Chapter 10, Problem 10.1PA

1.

To determine

To show: Accounting equation effect for the given transactions.

Explanation of Solution

Liabilities: Liabilities are debt and obligations of a business. These are the claims against the resources that a business owes to outsiders of the company. Liabilities may be Current liabilities, and Long-term liabilities.  Examples:Creditors, Bills payable, Bank overdraft, Salaries and wages payable, and Notes payable.

Accounting equation effect:

The following is the accounting equation for the given transactions:

$\begin{array}{c}\text{Date}\text{Assets }\text{= }\text{Liabilities }\text{+ }\text{Stockholders' Equity}\\ \text{April 30 }\text{+\$600,000}\left(\text{Cash}\right)\text{=}+\text{\$600,000}\left(\text{Notes}\text{Payable}\right)+\text{NE}\\ \text{June}6\text{+\$75,000}\left(\text{Inventory}\right)\text{=}+\text{\$75,000}\left(\text{Accounts}\text{Payable}\right)+\text{NE}\\ \text{July 15}-\text{\$75,000}\left(\text{Cash}\right)=-\text{\$75,000}\left(\text{Accounts}\text{Payable}\right)+\text{NE}\\ \text{August 31}\text{ +\$24,000}\left(\text{Cash}\right)\text{=}+\text{\$24,000}\left(\text{Unearned Revenue}\right)+\text{NE}\\ \text{December}\text{31}=+\$40,000\left(\begin{array}{l}\text{Salaries}\text{andWages}\\ \text{Payable}\end{array}\right)-\$40,000\left(\begin{array}{l}\text{Wage}\\ \text{Expense}\end{array}\right)\\ \text{December}\text{31}=+\$24,000\left(\begin{array}{l}\text{Interest}\\ \text{Payable}\end{array}\right)-\$24,000\left(\begin{array}{l}\text{Interest}\\ \text{Expense}\end{array}\right)\\ \text{December}\text{31}=-\$16,000\left(\begin{array}{l}\text{Unearned }\\ \text{Revenue}\end{array}\right)+\$16,000\left(\begin{array}{l}\text{Service}\\ \text{Revenue}\end{array}\right)\end{array}$

Working note:

Calculate interest expense at December 31 as below:

$\begin{array}{c}\text{Interest}\text{expense}=\text{Principal}\text{amount }\times \text{ Rate}\text{of interest }\times \text{ Time}\\ =\$600,000\times 6\%\times \frac{8}{12}\\ =\$24,000\end{array}$

Calculate the amount of unearned revenue earned at December 31 as below:

$\begin{array}{c}\text{Unearned revenue}\text{earned}=\$24,000\times \frac{4\text{months}}{6\text{months}}\\ =\$16,000\end{array}$

2.

To determine

To analyze: The impact of each transaction on debt to assets ratio.

Explanation of Solution

Debt to assets ratio: Debt to assets ratio is used to evaluate the relationship between the total liabilities and total assets of the company. Debt to equity ratio helps the company to determine the proportion of debt and assets. When the ratio is greater than 1, then it is higher and thus, company faces higher risk.

Debt to assets ratio is calculated by using the following formula:

$\text{Debt to assets ratio = }\frac{\text{Total liabilites}}{\text{Total assets}}$

Show the impact of each transaction on debt to assets ratio.

Impact of each transaction on debt to assets ratio
Transaction	Total liabilities	Total assets	Effect on Ratio
April 30	Increased	Increased	Increased
June 6	Increased	Increased	Increased
July 15	Decreased	Decreased	Decreased
August 31	Increased	Increased	Increased
December 31	Increased	No Change	Increased
December 31	Increased	No Change	Increased
December 31	Decreased	No Change	Decreased

Table (1)