Chapter 9, Problem 9.19E

(LO9–2, LO9–8)

On January 1, 2018, the general ledger of Freedom Fireworks includes the following account balances:

Accounts	Debit	Credit
Cash	$ 11,200
Accounts Receivable	34,000
Allowance for Uncollectible Accounts		$ 1,800
Inventory	152,000
Land	67,300
Buildings	120,000
Accumulated Depreciation		9,600
Accounts Payable		17,700
Common Stock		200,000
Retained Earnings		155,400
Totals	$384,500	$384,500

 During January 2018, the following transactions occur.

    January 1    Borrow $100,000 from Captive Credit Corporation. The installment note bears interest at 7% annually and matures in 5 years. Payments of $1,980 are required at the end of each month for 60 months.

    January 4    Receive $31,000 from customers on accounts receivable.

  January 10    Pay cash on accounts payable, $11,000.

    January 15    Pay cash for salaries, $28,900.

    January 30    Firework sales for the month total $195,000. Sales include $65,000 for cash and $130,000 on account. The cost of the units sold is $112,500.

    January 31    Pay the first monthly installment of $1,980 related to the $100,000 borrowed on January 1. Round your interest calculation to the nearest dollar.

  Required:

  1.    Record each of the transactions listed above.

  2.    Record adjusting entries on January 31.

  a.    Depreciation on the building for the month of January is calculated using the straight-line method. At the time the equipment was purchased, the company estimated a service life of 10 wars and a residual value of $24,000.

  b.    At the end of January, $3,000 of accounts receivable are past due, and the company estimates that 50% of these accounts will not be collected. Of the remaining accounts receivable, the company estimates that 2% will not be collected. No accounts were written off as uncollectible in January.

  c.    Unpaid salaries at the end of January are $26,100.

  d.    Accrued income taxes at the end of January are $8,000.

  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. (Hint: The carrying value of notes payable on January 31, 2018 is $98,603; $17,411 is reported as notes payable in the current liabilities section and $81,192 is reported as notes payable in the long-term liabilities section ($17, 411 + $81,192 = $98,603).

  6.    Record closing entries.

  7.    Analyze the following for Freedom Fireworks:

  a.    Calculate the debt to equity ratio. If the average debt to equity ratio for the industry is 1.0, is Freedom Fireworks more or less leveraged than other companies in the same industry?

  b.    Calculate the times interest earned ratio. If the average times interest earned ratio for the industry is 20 times, is the company more or less able to meet interest payments than other companies in the same industry?

  c.    Based on the ratios calculated in (a) and (b), would Freedom Fireworks be more likely to receive a higher or lower interest rate than the average borrowing rate in the industry?

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 FF are as follows:

Date	Account titles and Explanation	Debit	Credit
January 1	Cash	$100,000
	Notes payable		$100,000
	(To record issuance of notes payable)
Date	Account titles and Explanation	Debit	Credit
January 4	Cash	$31,000
	Accounts receivable		$31,000
	(To record cash received on account)
Date	Account titles and Explanation	Debit	Credit
January 11	Accounts payable	$11,000
	Cash		$11,000
	(To record cash payment made on account)
Date	Account titles and Explanation	Debit	Credit
January 15	Salaries expense	$28,900
	Cash		$28,900
	(To record cash payment made for salaries)
Date	Account titles and Explanation	Debit	Credit
January 30	Cash	$65,000
	Accounts receivable	$130,000
	Sales revenue		$195,000
	(To record inventory sold for cash and an account)
Date	Account titles and Explanation	Debit	Credit
January 30	Cost of goods sold	$112,500
	Inventory		$112,500
	(To record cost of merchandise inventory sold)
Date	Account titles and Explanation	Debit	Credit
January 31	Interest expense	$583
	Notes payable	$1,397
	Cash		$1,980
	(To record payment of monthly installment note)

Table (1)

To determine

To record: The given adjusting entries of FF.

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 FF are as follows:

Date	Account titles and Explanation	Debit	Credit
January 31	Depreciation expenses (1)	$800
	Accumulated depreciation		$800
	(To record Depreciation expense)
Date	Account titles and Explanation	Debit	Credit
January 31	Bad debt expense	$2,300
	Allowance for uncollectible Accounts		$2,300
	(To record uncollectible accounts)
Date	Account titles and Explanation	Debit	Credit
January 31	Salaries expense	$26,100
	Salaries payable		$26,100
	(To record salaries payable)
Date	Account titles and Explanation	Debit	Credit
January 31	Income tax expense	$8,000
	Income tax payable		$8,000
	(To record income tax expenses)

Table (2)

Working Notes:

a.

Calculate the depreciation on the equipment.

$\begin{array}{c}\text{Depreciation}\text{expense = }\frac{\text{Amount of Depreciation }-\text{Estimated residential value}}{\text{Number of months}}\\ =\frac{\$120,000\text{}-\text{}\text{\$24,000}}{\text{120 months}}\\ =\text{ \$800}\end{array}$ (1)

b.

Calculate the bad debt expense.

$\begin{array}{c}\begin{array}{l}\text{Closing Balance of}\\ \text{Accounts Receivable}\end{array}\}=\text{}\text{}\left(\text{\$34,000}+\text{ \$130,000 }-\text{\$31,000 }-\text{\$ 3,000}\right)\\ =\text{\$130,000}\end{array}$

$\begin{array}{c}\text{Bad debt expense = }\left(\begin{array}{l}\text{Accounts receivable estimate }+\text{Remaining accounts receivable estimate }\\ +\text{}\text{Ending balance of uncollectible accounts}\end{array}\right)\\ \text{= ( }\left[\$3,000\times 50\%\right]+\text{}\left[\$130,000\text{}\text{}\times \text{}2\%\right]-\$1,800\\ \text{= \$2,300}\end{array}$ (2)

To determine

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

Explanation of Solution

Adjusted Trail Balance
January 31, 2018
Accounts	Debit	Credit
Cash	$165,320
Accounts receivable	$133,000
Allowance for uncollectible accounts		$4,100
Inventory	$39,500
Land	$67,300
Buildings	$120,000
Accumulated depreciation		$10,400
Accounts payable		$6,700
Salaries payable		$26,100
Income tax payable		$8,000
Notes payable		$98,603
Common stock		$200,000
Retained earnings		$155,400
Sales revenue		$195,000
Cost of goods sold	$112,500
Salaries expense	$55,000
Bad debt expense	$2,300
Depreciation expense	$800
Interest expense	$583
Income tax expense	$8,000
Total	$704,303	$704,303

Table (3)

Calculation of adjusted trial balance of FF for the month January:

Accounts	Ending Balance		$\text{Opening balance+necessary transaction±}\left(\text{adusting entries}\right)$
Cash	$165,320	=	$\left(\begin{array}{l}\$11,200+\$100,000+\$31,000-\$11,000\\ -\$28,900+\$65,000-\$1,980\end{array}\right)$
Accounts Receivable	$133,000	=	$\left(\$34,000-\$31,000+\$130,000\right)$
Allowance for uncollectible accounts	$4,100	=	$\left(\$1,800+\$2,300\right)$
Inventory	$39,500	=	$\left(\$152,000-\$112,500\right)$
Land	$67,300	=	$67,300
Buildings	$120,000	=	$120,000
Accumulated Depreciation	$10,400	=	$\left(\$9,600+\$800\right)$
Accounts Payable	$6,700	=	$\left(\$17,700+\$11,000\right)$
Salaries payable	$26,100	=	$\left(\$26,100\right)$
Income Tax Payable	$8,000	=	$8,000
Notes Payable	$98,603	=	$\left(\$100,000-\$1,397\right)$
Common Stock	$200,000	=	$200,000
Retained Earnings	$155,400	=	$155,400
Sales Revenue	$195,000	=	$\left(\$195,000\right)$
Cost of Goods Sold	$112,500	=	$\left(\$112,500\right)$
Salaries Expense	$55,000	=	$\left(\$28,900+\$26,100\right)$
Bad Debt Expense	$2,300	=	$2,300
Depreciation Expense	$800	=	$800
Interest Expense	$583	=	$583
Income Tax Expense	$8,000	=	$8,000

(Table 4)

To determine

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

Explanation of Solution

FF
Multiple - Step Income Statement
For the Year month ended January 31, 2018
Sales revenue		$195,000
Less: Cost of goods sold		$112,500
Gross profit		$82,500
Less: Operating expenses:
Salaries expenses	$55,000
Bad debt expenses	$2,300
Depreciation expenses	$800
Total operating expenses		$58,100
Operating income		$24,400
Less: Interest expenses		$583
Income before taxes		$23,817
Less: Income tax expense		$8,000
Net income		$15,817

Table (5)

To determine

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

Explanation of Solution

Figure (1)

Working Notes:

$\begin{array}{c}\text{Retained Earnings = Beginning retained earnings }+\text{Net Income }-\text{Dividends}\\ \text{= \$155,400 }+\text{\$15,817 }-\$0\\ =\text{\$172,217}\end{array}$ (3)

To determine

To Record: the closing entries.

Explanation of Solution

Date	Account titles and Explanation	Debit	Credit
January 31, 2018	Sales revenue	$195,000
	Retained earnings		$195,000
	(To record the closing revenue accounts)
Date	Account titles and Explanation	Debit	Credit
January 31, 2018	Retained earnings	$179,183
	Cost of goods sold		$112,500
	Salaries expense		$55,000
	Bad debt expense		$2,300
	Depreciation expense		$800
	Interest expense		$583
	Income tax expense		$8,000
	(To record the closing expenses accounts)

Table (6)

To determine

To Calculate: the debt to equity ratio at the end of January.

Explanation of Solution

Calculate the debt to equity ratio at the end of January.

$\begin{array}{c}\text{Debt}\text{equity ratio}\text{= }\frac{\text{Total liabilites}}{\text{Shareholders' equity}}\\ =\frac{\$139,403}{\$371,217}\\ =\text{ 0}\text{.38: 1}\end{array}$

FF has liquidity less than the average level required by industry. They have low portion of total liabilities to meet out their total stockholders ‘equity which is comparatively lesser than the industry average of 1.0.

To determine

To Calculate: the times interest earned ratio at the end of January.

Explanation of Solution

Calculate the times interest earned ratio at the end of January.

$\begin{array}{c}\begin{array}{l}\text{Times interest}\\ \text{ earned ratio}\end{array})\text{ = }\frac{\text{Net income +}\text{Interest expense}\text{+}\text{Tax expense}}{\text{Interest expense}}\\ =\frac{\$15,817\$583+\$8,000}{\$583}\\ =41.9\text{Times}\end{array}$

FF has more able to meet interest payments than other companies in the same industry, since, FF has (41.9 times) more than the industry average of (20 times).

To determine

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

Explanation of Solution

Based on the debt to equity ratio and times interest earned ratio, FF would likely receive lesser interest rate than the average borrowing rate in the industry. Because, FF conveys lesser debt than the industry average and is capable to meet interest payments than the average company in the industry.