Chapter 8, Problem 8.16E

Complete the accounting cycle using current liability transcations (LO 8–1, 8–2, 8–4, 8–6)

On January 1, 2018. the general ledger of ACME Fireworks includes the following account balance:

Accounts	Debit	Credit
Cash	$ 25,100
Accounts Receivable	46,200
Allowance for Uncollectible Accounts		$ 4,200
Inventory	20,000
Land	46,000
Equipment	15,000
Accumulated Depreciation		1,500
Accounts Payable		28,500
Notes Payable (6%. due April 1, 2019)		50,000
Common Stock		35,000
Retained Earnings		33,100
Totals	$152,300	$152,300

During January 2018, the following transactions occur:

    January 2    Sold gift cards totaling $8,000. The cards are redeemable for merchandise within one year of the purchase date.

January 6    Purchase additional inventory on account, $147,000.

    January 15    Firework sales for the first half of the month total $135,000. All of these sales are on account. The cost of the units sold is $73,800.

January 23    Receive $125,400 from customers on accounts receivable.

January 25    Pay $90,000 to inventory suppliers on accounts payable.

January 28    Write off accounts receivable as uncollectible, $4,800.

    January 30    Firework sales for the second half of the month total $143,000. Sales include $11,000 for cash and $132,000 on account. The cost of the units sold is $79,500.

January 31    Pay cash for monthly salaries, $52,000.

Required:

1.    Record each of the transactions listed above.

2.    Record adjusting entries on January 31.

  a.    Depreciation on the equipment for the month of January is calculated using the straight-line method. At the time the equipment was purchased, the company estimated a residual value of $3,000 and a two-year service life.

  b.    At the end of January. $11,000 of accounts receivable are past due, and the company estimates that 30% of these accounts will not be collected. Of the remaining accounts receivable, the company estimates that 5% will not be collected.

  c.    Accrued interest expense on notes payable for January.

  d.    Accrued income taxes at the end of January are $13,000.

  e.    By the end of January, $3,000 of the gift cards sold on January 2 have been redeemed.

  3.    Prepare an adjusted trial balance as of January 31, 2018, after updating beginning balances (above) for transactions during January (Requirement 1) and adjusting entries at the end of January (Requirement 2).

4.    Prepare a multiple-step income statement for the period ended January 31, 2018.

5.    Prepare a classified balance sheet as of January 31, 2018.

6.    Record closing entries.

7.    Analyze the following for ACME Fireworks:

  a.    Calculate the current ratio at the end of January. If the average current ratio for the industry is 1.8, is ACME Fireworks more or less liquid than the industry average?

  b.    Calculate the acid-test ratio at the end of January. If the average acid-test ratio for the industry is 1.5, is ACME Fireworks more or less likely to haw difficulty paving its currently maturing debts (compared to the industry average)?

  c.    Assume the notes payable were due on April 1, 2018, rather than April 1, 2019. Calculate the revised current ratio at the end of January, and indicate whether the revised ratio would increase, decrease. or remain unchanged compared to your answer in (a).

To determine

To record: The journal entries for given transactions.

Explanation of Solution

Journal:

Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.

The journal entries for given transactions of Company ACME are as follows:

Date	Account Titles and Explanation		Debit($)	Credit($)
2018	Cash		8,000
January 2	Deferred Revenue			8,000
	(To record the sale of gift cards for cash)
2018	Inventory		147,000
January, 6	Accounts payable			147,000
	(To record purchase of inventory on account)
2018	Accounts Receivable		135,000
January 15	Sales Revenue			135,000
	(To record sales of inventory on account)
	Cost of goods sold		73,800
	Inventory			73,800
	(To record the cost of inventory sold)
2018
January 23	Cash		125,400
	Accounts Receivable			125,400
	(To record cash on account)
2018	Accounts Payable		90,000
January 25	Cash			90,000
	(To record pay of  cash )
2018	Allowance for uncollectible accounts		4,800
January 28	Accounts Receivable			4,800
	(To record the written off of uncollectible accounts)
2018	Cash		11,000
January 30	Accounts Receivable		132,000
	Sales Revenue			143,000
	( To record sale of inventory for cash)
	Cost of goods sold		79,500
	Inventory			79,500
	(To record of cost of inventory sold)
2018	Salaries Expense		52,000
January 31	Cash			52,000
	(To record payment of salaries)

Table (1)

To determine

To record: The given adjusting entries of Company ACME.

Explanation of Solution

Adjusting entries:

Adjusting entries refers to the entries that are made at the end of an accounting period in accordance with revenue recognition principle, and expenses recognition principle. The purpose of adjusting entries is to adjust the revenue, and the expenses during the period in which they actually occurs.

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.

Adjusting entries of Company ACME are as follows:

Date	Account Titles and Explanation		Debit($)	Credit($)
2018	Depreciation Expense (1)		500
January 31	Accumulated Depreciation			500
	(To record the depreciation for January)
2018	Bad Debt Expense (3)		12,500
January 31	Allowance for Uncollectible Accounts			12,500
	(To adjust uncollectible accounts)
2018	Interest Expense (4)		250
January 31	Interest Payable			250
	(To adjust interest expense)
2018	Income Tax Expense		13,000
January 31	Income Tax Payable			13,000
	(To adjust income taxes)
2018		Deferred Revenue	3,000
January 31	Sales Revenue			3,000
	(To adjust the revenue for the gift cards redeemed)

Table (2)

Working Notes:

a .

Calculate the depreciation on the equipment.

$\begin{array}{c}\text{Depreciation = }\frac{\text{Amount of Depreciation }-\text{Estimated residential value}}{\text{No of months}}\\ =\frac{\$15,000\text{}-\text{}\text{\$3000}}{24\text{ months}}\\ =\text{ \$500}\end{array}$ (1)

b.

Calculate the bad debt expense.

$\begin{array}{c}\begin{array}{l}\text{Ending Balance of}\\ \text{Uncollectible Accounts}\end{array}\}=\text{written off Allowance }-\text{Allowance for Uncollectible accounts}\\ \text{= \$4,800 }-\text{}\text{\$4,200}\\ \text{= }\text{\$600}\end{array}$ (2)

$\begin{array}{c}\begin{array}{l}\text{Closing Balance of}\\ \text{Accounts Receivable}\end{array}\}=\left(\begin{array}{l}\text{Opening balance+ Credit sales on Jan}\text{. 15 }-\text{Cash received from customer}\\ -\text{Allowance written off +Credit sales on Jan}\text{. 30 }\\ -\text{Cash received on the end of the year}\end{array}\right)\\ =\text{}\text{}\left(\begin{array}{l}\text{\$46,200}\text{+ \$ 135,000 }-\text{\$125,400 }-\text{\$ 4,800 }\\ +\$132,000-\text{ \$11,000}\end{array}\right)\\ =\text{\$172,000}\end{array}$

$\begin{array}{c}\text{Bad debt expense = }\left(\begin{array}{l}\text{Accounts receivable estimate }+\text{Remaining accounts receivable estimate }\\ +\text{}\text{Ending balance of uncollectible accounts}\end{array}\right)\\ \text{= ( }\left[\$11,000\times 30\%\right]+\text{}\left[\$172,000\text{}\text{}\times \text{}5\%\right]+\text{600(2))}\\ \text{= \$ 12,500}\end{array}$ (3)

c .

Calculate the Interest expense.

$\begin{array}{c}\text{Interest Expense = Notes Payable }\times \text{ rate of interest }\times \text{ months }\\ \text{= \$50,000 }\times \frac{6}{100}\times \frac{1}{12}\\ =\text{\$ 250}\end{array}$ (4)

To determine

To Prepare: Adjusted trial balance for the month January 31, 2018.

Explanation of Solution

ACME Fireworks
Adjusted Trial Balance
31-Jan-18
Accounts (Refer table 4)	Debit (Amount in $)	Credit (Amount in $)
Cash	$27,500
Accounts Receivable	183,000
Inventory	13,700
Land	46,000
Equipment	15,000
Allowance for Uncollectible Accounts		$11,900
Accumulated Depreciation		2,000
Accounts Payable		85,500
Deferred Revenue		5,000
Interest Payable		250
Income Tax Payable		13,000
Notes Payable		50,000
Common Stock		35,000
Retained Earnings		33,100
Sales Revenue		281,000
Cost of Goods Sold	153,300
Salaries Expense	52,000
Bad Debt Expense	12,500
Depreciation Expense	500
Interest Expense	250
Income Tax Expense	13,000
Totals	$516,750	$516,750

Table (3)

Calculation of adjusted trial balance of Company ACME for the month January:

Accounts	Ending Balance		$\text{Opening balance+necessary transaction±}\left(\text{adusting entries}\right)$
Cash	$27,500	=	$\left(\begin{array}{l}25,100+8,000+125,400-\\ 90,000+11,000-52,000\end{array}\right)$
Accounts Receivable	183,000	=	$\left(\begin{array}{l}46,200+135,000-125,400\\ -4,800+132,000\end{array}\right)$
Inventory	13,700	=	$\left(\begin{array}{l}20,000+147,000-\\ 73,800-79,500\end{array}\right)$
Land	46,000	=	46,000
Equipment	15,000	=	15,000
Allow for Uncollectible Accounts	11,900	=	$\left(4,200-4,800+12,500\right)$
Accumulated Depreciation	2,000	=	$\left(1,500+500\right)$
Accounts Payable	85,500	=	$\left(28,500+147,000-90,000\right)$
Deferred Revenue	5,000	=	$\left(8,000-3,000\right)$
Interest Payable	250	=	250
Income Tax Payable	13,000	=	13,000
Notes Payable	50,000	=	50,000
Common Stock	35,000	=	35,000
Retained Earnings	33,100	=	33,100
Sales Revenue	281,000	=	$\left(135,000+143,000+3,000\right)$
Cost of Goods Sold	153,300	=	$\left(73,800+79,500\right)$
Salaries Expense	52,000	=	52,000
Bad Debt Expense	12,500	=	12,500
Depreciation Expense	500	=	500
Interest Expense	250	=	250
Income Tax Expense	13,000	=	13,000

(Table 4)

To determine

To Prepare: the multiple income statement for the period ended January 31, 2018.

Explanation of Solution

ACME Fireworks
Multiple-Step Income Statement
For the year ended January 31, 2018
Particulars	Amount in $	Amount in $
Sales revenue	$281,000
Cost of goods sold	153,300
Gross profit		$127,700
Salaries expense	52,000
Bad debt expense	12,500
Depreciation expense	500
Total operating expenses		65,000
Operating income		62,700
Interest expense		250
Income before taxes		62,450
Income tax expense		13,000
Net income		$49,450

Table (5)

To determine

To Prepare: classified balance sheet as on January 31, 2018.

Explanation of Solution

Figure (1)

Working Notes:

$\begin{array}{c}\text{Retained Earnings = Beginning retained earnings }+\text{Net Income }-\text{Dividends}\\ \text{= \$33,100 }+\text{\$49,450 }-\$0\\ =\text{\$82,550}\end{array}$ (5)

To determine

To Record: the closing entries.

Explanation of Solution

Date	Account Titles and Explanation		Debit($)	Credit($)
2018	Sales Revenue		281,000
January 31	Retained Earnings			281,000
	(To record the closing revenue accounts)
	Retained Earnings		231,550
	Cost of goods sold			153,300
	Salaries Expense			52,000
		Bad debt Expense		12,500
	Depreciation Expense			500
	Interest Expense			250
	Income Tax Expense			13,000
	(To  close the expense accounts)

Table (6)

To determine

To Calculate: the current ratio at the end of January.

Explanation of Solution

Calculate the current ratio at the end of January.

$\begin{array}{c}\text{Current Ratio= }\frac{\text{Current assets}}{\text{Current Liabilities}}\\ =\frac{\$212,000}{\$103,750}\\ =\text{ 2}\text{.05}\end{array}$

Company ACME has liquidity more than the average level required by industry. They have high portion of current assets to meet out their current liabilities which is comparatively higher than the industry average of 1.8.

To determine

To Calculate: the acid-test ratio at the end of January.

Explanation of Solution

Calculate the acid –test ratio at the end of January.

$\begin{array}{c}\text{Acid-Test Ratio = }\frac{\text{Cash }+\text{Current Investments }+\text{Accounts Receivable}}{\text{Current Liablities}}\\ =\frac{\$27,500+\text{\$ 0 + \$171,000}}{\$103,750}\\ =\text{ \$1}\text{.91}\end{array}$

Company ACME has less difficulty in its paying its currently maturing debts. They have high portion of quick assets to meet out their current liabilities which is comparatively higher than the industry average of 1.5.

To determine

To Indicate: whether the revised ratio would increase, decrease or remain unchanged compared to the requirement a.

Explanation of Solution

Calculate current ratio assuming notes payable as current liabilities.

$\begin{array}{c}\text{Current Ratio= }\frac{\text{Current assets}}{\text{Current Liabilities}}\\ =\frac{\$212,000}{\$153,750}\\ =\text{ 1}\text{.38}\end{array}$

Notes payable would be included in the current liabilities as the notes payable are to be due on April. This would decrease the value of the current assets and increase the value of current liabilities because ratio gets reduced when they are divided by larger number.