FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS

Exercise 5.2 (Financial Statement Preparation) TUTORS FOR RENT, INC. Income Statement December 31, 2005 (Rs.)
Revenue: Tutoring revenue earned Expenses: Salary expense Supply expense Advertising expense Depreciation expense: equipment Income before taxes Income taxes expense Net income TUTORS FOR RENT, INC. Statement of Retained Earnings For me Year Ended December 31, 2005 52,000 1,200 300 1,000

(Rs.)
96,000

54,500 41,500 11,600 29,900

(Rs.)
Retained earnings (1/1/05) Add: Net income Less: Dividends Retained earnings (12/31/05) 45,000 29,900 2,000 72,900

TUTORS FOR RENT, INC. Balance Sheet December 31. 2005

(Rs.)
Assets Cash Accounts receivable Supplies Equipment Less: Accumulated depreciation: equipment TOTAL ASSETS Liabilities Accounts payable Income taxes payable TOTAL LIABILITIES Stockholders' Equity Capital stock Retained earnings TOTAL STOCKHOLDERS' EQUITY TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

(Rs.)
91,100 4,500 300

12,000 5,000

7,000 102,900 1,500 3,500 5,000 25,000 72,900 97,900 102,900

Page 1 of 13

FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS General Journal

(1)
Dec. 31 Mowing Revenue Earned Income Summary To close Mowing Revenue Earned (2) Income Summary Insurance Expense Office Rent Expense Supplies Expense Salary Expense Deprecation Expense: Trucks Deprecation Expense: Mowing Equip. Repair & Maintenance Expense Fuel Expense Income Taxes Expense To close all expense accounts (3) Depreciation Expense: Fixtures and Equipment Accumulated Depreciation: Fixtures and Equipment To record August depreciation (Rs. 36,000 + 60 months) (4) Interest Expense Interest Payable Interest expense accrued in August (5) Unearned Admissions Revenue (YMCA) Admissions Revenue To record advance payment from YMA earned in August (Rs. 1,500 c 1/3) (6) Concessions Revenue Receivable Concessions Revenue To record accrued concessions revenue (7) Salaries Expense Salaries Payable To record accrued salary expense in August. (8) Income Taxes Expense Income Taxes Payable To record income taxes accrued in August (9) No adjusting entry required.

(Rs.)
15,200

(Rs.)
15,200 700 700 600 600 1,500 1,500 500 500

31

31

31

31

31

2,250 2,250 1,700 1,700 4,200 4,200

31

31

31

The company appears to be extremely liquid. Cash and accounts receivable comprise 93% of total assets. Together, these highly liquid assets total Rs. 95,600, compared to only Rs. 5,000 in liabilities coming due. In other words, the combined total of cash and accounts receivable are 19 times the obligations coming due in the near future. The Rs. 45,000 credit Retained Earnings balance reported in the company's adjusted trial balance is its beginning balance. In order to have retained Rs. 45,000 in earnings, the company must have been profitable in the past.

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FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS

Exercise 5.3 (Financial Statement Preparation)

WILDERNESS GUIDE SERVICES, INC. Income Statement For the Year Ended December 31, 2005

(Rs.)
Revenue: Guide revenue earned Expenses: Salary expense Camping supply expense Insurance expense Depreciation expense: equipment Interest expense Net Loss WILDERNESS GUIDE SERVICES, INC. Statement of Retained Earnings For the Year Ended December 31, 2005 87,500 1,200 9,600 5,000 1,700

(Rs.)
102,000

105,000 3,000

(Rs.)
Retained earnings (1/1/05) Less: Net loss Less: Dividends Retained earnings (12/31/05) WILDERNESS GUIDE SERVICES, INC. Balance Sheet December 31, 2005

(Rs.)
15,000 3,000 1,000 11,000

(Rs.)
Assets Cash Accounts receivable Camping supplies Unexpired insurance policies Equipment Less: Accumulated depreciation: equipment TOTAL ASSETS Liabilities Notes payable (due 4/1/06) Accounts payable TOTAL LIABILITIES Stockholders' Equity Capital stock Retained earnings TOTAL STOCKHOLDERS' EQUITY TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

(Rs.)
12,200 31,000 7,900 2,400

70,000 60,000

10,000 63,500 18,000 9,500 27,500 25,000 11,000 36,000 63,500

b.

The company appears to be liquid. Cash and accounts receivable comprise 68% of the company's total assets. These highly liquid assets total Rs. 43,200, in comparison to Rs. 27,500 in liabilities coming due in the near future. However, given that its equipment is nearly fully depreciated, it may have to invest in new equipment shortly. Page 3 of 13

c.

FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS The company was not profitable in the current period as evidenced by the Rs. 3,000 net loss reported in the income statement. However, the Rs. 15,000 credit Retained Earnings balance reported in the company's adjusted trial balance is the balance carried forward from prior years. In order to have retained Rs. 15,000 in earnings, the company must have been profitable in the past.

Exercise 5.6 (Preparing Closing Entries)

a. Close Counseling Revenue to the Income Summary account.

(Rs.)
Counseling Revenue Income Summary

(Rs.)
225,000

225,000 170,400 1,800 94,000 1,200 850 6,000 24,000 2,650 4,500 6,000 29,400 54,600 54,600 6,000 6,000

Close all expenses to the Income Summary account: Income Summary Advertising Expense Salaries Expense Office Supplies Expense Utilities Expense Malpractice Insurance Expense Office Rent Expense Continuing Education Expense Depreciation Expense: Fixtures Miscellaneous Expense Income Taxes Expense Close the Income Summary to the Retained Earnings account: Income Summary Retained Earnings Close the Dividends account to the Retained Earnings account: Retained Earnings Dividends b. Retained Earnings, January 1, 2005 Plus: Net Income Less: Dividends Declared in 2005 Retained Earnings, December 31, 2005

(Rs.)
92,000 54,600 146,600 (6,000) 140,600

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FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS

Problem 5.2

(Preparing Financial Statements and Closing Entries of a Profitable Company) LAWN PRIDE, INC. Income Statement For the Year Ended December 31, 2005 (Rs.) (Rs.)
170,000 2,400 36,000 5,200 60,000 3,000 4,000 3,000 1,500 5,000 3,000

Revenue: Mowing revenue earned Expenses: Insurance expense Office rent expense Supplies expense Salary expense Deprecation expense: trucks Deprecation expense: mowing equipment Repair & maintenance expense Fuel expense Miscellaneous expense Interest expense Income before income taxes Income taxes expense Net Income

150,100 19,900 6,000 13,900

LAWN PRIDE, INC. Statement of Retained Earnings For the Year Ended December 31, 2005 (Rs.)
Retained earnings (1/1/05) Add: Net Income Less: Dividends Retained earnings (12/31/05) 30,000 13,900 5,000 38,900

LAWN PRIDE, INC. Balance Sheet December 31, 2005 (Rs.)

Assets Cash Accounts receivable Unexpired insurance Prepaid rent Supplies Trucks Less: Accumulated deprecation: trucks Mowing equipment Less: Accumulated deprecation: mowing equipment TOTAL ASSETS Liabilities Accounts payable Notes payable Salaries payable Page 5 of 13

(Rs.)
58,525 4,800 8,000 3,000 1,075

150,000 120,000 20,000 12,000

30,000 8,000 113,400 1,500 50,000 900

FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS

(Rs.)
Interest payable Income taxes payable Unearned mowing revenue TOTAL LIABILITIES Stockholders Equity Capital stock Retained earnings TOTAL STOCKHOLDERS EQUITY TOTAL LIABILITIES AND STOCKHOLDERS EQUITY

(Rs.)
150 1,050 900 54,500 20,000 38,900 58,900 113,400

General Journal 2005

Dec. 31

(1)
Mowing Revenue Earned Income Summary To close Mowing Revenue Earned. (2) Income Summary Insurance Expense Office Rent Expense Supplies Expense Salary Expense Depreciation Expense: Trucks Depreciation Expense: Mowing Equip. Repair & Maintenance Expense Fuel Expense Miscellaneous Expense Interest Expense Income Taxes Expense To close all expense accounts. (3) Income Summary Retained Earnings To transfer net income earned In 2005 to the Retained Earnings account (Rs. 170,000 Rs. 156,100 = Rs. 13,900). (4) Retained Earnings Dividends To transfer dividends declared in 2005 to the Retained Earnings account.

(Rs.)
170,000

(Rs.)
170,000

31

156,100 2,400 36,000 5,200 60,000 30,000 4,000 3,000 1,500 5,000 3,000 6,000 13,900 13,900

31

31

5,000 5,000

LAWN PRIDE, INC. After Closing Trial Balance December 31, 2005 (Rs.)
Cash Accounts receivable Unexpired Insurance Prepaid rent Supplies Trucks Accumulated depreciation: trucks Mowing equipment Accumulated depreciation: mowing equipment Page 6 of 13 58,525 4,800 8,000 3,000 1,075 150,000 120,000 200,000 12,000

(Rs.)

FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS

(Rs.)
Accounts payable Notes payable Salaries payable Interest payable Income taxes payable Unearned mowing revenue Capital stock Retained earnings Totals d.

(Rs.)
1,500 50,000 900 150 1,050 900 20,000 38,900 245,400

_______ 245,400

For the year ended December 31, 2005, the company generated net income of Rs. 13,900 on Rs. 170,000 sales. Thus, net income as a percentage of sales was approximately 8.2%. Moreover, the Rs. 13,900 profit represented a return on stockholders' equity of approximately 24%, which is a fairly strong return on investment. The company's balance sheet at December 31, 2005, reports cash and accounts receivable totaling Rs. 63,325. It also reports various payables (liabilities) totaling Rs. 53,600. Depending on when the Rs. 50,000 note payable reported in the balance sheet is due, the company may be extremely solvent. If this obligation is not due in the near future, the company has 563,325 in cash and accounts receivable to cover obligations of only Rs. 3,600. Even if this note is due shortly, the company still appears to be solvent.

Problem 5.3

(Preparing Financial Statements and Closing Entries of an Unprofitable Company) MYSTIC MASTERS, INC. Income Statement For the Year Ended December 31, 2005 (Rs.) (Rs.)
52,000 6,000 9,000 440 48,000 1,400 3,000 4,900 1,500 4,000 5,000

Revenue: Client revenue earned Expenses: Insurance expense Office rent expense Supplies expense Salary expense Depreciation expense: furniture & fixtures Office and telephone expense Internet service expense Legal expense Interest expense Miscellaneous expense Net loss

83,240 (31,240)

MYSTIC MASTERS, INC. Statement of Retained Earnings For the Year Ended December 31, 2005 (Rs.)
Retained Earnings (1/1/05) Less: Net loss Retained Earnings (12731/05) 2,600 31,240 (28,640)

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FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS

MYSTIC MASTERS, INC. Statement of Retained Earnings For the Year Ended December 31, 2005 (Rs.)
Assets Cash Accounts receivable Unexpired insurance Prepaid rent Supplies Furniture & fixtures Less: Accumulated depreciation: furniture & fixtures TOTAL ASSETS Liabilities Accounts payable Notes payable Salaries payable Interest payable Unearned client revenue TOTAL LIABILITIES Stockholders' Equity Capital stock Retained deficit TOTAL STOCKHOLDERS' EQUITY (DEFICIT) TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

(Rs.)
960 300 2,000 1,500 200

8,400 5,200

3,200 8,160 6,540 24,000 1,700 360 200 32,800 4,000 (28,640) (24,640) ______ 8,160

General Journal (1)

Dec. 31 Client Revenue Earned Income Summary To close Client Revenue Earned. (2) Income Summary Insurance Expense Office Rent Expense Supplies Expense Salary Expense Depreciation Expense: Furniture & Fixture Office & Telephone Expense Internet Service Expense Legal Expense Interest Expense Miscellaneous Expense To close all expense accounts. (3) Retained Earnings Income Summary To transfer net loss incurred in 2005 to the Retained Earnings account (Rs. 52,000 - Rs. 83,240 = Rs. 31,240 loss) (4) No dividends were declared In 2005. Page 8 of 13

(Rs.)
52,000

(Rs.)
52,000 83,240 6,000 9,000 440 48,000 1,400 3,000 4,900 1,500 4,000 5,000 31,240 31,240

31

31

31

FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS

MYSTIC MASTERS, INC. After Closing Trial Balance December 31, 2005 (Rs.)
Cash Accounts receivable Unexpired insurance Prepaid rent Supplies Furniture & fixtures Accumulated depreciation: furniture & fixtures Accounts payable Notes payable Salaries payable Interest payable Unearned client revenue Capital stock Retained deficit Totals d. 960 300 2,000 1,500 200 8,400 5,200 6,540 24,000 1,700 360 200 4,000 (28,640) 13,360

(Rs.)

______ 13,360

For the year ended December 31, 2005, the company suffered a net loss of Rs. 31,240 on Rs. 52,000 sales. Thus, the net loss as a percentage of sales was approximately 60%. The net loss, in combination with the deficit balance in stockholders' equity, makes meaningful interpretations of return on equity impossible. It will suffice to say that the company is extremely unprofitable. The company's balance sheet at December 31, 2005, reports cash and accounts receivable totaling only Rs. 1,260. It reports various payables (liabilities) totaling Rs. 32,600, for a shortfall of Rs. 31,340. Thus, in addition to being unprofitable, the company is insolvent, as well. Even if the note payable reported in the balance sheet is not due in the near future, the company still faces a significant shortfall with respect to its ability to make good on its current obligations. The primary issue to be addressed in the notes to the financial statements is the company's ability, or lack thereof, to remain a going concern. In other words, just how much longer can this business stay afloat given its desperate financial condition? Information about the Rs. 24,000 note payable should also be disclosed. Who is the maker of this note? When is it due? Is it secured with company assets? Etc. The company may also have to disclose information concerning any legal problems it faces. The legal expenses reported in the income statement may suggest that one or more lawsuits are currently pending.

e.

Problem 5.5

(Short Comprehensive Problem Including Both Adjusting and Closing Entries) General Journal

a. (Rs.)
Dec. 31 Supply Expense Supplies To record supplies used In December. (2) Studio Rent Expense Prepaid Studio Rent To record portion of prepaid rent expired In December. (3) Depreciation Expense: Equipment Accumulated Depreciation: Equipment Page 9 of 13 5,000 5,000 1,250 1,250

(Rs.)

31

31

800

FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS

(Rs.)
31 To record depreciation of equipment in December. _ (4) Interest Expense Interest Payable To record interest expense accrued in December. (5) Unearned Client Fees Client Fees Earned To convert unearned revenue to earned revenue in December. (6) Client Fees Receivable Client Fees Earned To record additional revenue accrued in December (7) Salary Expense Salaries Payable To record salary expense accrued at the end of December. (8) Income Taxes Expense Income Taxes Payable To record Income taxes expense accrued In December. 240

(Rs.)
800 240 3,000 3,000 690 690 750 750 2,000 2,000

31 31 31

31

31

a.

(continued) Computations for each of the adjusting journal entries:

Computations 1. Rs. 6,000 (supplies per trial balance) Rs. 1,000 (at 12/31) = Rs. 5,000 used in December. 2. Rs. 2,500 (prepaid rent per trial balance) / 2 months remaining at 11/30/05 = Rs. 1,250 per month. 3. Rs. 96,000 (studio equipment per trial balance) / 120 months = Rs. 800 per month. 4. Rs. 24,000 (note payable per trial balance) x 12% x 1/12 = Rs. 240 interest expense per month. 5. Unearned client fees need to be reduced by the Rs. 3,000 amount earned in December. 6. Accounts receivable needs to be increased by the Rs. 690 of accrued revenue in December. 7. Salaries payable of Rs. 750 needs to be reported for salaries accrued at the end of December. 8. Rs. 7,000 total income taxes expense Rs. 5,000 (per trial balance) = Rs. 2,000 accrued in December. Based upon the adjusting entries made above, the company's adjusted trial balance at December 31, 2005, appears at the top of the following page: a. (continued) Adjusted trial balance at December 31, 2005.

BRUSHSTOKE ART STUDIO, INC. Adjusted Trial Balance December 31, 2005 (Rs.)
Cash Client fees receivable Supplies Prepaid studio rent Studio equipment Accumulated depreciation: studio equipment Accounts payable Salaries payable Notes payable Interest payable Unearned client fees Income taxes payable Page 10 of 13 22,380 71,640 1,000 1,250 96,000 52,800 6,420 750 24,000 720 5,000 70,000

(Rs.)

FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS

(Rs.)
Capital stock Retained earnings Client fees earned Supply expense Salary expense Interest expense Studio rent expense Utilities expense Depreciation expense: studio equipment Income tax expense Totals

(Rs.)
50,000 20,000 86,000

9,000 18,000 720 12,500 3,300 9,600 7,000 252,690

______ 252,690

BRUSHSTOKE ART STUDIO, INC. Income Statement For the Year Ended December 31, 2005 b.
Revenue: Client fees earned Expenses: Supply expense Salary expense Studio rent expense Utilities expense Depreciation expense: studio equipment Interest expense Income before taxes Income tax expense Net income 9,000 18,000 12,500 3,300 9,600 720

(Rs.)

(Rs.)
86,000

53,120 32,880 7,000 25,880

BRUSHSTOKE ART STUDIO, INC. Statement of Retained Earnings For the Year Ended December 31, 2005 (Rs.)
Retained earnings (1/1/05) Add: Net income Retained earnings (12/31/05) WILDERNESS GUIDE SERVICES, INC. Balance Sheet December 31, 2005 20,000 25,880 45,880

b.
Assets Cash Client fees receivable Supplies Prepaid studio rent Studio equipment Less: Accumulated depreciation: studio equipment TOTAL ASSETS Liabilities Accounts payable Salaries payable Page 11 of 13

(Rs.)

(Rs.)
22,380 71,940 1,000 1,250

96,000 52,800

43,200 139,770 6,420 750

FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS Notes payable Interest payable Unearned client fees Income taxes payable TOTAL LIABILITIES Stockholders' Equity Capital stock Retained earnings TOTAL STOCKHOLDERS' EQUITY TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY

24,000 720 5,000 7,000 43,890 50,000 45,880 95,880 ______ 139,770

General Journal c.
(1) Dec. 31 Client Fee Earned Income Summary To close Client Fees Earned. (2) Income Summary Supply Expense Salary Expense Interest Expense Studio Rent Expense Utilities Expense Depreciation Expense: Studio Equip. Income Taxes Expense To close all expense accounts. (3) Income Summary Retained Earnings To transfer net income earned In 2005 to the Retained Earnings account (Rs. 86.000 - Rs. 60,120 - Rs. 25.880). (4) No dividends were declared in 2005. 86,000 86,000 60,120 9,000 108,000 720 12,500 3,300 9,600 7,000 25,880 25,880

(Rs.)

(Rs.)

31

31

31

BRUSHSTOKE ART STUDIO, INC. After Closing Trial Balance December 31, 2005 d.
Cash Client fees receivable Supplies Prepaid studio rent Studio equipment Accumulated depreciation: studio equipment Accounts payable Salaries payable Notes payable Interest payable Unearned client fees Income taxes payable Capital stock Retained earnings Totals Page 12 of 13

(Rs.)
22,380 71,940 1,000 1,250 96,000

(Rs.)

_______ 192,570

52,800 6,420 750 24,000 720 5,000 7,000 50,000 45,880 192,570

e.

FINANCIAL ACCOUNTING (CHAPTER # 5) EXERCISE & PROBLEMS ANSWERS The studio's rent expense has increased by Rs. 250 per month as shown below: Total rent expense through November 30,2005 (per unadjusted trial balance) Less: Rent expense in November (see computation 2., part a.) Total rent expense through October 31, 2005 Rent expense per month through October 31,2005 (Rs. 10,000 + 10 months). Increase in monthly rent expense (Rs. I,250 - Rs. 1,000) (Rs.) 11,250 1,250 10,000 1,000/mo 250/mo

Problem 5.9 (Evaluating Profitability and Liquidity)

(Rs.) a. Net income percentage: Net Income + Total Revenue Rs. 191,000,000+ Rs. 13,400,000,000 Return on equity: Net Income + Average Stockholders' Equity Rs. 191,000,000 + Rs. 2,460,000,000* * Average Stockholders' Equity = (Rs. 2.56 billion + Rs. 2.36 billion) + 2 b. Working capital: Current Assets-Current Liabilities Beginning of year: Rs. 2,850,000,000 - Rs. 1,290,000,000 End of year: Rs. 3,080,000,000 -Rs. 1,420,000,000 Current ratio: Current .Assets + Liabilities Beginning of year: Rs. 2,850,000,000 + Rs. 1,290,000,000 End of year: Rs. 3,080,000,000+Rs. 1,420,000,000 c. The company was profitable, given its reported net income of Rs. 191 million. However, its net income percentage, reveals that management was able to earn income of only 1.4 cents for every rupees of revenue generated. Thus, expenses, in comparison to revenue, seem relatively high. The company also appears solvent, based upon its working capital and current ratios. However, if it is not able to convert a sufficient portion of its current assets into cash in a timely manner, it may have difficulty paying its current liabilities as they come due. 1,560,000,000 1,660,000,000 2.21:1 2.17:1 1.4% 7.8%

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