Chapter 5, Problem 31P

The following trial balance was prepared for Tile, Etc., Inc. on December 31, 2017, after the closing entries were posted:

Tile, Etc. had the following transactions in 2018:

1. 1. Purchased merchandise on account for $580,000.
2. 2. Sold merchandise that cost $420,000 for $890,000 on account.
3. 3. Sold for $245,000 cash merchandise that had cost $160,000.
4. 4. Sold merchandise for $190,000 to credit card customers. The merchandise had cost $96,000. The credit card company charges a 4 percent fee.
5. 5. Collected $620,000 cash from accounts receivable.
6. 6. Paid $610,000 cash on accounts payable.
7. 7. Paid $145,000 cash for selling and administrative expenses.
8. 8. Collected cash for the full amount due from the credit card company (see item 4).
9. 9. Loaned $60,000 to J. Parks. The note had an 8 percent interest rate and a one-year term to maturity.
10. 10. Wrote off $7,500 of accounts as uncollectible.
11. 11. Made the following adjusting entries:
    1. (a) Recorded uncollectible accounts expense estimated at 1 percent of sales on account.
    2. (b) Recorded seven months of accrued interest on the note at December 31, 2018 (see item 9).

Required

1. a. Organize the transaction data in accounts under an accounting equation.
2. b. Prepare an income statement, a statement of changes in stockholders’ equity, a balance sheet, and a statement of cash flows for 2018.

To determine

Organize the transaction data in accounts under an accounting equation.

Explanation of Solution

Percentage of sales method: Credit sales are recorded by debiting (increasing) accounts receivable account. The bad debts is a loss incurred out of credit sales, hence uncollectible accounts can be estimated as a percentage of credit sales or total sales.

It is a method of estimating the bad debts (expected loss on extending credit), by multiplying the expected percentage of uncollectible with the total amount of net credit sale (or total sales) for a specific period. Under percentage of sales method, estimated bad debts would be treated as a bad debt expense of the particular period.

Horizontal statements model: The model that represents all the financial statements, balance sheet, income statement, and statement of cash flows in one table in a horizontal form, is referred to as, horizontal statements model.

Organize the transaction data in accounts under an accounting equation.

Table (1)

Working note:

(1) Calculate the amount of credit card sales made to customers:

The merchandise sold to credit card customers for $190,000 and the company charges a fee of 4% on sales. So, the credit card expense is $\left(\$190,000\times 4\%\right)$ $7,600. Thus, the amount of credit card sales made to customers is calculated as follows:

$\begin{array}{c}\begin{array}{l}\text{Credit card sales }\\ \text{made to customers}\end{array}\}\text{= Credit card sales}-\text{Credit card expense}\\ =\$190,000-\$7,600\left(\text{A}\right)\\ =\$182,400\end{array}$

(2) Calculate the amount for uncollectible accounts expense:

$\begin{array}{c}\text{Uncollectible accounts expense}=\text{Accounts receivable}\times \text{Rate of interest}\\ =\$890,000\times 1\%\\ =\$8,900\end{array}$

Calculate the amount of interest receivable:

Given: The loan amount is $60,000 and the rate of interest is 8%. So the total interest income is calculated as follows:

$\begin{array}{c}\text{Total interest}=\text{Loan amount}\times \text{Rate of interest}\\ =\$60,000\times 8\%\\ =\$4,800(\text{B)}\end{array}$

$\begin{array}{c}\text{Interest receivable}=\text{Total interest}\times \frac{\text{Number of months}}{\text{Months in a year}}\\ =\$4,800(\text{B)}\times \frac{7}{12}\left(\text{Maturity period}\right)\\ =\$2,800\end{array}$

To determine

Prepare an income statement, statement of changes in stockholders’ equity, a balance sheet, and a statement of cash flows for 2018.

Explanation of Solution

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.

Prepare the income statement.

Incorporation TE
Income statement
For the year ended December 31, 2018
Particulars	Amount	Amount
Revenue
Sales revenue	$1,325,000
Less: Cost of goods sold	$676,000
Gross profit		$649,000
Less:  Operating Expenses
Credit card expenses	$7,600
Selling and administrative expenses	$145,000
Uncollectible accounts expense	$8,900
Total operating income		($161,500)
Operating income		$487,500
Add: Non-operating items
Interest revenue		$2,800
Net income		$490,300

Table (2)

Statement of changes in the stockholders’ equity: This statement reflects whether the components of stockholders’ equity have increased or decreased during the period.

Prepare the statement of changes in stockholders’ equity.

Incorporation TE
Statement of changes in stockholders’ equity
For the year ended December 31, 2018
Particulars	Amount	Amount
Beginning common stock	$450,000
Add: Common stocks issued	$0
Ending common stock		$450,000
Beginning retained earnings	$97,000
Add: Net income	$490,300
Less: Dividends	($0)
Ending retained earnings		$587,300
Total stockholders’ equity		$1,037,300

Table (3)

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.

Prepare the balance sheet.

Incorporation TE
Balance sheet
As of December 31, 2018
Particulars	Amount	Amount
Assets
Cash		$342,400
Accounts receivable	$387,500
Less: Allowance for doubtful accounts	$19,400	$368,100
Merchandise inventory		$329,000
Interest receivable		$2,800
Notes receivable		$60,000
Total assets		$1,102,300
Liabilities
Accounts payable	$65,000
Total liabilities		$65,000
Stockholders’ equity
Common stock	$450,000
Retained earnings	$587,300
Total stockholders' equity		$1,037,300
Total liabilities and stockholders' equity		$1,102,300

Table (4)

Statement of cash flows: This statement reports all the cash transactions involves for inflow and outflow of cash, and the result of these transactions is reported as an ending balance of cash at the end of reported period.

Prepare the statement of cash flows.

Incorporation TE
Statement of cash flow
For the year December 31, 2018
Particulars	Amount	Amount
Cash flow from operating activities:
Inflow from customers (4)	$1,047,400
Outflow for inventory	($610,000)
Outflow for expenses	($145,000)
Net cash flow from operating activities		$292,400
Cash flow from investing activities
Outflow for notes receivable	($60,000)
Net cash flow from investing activities		($60,000)
Cash flow from financing activities		$0
Net change in cash		$232,400
Add: Beginning cash balance		$110,000
Ending cash balance		$342,400

Table (5)

Working note:

(4) Calculate the amount of inflow from customers.

$\begin{array}{c}\text{Total inflow from customers}=\left(\begin{array}{l}\text{Cash sales+}\\ \text{Collection from accounts receivable}+\\ \text{Credit card sales collection}\end{array}\right)\\ =\$245,000+\$620,000+\$182,400\\ =\$1,047,400\end{array}$