Chapter 7, Problem 21E

a.

To determine

Show the effect of the given transactions using horizontal statement model.

Explanation of Solution

Liabilities:

Liabilities are an obligation of the business to pay to the creditors in future for the goods and services purchased on account or any for other financial benefit received. It can be current liabilities or a non-current liabilities depending upon the time period in which it is paid.

Table (1)

• Receiving money of $60,000 from the issue of common stock increases the value of an asset and the stockholder’s equity and affects the statement of cash flow by increasing the financing activity.
• Purchasing equipment for $160,000 on account increase the value of an asset and the value of liability of the company.
• Sale of equipment for $220,000 cash increases the value of an asset and the value of the stockholder’s equity. Sale of equipment increases the net income of the company by increasing the value of the revenue in the income statement and it affects the statement of cash flow by increasing the operating activity.
• The cost of the goods sold (inventory) $140,000 decreases the value of an asset and the value of the stockholder’s equity; cost of the merchandise decreases the net income of the company by increasing the value of an expense.
• Providing six month warranty on the equipment increases the value of a liability and decreases the value of the stockholder’s equity; providing six month warranty on the equipment decreases the net income of the company by increasing the value of an expense.
• Paying sales tax to the state agency decreases the value of assets and it affects the statement of the cash flow by decreasing the value of an operating activity.
• Borrowing $40,000 note from the local bank increases the value of an asset and the liability; borrowing money from the local bank affects the statement of cash flow by increasing the value of the financing activity.
• Amount paid on warranty repairs during the year decreases the value of an asset and the liability; paying $6,600 for warranty repairs affects the statement of the cash flow by decreasing the value of an operating activity.
• Amount paid on operating expense decreases the value of an asset and the value of the stockholder’s equity; it decreases the value of the income by increasing the value of an expenses and amount paid on operating expense affects the statement of the cash flow by decreasing the value of an operating activity.
• Amount paid on accounts payable decreases the value of an asset and the liability; amount paid on accounts payable affects the statement of the cash flow by decreasing the value of an operating activity.
• Recording accrued interest on the note issued increases the value of a liability and decreases the value of a stockholder’s equity; it decreases the value of the income by increasing the value of an expenses.

b.

To determine

Prepare the income statement, balance sheet and the statement of cash flow for the year 2014.

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.

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.

Balance Sheet:

Balance Sheet summarizes 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 income statement of the Company M for the year 2014:

Company M
Income Statement
For the year ended 2014
Particulars	Amount in $	Amount in $
Sales Revenue		220,000
Cost of Goods Sold		(140,000)
Gross Margin		80,000
Expense:
Operating expense	61,000
Warranty expense	8,800
Total operating expense		(69,800)
Operating income		10,200
Interest expense		(800)
Net Income		9,400

(Table 3)

Therefore, Company M reported and $9,400 in its income statement for the year 2014.

Prepare the balance sheet of the Company M for the year 2014:

Company M
Balance Sheet
As of December 31, 2014
Particulars	Amount in $	Amount in $
Assets:
Cash		110,600
Merchandise Inventory		20,000
Total Assets		130,600
Total Liabilities and Stockholders’ Equity:
Liabilities:
Accounts Payable		15,000
Sales Tax Payable		3,200
Warranties Payable		2,200
Interest Payable		800
Notes Payable		40,000
Total Liabilities		61,200
Stockholders’ Equity:
Common Stock	60,000
Retained Earnings	9,400
Total Stockholders’ Equity		69,400
Total Liabilities and Stockholders’ Equity		130,600

(Table 4)

Therefore, the balance sheet of the Company M for the year 2014 is $130,600.

Prepare the statement of cash flow of the Company M for the year 2014:

Company M
Statement of Cash Flows
For the Year Ended December 31, 2014
Particulars	Amount in $	Amount in $
Cash Flows From Operating Activities:
Inflow from Customers	220,000
Inflow from Sales Tax	17,600
Outflow to Purchase Inventory	(145,000)
Outflow for Expenses (1)	(67,600)
Outflow for Sales Tax	(14,400)
Net Cash Flow from Operating Activities		10,600
Cash Flows From Investing Activities:		0
Cash Flows From Financing Activities:
Inflow from Stock Issue	60,000
Inflow from Loan	40,000
Net Cash Flow from Financing Activities		100,000
Net Change in Cash		110,600
Add: Beginning Cash Balance		0
Ending Cash Balance		110,600

(Table 5)

Therefore, Company M reported an amount of $110,600 in its statement of cash flow for the year 2014.

Working Note 1: Compute the outflow of expense.

$\begin{array}{c}\text{Outflow of Expense =}\left[\begin{array}{l}\text{Amount paid on}\\ \text{ operating expense}\end{array}\right]+\left[\begin{array}{l}\text{Amount paid on}\\ \text{ warranty repairs}\end{array}\right]\\ =\$61,000+\$6,600\\ =\$67,600\end{array}$

c.

To determine

Calculate the total amount of current liabilities at December 31, 2014.

Explanation of Solution

Current liability: Current liability is a debt that the companies need to pay the debts from existing current assets or creation of other current liabilities within a fiscal year or the operating cycle whichever is higher.

Calculate the total amount of current liabilities at December 31, 2014:

Particulars	Amount in $
Current Liabilities:
Accounts Payable	15,000
Sales Tax Payable	3,200
Warranty Payable	2,200
Interest Payable	800
Notes Payable	40,000
Total Current Liabilities	61,200

(Table 6)

Therefore, the total amount of current liabilities at December 31, 2014 is $61,200.