Chapter 2, Problem 2.8E

(a)

To determine

Financial statements: Financial statements are condensed summary of transactions communicated in the form of reports for the purpose of decision making.

Income statement: The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Retained earnings Statement: This statement reports the beginning retained earnings and all the changes which led to ending retained earnings. Net income from income statement is added to and dividends is deducted from beginning retained earnings to arrive at the end result, ending retained earnings.

To prepare: (a) Income statement and retained earnings statement for Corporation F.

Explanation of Solution

Prepare income statement for Corporation F for the year ended July 31, 2017.

Corporation F
Income Statement
For the Year Ended July 31, 2017
Revenues
Service revenue	$6,100
Rent revenue	8,500
Total revenue		$74,600
Expenses
Salaries and wages expense	$57,500
Supplies expense	15,600
Depreciation expense	4,000
Total expenses		77,100
Net loss		$(2,500)

Table (1)

Prepare retained earnings statement for Corporation F for the year ended July 31, 2017.

Corporation F
Retained Earnings Statement
For the Year Ended July 31, 2017
Retained earnings, August 1, 2017	$34,000
Less: Net loss	2,500
	31,500
Less: Dividends	4,000
Retained earnings, July 31, 2017	$27,500

Table (2)

Note: Refer to Table (1) for net income value.

(b)

To determine

Balance sheet: This financial statement 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.

To prepare: (a) Income statement and retained earnings statement for Corporation F.

Explanation of Solution

Prepare classified balance sheet for Corporation F as at July 31, 2017.

Corporation F
Balance Sheet
July 31, 2017
Assets
Current assets
Cash	$29,200
Accounts receivable	9,780
Total current assets		$38,980
Property, plant, and equipment
Equipment	18,500
Less: Accumulated depreciation	6,000	12,500
Total assets		$51,480
Liabilities and Stockholders’ Equity
Current liabilities
Accounts payable	$4,100
Salaries and wages payable	2,080
Total current liabilities		$6,080
Long-term liabilities
Notes payable		1,800
Total liabilities		7,980
Stockholders’ equity
Common stock	16,000
Retained earnings	27,500
Total stockholders’ equity		43,500
Total liabilities and stockholders’ equity		$51,480

Table (3)

Note: Refer to Table (2) for retained earnings value.

(c)

To determine

Current ratio: The financial ratio which evaluates the ability of a company to pay off the debt obligations which mature within one year or within completion of operating cycle is referred to as current ratio. This ratio assesses the liquidity of a company.

Formula of current ratio:

$\text{Current ratio = }\frac{\text{Current assets}}{\text{Current liabilities}}$

Debt to assets ratio: This financial ratio evaluates the ability of a company to pay off long-term debt obligations owed to creditors. This ratio assesses the solvency of a company.

Formula of debt to assets ratio:

$\text{Debt to assets ratio = }\frac{\text{Total liabilities}}{\text{Total assets}}$

To prepare: (a (c) Determine current ratio and debt to assets ratio.

Explanation of Solution

Compute current ratio for Corporation F, if current assets are $38,980 and current liabilities are $6,180.

$\begin{array}{c}\text{Current ratio = }\frac{\text{Current assets}}{\text{Current liabilities}}\\ =\frac{\$38,980}{\$6,180}\\ =6.31:1\end{array}$

Note: Refer to Table (3) for current assets and current liabilities values.

Compute debt to assets ratio for Corporation F, if total assets are $51,480 and total liabilities are $7,980.

$\begin{array}{c}\text{Debt to assets ratio = }\frac{\text{Total liabilities}}{\text{Total assets}}\\ \text{=}\frac{\text{\$7,980}}{\text{\$51,480}}\\ \text{= 0}\text{.155 or 15}\text{.5\%}\end{array}$

Note: Refer to Table (3) for total assets and total liabilities values.

(d)

To determine

To prepare: (d) Analyze the current ratio and debt to assets ratio, and decide whether to sell the equipment to Corporation F

Explanation of Solution

Change in current ratio and debt to assets ratio: Equipment is a fixed asset, not a current asset. 5-year note payable is a long-term liability. So, these two items will have no effect on current ratio. But the referred loan (note payable) would affect Corporation F’s debt to asset ratio. If total assets and total liabilities increase, the debt to assets ratio will also increase from 15.5% to 39.1% as shown below:

$\begin{array}{c}\text{Debt to assets ratio = }\frac{\text{Total liabilities}}{\text{Total assets}}\\ \text{=}\frac{\text{\$7,980+\$20,000}}{\text{\$51,480+\$20,000}}\\ =\frac{\text{\$27,980}}{\text{\$71,480}}\\ \text{= 0}\text{.391 or 39}\text{.1\%}\end{array}$

Decision to make sale: The sales manager of L Equipment would prefer to make sale of equipment based on the computed current ratio of 6.3:1 and debt to assets ratio of 15.5%. These ratios indicate that the company has good ability to pay off short-term and long-term obligations. But the sales manager would also estimate the interest paying capacity of L Equipment in the future. Moreover, this year Corporation F is in losses. The sales manager could better lower his note payable amount by considering a down payment initially.