Chapter 10, Problem 22P

a.

To determine

Prepare an income statement, a balance sheet and statement of cash flows of Company L; assume Company L is a promoter of rock concerts.

Explanation of Solution

Income statement:

The income statement is the financial statement of a company that shows all the revenues earned and expenses incurred by the company over a period of time.

Balance sheet:

Balance Sheet is one of the financial statements that summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Statement of cash flows:

This statement reports all the cash transactions which are responsible for inflow and outflow of cash, and result of these transactions is reported as ending balance of cash at the end of reported period. Statement of cash flows includes the changes in cash balance due to operating, investing, and financing activities. Operating activities include cash inflows and outflows from business operations. Investing activities includes cash inflows and cash outflows from purchase and sale of land or equipment, or investments. Financing activities includes cash inflows and outflows from issuance of common stock and debt, payment of debt and dividends.

The calculation of income statement of Company L is as follows:

Company L
Income Statement
Particulars	Amount ($)
Sales revenue	$95,000
Less: operating expense	75,000
Net income	20,000

Table (1)

The calculation of balance sheet of Company L is as follows:

Company L
Balance Sheet
Assets:
Cash (1)	$84,000
Total assets	$84,000
Equity:
Common stock	$64,000
Retained earnings	20,000
Total equity	$84,000

Table (2)

The calculation of statement of cash flows of Company L is as follows:

Statement of Cash Flows
Operating Activities
Inflow from Revenue	$95,000
Less: Outflow for operating Expenses	(75,000)
Net Outflow from Operation Activities	20,000
Investing Activities	-
Add: Financing Activities	64,000
Net Change in Cash	84,000
Beginning Cash Balance	-
Ending Cash Balance	84,000

Table (3)

Note:

The entire $75,000 is treated as operating expenses.

Working note (1):

The total cash is calculated as follows:

$\begin{array}{c}\text{Total cash}=\text{Acquired capital}+\text{Sales revenue}-\text{Spendings}\\ =\$64,000+\$95,000-\$75,000\\ =\$159,000-\$75,000\\ =\$84,000\end{array}$

Hence, the total cash is $84,000.

b.

To determine

Prepare an income statement, a balance sheet and statement of cash flows of Company L; assume Company L is the car rental business.

Explanation of Solution

The calculation of income statement of Company L is as follows:

Company L
Income Statement
Particulars	Amount ($)
Sales revenue	$95,000
Less: Depreciation expense (2)	15,000
Net income	80,000

Table (3)

The calculation of balance sheet of Company L is as follows:

Company L
Balance Sheet
Assets:
Cash (1)	$84,000
Rental equipment	75,000
Less: Accumulated depreciation (2)	15,000
Total assets	$144,000
Equity:
Common stock	$64,000
Retained earnings	80,000
Total equity	$144,000

Table (4)

The calculation of statement of cash flows of Company L is as follows:

Statement of Cash Flows
Operating Activities
Inflow from Revenue	$95,000
Less: Outflow for operating Expenses	(75,000)
Net Outflow from Operation Activities	20,000
Investing Activities	-
Add: Financing Activities	64,000
Net Change in Cash	84,000
Beginning Cash Balance	-
Ending Cash Balance	84,000

Table (5)

Working note (2):

The depreciation is calculated as follows:

$\begin{array}{c}\text{Depreciation}=\frac{\text{Automobiles purchased}}{\text{Number of years}}\\ =\frac{\$75,000}{5}\\ =\$15,000\end{array}$

c.

To determine

Prepare an income statement, a balance sheet and statement of cash flows of Company L; assume Company L is a manufacturing company.

Explanation of Solution

The calculation of income statement of Company L is as follows:

Company L
Income Statement
Particulars	Amount ($)
Sales revenue	$95,000
Less: Cost of goods sold (5)	33,000
Gross margin	62,000
Less: Administration expense	5,000
Net income	57,000

Table (3)

The calculation of balance sheet of Company L is as follows:

Company L
Balance Sheet
Assets:
Cash (1)	$84,000
Finished goods inventory (6)	11,000
Manufacturing equipment	36,000
Less: Accumulated depreciation (3)	10,000
Total assets	$121,000
Equity:
Common stock	$64,000
Retained earnings	57,000
Total equity	$121,000

Table (4)

The calculation of statement of cash flows of Company L is as follows:

Statement of Cash Flows
Operating Activities
Inflow from Revenue	$95,000
Less: Outflow for Inventory	(34,000)
Less: Outflow for administration expenses	(5,000)
Net Outflow from Operation Activities	56,000
Investing Activities:
Outflow to Purchase Equipment	(36,000)
	20,000
Financing Activities	54,000
Issue stock	84,000
Beginning Cash Balance	-
Ending Cash Balance	84,000

Table (5)

Working note (3):

The depreciation on the manufacturing equipment is calculated as follows:

$\begin{array}{c}\text{Depreciation}=\frac{\text{Manufacturing equipment}-\text{Salvage value}}{\text{Number of years}}\\ =\frac{\$36,000-\$6,000}{3}\\ =\frac{\$30,000}{3}\\ =\$10,000\end{array}$

Working note (4):

The cost per unit is calculated as follows:

$\begin{array}{c}\text{Cost per unit}=\frac{\text{Materials}+\text{Labor}+\text{Overheads (depreciation on equipments)}}{\text{Total number of units produced}}\\ =\frac{\$12,000+\$22,000+\$10,000}{2,000\text{ units}}\\ =\frac{\$44,000}{2,000\text{ units}}\\ =\$22\end{array}$

Working note (5):

Calculate the cost of goods sold:

$\begin{array}{c}\text{Cost of goods sold}=\text{Cost per unit}\times \text{Number of goods sold}\\ =\$22(4)\times 1,500\text{ units}\\ =\$33,000\end{array}$

Working note (6):

The total finished goods are calculated as follows:

$\begin{array}{c}\text{Finished goods}=\text{Cost per unit}\times \text{Completed goods}-\text{Number of goods sold}\\ =\$22\times 2000\text{ units}-1500\text{ units}\\ =\$22\times 500\text{ units}\\ =\$11,000\end{array}$

d.

To determine

Explain the reason why management might be more interested in average cost than the actual cost.

Explanation of Solution

The exact cost of the product cannot be determined because the labor and material usage will differ among the same products. Cost average is an element that smoothen these differences.