Chapter 1, Problem 21BE

a.

To determine

Calculate the amount of retained earnings as of January, year 2.

Explanation of Solution

Accounting equation:

Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners. Accounting equation is expressed as shown below:

$\text{Assets = Liabilities + Stockholders’ equity}$

Amount of retained earnings is calculated as follows:

Company Z
Accounting Equation
As of January 1, year 2
Assets			=	Liabilities	+	Stockholders’ Equity
Cash	+	Land	=	Notes payable	+	Common Stock	+	Retained Earnings (1)
$200		$1,800		$600		$1,000		400

Table (1)

Working note:

Calculate the amount of retained earnings:

$\begin{array}{c}\text{Retained}\text{earnings}\text{=}\left[\begin{array}{l}\text{Asset}-\text{Liabilities}\left(\text{Notes}\text{payable}\right)-\\ \text{Stockholders'}\text{equity}\left(\text{Common}\text{stock}\right)\end{array}\right]\\ \text{=}\text{\$2,000}-\text{\$600}-\text{\$1,000}\\ \text{=}\text{\$400}\end{array}$ (1)

Note: $\text{Asset}\left(\text{\$2,000}\right)\text{=Cash}\left(\text{\$200}\right)\text{+Land}\left(\text{\$1,800}\right)$

Conclusion

Therefore, the amount of retained earnings is $400.

b.

To determine

State the reason whether the dividend can be paid or cannot be paid.

Explanation of Solution

Dividends:

Dividends are the rewards to the stockholders for investing their money in the company. Payment of dividend depends upon the decision of the management.

The company has only $\$200$ as cash balance . Therefore, it cannot pay $3,000 as dividend. Retained earnings account balance is zero. Dividends can be paid only if the company has enough balance in its retained earnings account.

c.

To determine

Ascertain the percentage of assets acquired from creditors.

Explanation of Solution

Debt to Asset Ratio:

Debt to asset ratio is the ratio that measures the difference between total asset and total liability of the company. Debt ratio reflects the finance strategy of the company. It is used to evaluate company’s ability to pay its debts. Higher debt ratio implies the higher financial risk.

Calculate the percentage of assets acquired from creditors

$\begin{array}{c}\begin{array}{l}\text{Percentage}\text{of}\text{assets}\\ \text{ acquired from creditors}\end{array})\text{=}\frac{\text{Creditor's}\text{ loan}}{\text{Total}\text{assets}}\text{×100}\\ \text{=}\frac{\text{\$600}}{\text{\$2,00}}\text{×100}\\ \text{=30\%}\end{array}$

Note: $\text{Asset}\left(\text{\$2,000}\right)\text{=Cash}\left(\text{\$200}\right)\text{+Land}\left(\text{\$1,800}\right)$

Conclusion

Therefore, The Percentage of total assets acquired from creditors is 30%.

d.

To determine

Ascertain the percentage of assets acquired from investors.

Explanation of Solution

Stockholders’ equity to asset ratio:

Stockholders ‘equity to asset ratio is the ratio that measures the difference between total asset and stockholders ‘equity of the company. Stockholders’ equity ratio reflects the amount of assets that can be claimed by the stockholders in proportion to the value of shares owned by them.

Percentage of total assets acquired from investors is calculated as follows:

$\begin{array}{c}\begin{array}{l}\text{Percentage}\text{of total}\text{assets}\\ \text{acquired from}\text{investors}\end{array})\text{=}\frac{\text{Investor's}\text{contribution}}{\text{Total}\text{assets}}\text{×100}\\ \text{=}\frac{\text{\$1,000}}{\text{\$2,000}}\text{×100}\\ \text{=50\%}\end{array}$

Note: $\text{Asset}\left(\text{\$2,000}\right)\text{=Cash}\left(\text{\$200}\right)\text{+Land}\left(\text{\$1,800}\right)$

Conclusion

Therefore, The Percentage of total assets acquired from investors is 50%.

e.

To determine

Ascertain the percentage of assets acquired from retained earnings.

Explanation of Solution

Retained earnings:

Retained earnings are the portion of earnings kept by the business for the purpose of reinvestments, payment of debts, or for future growth.

Percentage of total assets acquired from retained earnings:

$\begin{array}{c}\begin{array}{l}\text{Percentage}\text{of}\text{total}\text{assets}\\ \text{acquired}\text{from}\text{retained}\text{earnings}\end{array})\text{=}\frac{\text{Retained}\text{earnings}}{\text{Total}\text{assets}}\text{×100}\\ \text{=}\frac{\text{\$4,00}}{\text{\$2,000}}\text{×100}\\ \text{=20\%}\end{array}$

Note: $\text{Asset}\left(\text{\$2,000}\right)\text{=Cash}\left(\text{\$200}\right)\text{+Land}\left(\text{\$1,800}\right)$

Conclusion

Therefore, The Percentage of total assets acquired from retained earnings is 20%

f.

To determine

Create an accounting equation using percentage for the right side of the accounting equation.

Explanation of Solution

Accounting equation:

Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners. Accounting equation is expressed as shown below:

$\text{Assets = Liabilities + Stockholders’ equity}$

Accounting equation is created as follows:

Company Z
Accounting Equation
As of January 1, year 2
Assets			=	Liabilities	+	Stockholders’ Equity
Cash	+	Land	=	Notes payable	+	Common	+	Retained
						Stock		Earnings (2)
$200		$1,800		30%		50%		20%

Table (2)

Working note:

Calculate Percentage of total assets acquired from retained earnings:

$\begin{array}{c}\begin{array}{l}\text{Percentage}\text{of total}\text{assets}\\ \text{acquired}\text{from}\text{retained}\text{earnings}\end{array})\text{=}\frac{\text{Retained}\text{earnings}}{\text{Total}\text{assets}}\text{×100}\\ \text{=}\frac{\text{\$4,00}}{\text{\$2,000}}\text{×100}\\ \text{=20\%}\end{array}$

Note: $\text{Asset}\left(\text{\$2,000}\right)\text{=Cash}\left(\text{\$200}\right)\text{+Land}\left(\text{\$1,800}\right)$ (2)

g.

To determine

Prepare income statement, statement of changes in stockholders’ equity, a balance sheet, and a statement of cash flows.

Explanation of Solution

Accounting equation:

Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners. Accounting equation is expressed as shown below:

$\text{Assets = Liabilities + Stockholders’ equity}$

Income statement:

Income statement is the financial statement of a company which shows all the revenues earned and expenses incurred by the company over a period of time.

Statement of changes in stockholders' equity:

Statement of changes in stockholders' equity records the changes in the owners’  equity during the end of an accounting period by explaining about the increase or  decrease in the capital reserves of shares.

Balance sheet:

Balance is the financial statement that 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.

Statement of cash flows:

Statement of cash flows is one among the financial statement of a Company statement that shows aggregate data of all cash inflows and cash outflows that is received and paid by the Company from its ongoing business operations.

Accounting equation is created as follows:

Company Z
Accounting Equation
As of December 31, Year 2
Assets			Liabilities			Stockholders’ Equity
Cash	+	Land	=	Notes Payable	+	Common Stock	+	Retained Earnings	Account title
$200		$1,800		$600		$1,000		$400
$500		NA		NA		NA		$500	Revenue
($300)		NA		NA		NA		(300)	Expenses
($50)		NA		NA		NA		(50)	Dividends
$350		$1,800		$600		$1,000		$550

Table (3)

Income statement is prepared as follows:

Company Z
Income Statement
For the year Ended December 31, Year 2
Particulars	Amount ($)
Revenues	500
Expenses	(300)
Net Income	200

Table (4)

Statement of changes in stockholders’ equity is prepared as follows:

Company Z
Statement of Changes in Stockholders’ Equity
For the Year Ended December 31, Year 2
Particulars	Amount ($)	Amount ($)
Beginning Common Stock	1,000
Add: Common Stock Issued	0
Ending Common Stock		1,000
Beginning Retained Earnings	400
Add: Net Income	200
Less: Dividends	(50)
Ending Retained Earnings		500
Total Stockholders’ Equity		1,550

Table (5)

The Balance sheet is prepared as follows:

Company Z
Balance Sheet
As of December 31, Year 2
Particulars	Amount ($)	Amount ($)
Assets:
Cash	350
Land	1,800
Total Assets		2,150
Liabilities:
Notes Payable	600
Total Liabilities		600
Stockholders’ Equity:
Common Stock	1,000
Retained Earnings	550
Total Stockholders’ Equity		1,550
Total Liabilities and Stockholders’ Equity		2,150

Table (6)

Statement of cash flows is prepared as follows:

Company Z
Statement of Cash Flows
For the Year Ended December 31, Year 2
Particulars	Amount ($)	Amount ($)
Cash Flows From Operating Activities:
Cash Receipts from Customers	500
Cash Payments for Expenses	(300)
Net Cash Flow from Operating Activities		200
Cash Flows From Investing Activities:		0
Cash Flows From Financing Activities:
Cash Payments for Dividends	(50)
Net Cash Flow from Financing Activities		(50)
Net Increase in Cash		150
Add: Beginning Cash Balance		200
Ending Cash Balance		350

Table (7)

h.

To determine

Comment on the terminology used to date each statement.

Explanation of Solution

Comment on the terminology used is as follows:

• The statements of income, changes in stockholders’ equity and cash flows explain about the happening of the company over a span of time. The span of time in this case is one year. Therefore, these statements use terminology “For the year ended December 31, year 2”.
• On the other hand, the balance sheet is prepared at a specific point of time. Therefore this statement use terminology “As of December 31, year 2 “

i.

To determine

State the way the fact of appraised value of land will change the financial statements.

Explanation of Solution

Historical cost principle:

Historical cost principle refers to the original cost of an asset at the time, when the asset is acquired.

Generally, the market value of the asset is not recorded in the fianancial statements as the assets are reported by the amount paid (original cost) for them regardless of the increase in the market value of the asset according to the historical cost concept.

j.

To determine

Ascertain the balance in the revenue account on January 1, year 3.

Explanation of Solution

The revenue account had zero balance on January 1, year 3 because the balance in this account is transferred to retained earnings account during December 31, Year 2 closing process.