Chapter 7, Problem 26AP

a.

To determine

Prepare the general journal entry and post the entries to T-accounts, an income statement, statement of changes in stockholders’ equity, a balance sheet, and a statement of cash flows for Year 2.

Explanation of Solution

Allowance method: It is a method for accounting bad debt expense, where amount of uncollectible accounts receivables are estimated and recorded at the end of particular period. Under this method, bad debts expenses are estimated and recorded prior to the occurrence of actual bad debt, in compliance with matching principle by using the allowance for doubtful account.

Prepare the journal entries.

Event	Account Titles and explanation	Debit ($)	Credit ($)
1.	Merchandise Inventory	580,000
	Accounts Payable		580,000
	(To receord the purchase of inventories on account)
2a.	Accounts Receivable	890,000
	Sales Revenue		890,000
	(To record the sales made on account)
2b.	Cost of Goods Sold	420,000
	Merchandise Inventory		420,000
	(To record the cost of goods sold)
3a.	Cash	245,000
	Sales Revenue		245,000
	(To record the sales made for cash)
3b.	Cost of Goods Sold	160,000
	Merchandise Inventory		160,000
	(To record the cost of goods sold)
4a.	Accounts Receivable	182,400
	Credit Card Expense $\left(\$190,000\times 4\%\right)$	7,600
	Sales Revenue		190,000
	(To record the credit card sales)
4b.	Cost of Goods Sold	96,000
	Merchandise Inventory		96,000
	(To record the cost of goods sold)
5.	Cash	620,000
	Accounts Receivable		620,000
	(To record the cash collected  from accounts receivable)
6.	Accounts Payable	610,000
	Cash		610,000
	(To record the cash payment made for accounts payable)
7.	Selling and Administrative Expenses	145,000
	Cash		145,000
	(To record the payment made for selling and administrative expenses)
8.	Cash	182,400
	Accounts Receivable		182,400
	(To record the collection of cash for the sales made on account in event 4)
9.	Notes receivable	60,000
	Cash		60,000
	(To record the notes receivable)
10.	Allowance for doubtful accounts	7,500
	Accounts receivable		7,500
	(To record the allowance for doubtful accounts)
11.a.	Uncollectible accounts expense (1)	8,900
	Allowance for doubtful accounts		8,900
	(To record the uncollectible accounts expense)
11.b	Interest receivable (2)	2,800
	Interest revenue		2,800
	(To record the revenue from interest)

Table (1)

Working note:

Calculate the amount for uncollectible accounts expense.

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

Calculate the amount of interest receivable.

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

Calculate the amount of interest receivable.

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

T-account:

T-account is the form of the ledger account, where the journal entries are posted to this account. It is referred to as the T-account, because the alignment of the components of the account resembles the capital letter ‘T’.

The components of the T-account are as follows:

a) The title of the account

b) The left or debit side

c) The right or credit side

Post the transactions to T-account.

Cash
Beginning balance	$110,000	6.	$610,000
3a.	$245,000	7.	$145,000
5.	$620,000	9.	$60,000
8.	$182,400
Ending balance	$342,000

Accounts receivable
Beginning balance	$125,000	5.	$620,000
2a.	$890,00	8.	$182,400
4a.	$182,400	10.	$7,500
Ending balance	$387,500

Allowance for doubtful accounts
		Beginning balance	$18,000
10.	$7,500	11a.	$8,900
		Ending balance	$19,400

Merchandise inventory
Beginning balance	$425,000	2b.	$420,000
10.	$7,500	11a.	$8,900
		4b.	$96,000
Ending balance	$329,000

Notes receivable
9.	$60,000
Ending balance	$60,000

Interest receivable
11b.	$2,800
Ending balance	$2,800

Accounts payable
6.	$610,000	Beginning balance	$95,000
		1.	$580,000
		Ending balance	$65,000

Common stock
		Balance	$450,000

Retained earnings
		Balance	$450,000

Sales revenue
		2a.	$890,000
		3a.	$245,000
		4a.	$190,000
		Ending balance	$1,325,000

Cost of goods sold
2b.	$420,000
3b.	$160,000
4b.	$96,000
Ending balance	$676,000

Credit card expense
4a.	$7,600
Ending balance	$7,600

Selling and administrative expense
7.	$145,000
Ending balance	$145,000
Uncollectible accounts expense
11a.	$8,900
Ending balance	$8,900

Interest revenue
		11b.	$2,800
		Ending balance	$2,800

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 31st December, Year 2
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		487,5000
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 31st December, Year 2
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: 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.

Prepare the balance sheet.

Incorporation TE
Balance sheet
As of 31st December, Year 2
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		1,307,300
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 ended 31st December, Year 2
Particulars	Amount ($)	Amount ($)
Cash flow from operating activities:
Inflow from customers (3)	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:

Calculate the amount of inflow from customers.

$\begin{array}{c}\text{Total inflow from customers}=\left(\begin{array}{l}\text{Cash sales+}\\ \text{Collection from accounts receivable}+\\ \text{Credit card sales collection}\end{array}\right)\\ =\$245,000+\$620,000+\$182,400\\ =\$1,047,400\end{array}$ (3)

b.

To determine

Compute the net realizable value of the accounts receivable at December 31, Year 2.

Explanation of Solution

Net realizable value: Net realizable value is the net amount of receivables which a business expects to collect from its debtors. Accounts receivable less allowance for doubtful accounts is represented as cash realizable value.

Calculate the net realizable value:

$\begin{array}{c}\text{Net realizable value}=\text{Accounts receivable}-\text{Allowance for doubtful debts}\\ =\$368,100-\$19,400\\ =\$368,100\end{array}$

Hence, the net realizable value is $368,100

c.

To determine

Identify the amount of uncollectible accounts expense that would be reported on the income statement.

Explanation of Solution

Uncollectible accounts expense:

Uncollectible accounts expense is an expense account. Amount of loss incurred from extending credit to the customers are recorded as uncollectible accounts expense. In other words, estimated uncollectible accounts receivable are known as uncollectible accounts expense.

The amount of uncollectible expense using direct write-off method is $7,500 is the amount that would be reported on the income statement.