26.~54 $1,241,558

$1,242,478

Bad Debt Expense ..

Allowance for Doubtful Accounts ..

29,886

The bad debt expense is 0.3 percent * $1,242,478 = $37,274. The entry, therefore, would be:

29,886

The Allowance for Doubtful Accounts remaining on the books at the end of2006 is calculated as follows:

Allowance for Doubtful Accounts, December 31,2005 .

Less Accounts Receivable written off in 2006 .

Add increase to Allowance for Doubtful Accounts for previously written-off accounts which were collected during

the year or deemed collectible in the future .

Balance in account. ..

Add additional bad debt expense needed ..

Total allowance for Doubtful Accounts, December 31, 2006.

$29,648 26.854 2,794

7,388 29,886

$37,274

The Allowance for Doubtful Accounts remaining on the books at the end of2006 is calculated as follows:

Under (b) or (c), 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 0[2006 is calculated as follows:

Allowance for Doubtful Accounts, December 31,2005 ..

Less Accounts Receivable written off in 2006 .

Balance in account .

Add additional bad debt expense .

Total Allowance for Doubtful Accounts, December 31,2006

Question 2

Using (0)

Balance of accounts as ofDccember 31,2006:

Accounts Receivable .

Less allowance for dou btful accounts " ..

$1,242,478 37.274 $1,205,204

74

$29,648 26,~54 $2,79!j 34453

$37,247

Using (b) or (c)

$1,241,558 37247 $1,204,311