Chapter 1, Problem 32BP

a.

To determine

Write an accounting equation and record the effects of each accounting events under the appropriate headings for each year. Record the amounts of expenses, revenue, and dividends in the retained earnings column.

Explanation of Solution

Accounting event:

An accounting event is a cost-effective event that affects assets, liabilities, or stockholders’ equity of a Company.

• Write an accounting equation and record the effects of each accounting events under the appropriate headings for year 1 as follows:

Table (1)

• Write an accounting equation and record the effects of each accounting events under the appropriate headings for year 2 as follows:

Table (2)

b.

To determine

Prepare an income statement, statement of changes in stockholder’s equity, year-end balance sheet and statement of cash flows for each year.

Explanation of Solution

Income statement:

Income statement is the financial statement of a company which shows all the revenues earned and expenses incurred by the company over a period of time.

Statement of changes in stockholders' equity:

Statement of changes in stockholders' equity records the changes in the owners’  equity during the end of an accounting period by explaining about the increase or  decrease in the capital reserves of shares.

Balance sheet:

Balance is the financial statement that reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

• Prepare an income statement for each Year as follows:

Company M
Income Statement
For the Period Ended December 31, Year 1
Particulars	$
Service Revenue	100,000
Expenses	(60,000)
Net Income	40,000

Table (3)

Company M
Income Statement
For the Period Ended December 31, Year 2
Particulars	$
Service Revenue	130,000
Expenses	(75,000)
Net Income	55,000

Table (4)

• Prepare a statement of changes in stockholder’s equity for each Year as follows:

Company M
Statement of Changes in Stockholders’ Equity
For the Period Ended December 31, Year 1
Particulars	$	$
Beginning Common Stock	0
Add: Common Stock Issued	50,000
Ending Common Stock		$50,000
Beginning Retained Earnings	0
Add: Net Income	$40,000
Ending Retained Earnings		40,000
Total Stockholders’ Equity		$90,000

Table (5)

Company M
Statement of Changes in Stockholders’ Equity
For the Period Ended December 31, Year 2
Particulars	$	$
Beginning Common Stock	$50,000
Add: Common Stock Issued	20,000
Ending Common Stock		$70,000
Beginning Retained Earnings	40,000
Add: Net Income	55,000
	95,000
Less: Dividends	(15,000)
Ending Retained Earnings		80,000
Total Stockholders’ Equity		$150,000

Table (6)

• Prepare an year-end balance sheet for each Year as follows:

Company M
Balance Sheet
As of December 31, Year 1
Particulars	$	$
Assets:
Cash	$65,000
Land	40,000
Total Assets		$105,000
Liabilities:
Notes Payable		$15,000
Stockholders’ Equity:
Common Stock	$50,000
Retained Earnings	40,000
Total Stockholders’ Equity		90,000
Total Liabilities and Stockholders’ Equity		$105,000

Table (7)

Company M
Balance Sheet
As of December 31, Year 2
Particulars	$	$
Assets:
Cash	$115,000
Land	40,000
Total Assets		$155,000
Liabilities:
Notes Payable		$5,000
Stockholders’ Equity:
Common Stock	$70,000
Retained Earnings	80,00
Total Stockholders’ Equity		150,000
Total Liabilities and Stockholders’ Equity		$155,000

Table (8)

• Prepare a statement of cash flows for each Year as follows:

Company M
Statement of Cash Flows
For the Year Ended December 31, Year 1
Particulars	$	$
Cash Flows From Operating Activities:
Cash Receipts from Customers	100,000
Cash Payments for Expenses	(60,000)
Net Cash Flow from Operating Activities		40,000
Cash Flows From Investing Activities:
Cash Payment for Land	(40,000)
Net Cash Flow from Investing Activities		(40,000)
Cash Flows From Financing Activities:
Cash Receipts from Borrowed Funds	15,000
Cash Receipts from Stock Issue	50,000
Net Cash Flow from Financing Activities		65,000
Net Increase in Cash		65,000
Add: Beginning Cash Balance		-0-
Ending Cash Balance		65,000

Table (9)

Company M
Statement of Cash Flows
For the Year Ended December 31, Year 2
Particulars	$	$
Cash Flows From Operating Activities:
Cash Receipts from Customers	130,000
Cash Payments for Expenses	(75,000)
Net Cash Flow from Operating Activities		55,000
Cash Flows From Investing Activities:		0
Cash Flows From Financing Activities:
Cash Receipts from Stock Issue	$20,000
Cash Payment on Debt	(10,000)
Cash Payment for Dividends	(15,000)
Net Cash Flow from Financing Activities		5,000
Net Increase in Cash		50,000
Add: Beginning Cash Balance		65,000
Ending Cash Balance		115,000

Table (10)

c.

To determine

Compute the amount of cash in the retained earnings account at the end of Year 1 and Year 2.

Explanation of Solution

The retained earnings account does not contain any cash.

d.

To determine

Examine the balance sheets for the two years and describe the changes in the value of assets from Year 1 to Year 2.

Explanation of Solution

Due to the increase in cash, the value of assets increased from $105,000 (at December 31, Year 1) to $155,000 (at December 31, Year 2). Therefore the value of asset gets increased by $50,000 from Year 1 to Year 2$\left(\$155,000-\$105,000\right)$.

e.

To determine

Compute the balance in the retained earnings account immediately after events 2 in Year 1 and in Year 2 are recorded.

Answer to Problem 32BP

• Immediately after Event 2 in Year 1 is recorded the balance in the Retained Earnings account is zero.
• Immediately after Event 2 in Year 2 is recorded the balance in the Retained Earnings account is $40,000.

Explanation of Solution

• This is because for Year 1, the revenue is recorded in the revenue account but not in the retained earnings account, as the expense, dividend, and revenue are closed at the end of accounting period.  The Retained Earnings accounts will have a balance of $40,000$\left(\$100,000-60,000\right)$, after closing the accounts at the end of Year 1.
• However, this Retained Earnings balance of $40,000 becomes the beginning balance of Retained Earnings account on January 1, Year 2.  This is because the Year 1 ending balance becomes the beginning balance of Year 2. Thus, the balance of $40,000 in the retained earnings for Year 2 will not change until the closing process is completed in December Year 2.