Chapter 13, Problem 7AP

To determine

Compute the missing amounts, and complete the financial statements of Company O.

Explanation of Solution

Prepare income statement of Company O as follows:

Company O
Income Statement
For the Year Ended December 31, 2012
Particulars	Amount
Sales revenue	$7,000,000
Less: Cost of Goods sold	$4,760,000
Gross profit	$2,240,000
Less: Selling and administrative expenses	$1,360,000
Income before interest expense and income taxes	$880,000
Less: Interest expense	$80,000
Income before income taxes	$800,000
Less: Income tax expense (30%)	$240,000
Net income	$560,000

Table (1)

Working notes:

 Calculate sales revenue.

$\begin{array}{c}\text{Sales revenue = }\frac{\text{Net income}}{\text{Return on sales}}\\ =\frac{\$560,000}{8\%}\\ =\$7,000,000\end{array}$ (1)

Calculate gross profit.

$\begin{array}{c}\text{Gross profit = Sales revenue }\times \text{Gross profit percentage}\\ \text{=}\text{\$7,000,000}\times \text{32\%}\\ \text{=}\text{\$2,240,000}\end{array}$ (2)

Calculate cost of goods sold.

$\begin{array}{c}\text{Cost of goods sold = Sales revenue }-\text{Gross profit}\\ \text{=}\text{\$7,000,000}-\$2,240,000\\ =\$4,760,000\end{array}$ (3)

Calculate income before income taxes.

$\begin{array}{c}\text{Income before income taxes = Net income }\times \frac{1}{0.70}\\ =\$560,000\times \frac{1}{0.70}\\ =\$800,000\end{array}$ (4)

Calculate Income tax expense.

$\begin{array}{c}\text{Income tax expense = Income before income taxes }\times \text{Income tax percent}\\ \text{= \$800,000}\times \text{30\%}\\ \text{= \$240,000}\end{array}$ (5)

Calculate Income before interest expense and income taxes.

$\begin{array}{c}\begin{array}{l}\text{Income before interest }\\ \text{expense and income taxes}\end{array})\text{ = Income before income taxes + Interest expenses}\\ \text{= \$800,000}\text{+\$80,000}\\ \text{= \$880,000}\end{array}$ (6)

Calculate Selling and administrative expenses.

$\begin{array}{c}\begin{array}{l}\text{Selling and }\\ \text{administrative expenses}\end{array})\text{ = }\left(\begin{array}{l}\text{Gross profit }-\text{Income before }\\ \text{interest expense and income taxes}\end{array}\right)\\ =\$2,240,000-\$880,000\\ =\$1,360,000\end{array}$ (7)

Prepare Balance sheet of Company O as follows:

Company O
Balance Sheet
December 31, 2012
Cash	$710,000	Current liabilities	$300,000
Accounts Receivable	$890,000	8% Bonds payable	$1,000,000
Inventory	$980,000	Common stock	$3,700,000
Equipment (net)	$3,320,000	Retained earnings	$900,000
Total Assets	$5,900,000	Total liabilities and Stockholders' equity	$5,900,000

Table (2)

Working notes:

Calculate accounts receivable.

$\begin{array}{c}\text{Accounts receivable turnover = }\frac{\text{Sales revenue}}{\text{Average accounts receivable}}\\ 8=\frac{\$7,000,000}{\left(\$860,000+x\right)÷2}\\ 8\times \left(\$860,000+x\right)÷2=\$7,000,000\\ \left(\$860,000+x\right)÷2=\frac{\$7,000,000}{8}\end{array}$

$\begin{array}{c}\left(\$860,000+x\right)÷2=\$875,000\\ \left(\$860,000+x\right)=\$875,000\times 2\\ x=\$1,750,000-\$860,000\\ x=\$890,000\end{array}$

Hint: ‘x’ denotes ending accounts receivable.

(8)

Calculate inventory.

$\begin{array}{c}\text{Inventory turnover = }\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ 5=\frac{\$4,760,000}{\left(\$924,000+x\right)÷2}\\ 5\times \left(\$924,000+x\right)÷2=\$4,760,000\\ \left(\$924,000+x\right)÷2=\frac{\$4,760,000}{5}\end{array}$

$\begin{array}{c}(\$924,000+x)÷2=\$952,000\\ (\$924,000+x)=\$952,000\times 2\\ x=\$1,904,000-\$924,000\\ x=\$980,000\end{array}$

Hint ‘x’ denotes ending inventory.

(9)

Calculate cash.

$\begin{array}{c}\text{Quick ratio}\text{=}\frac{\text{Cash +}\text{Accounts receivables}}{\text{Current liabilites}}\\ 0.90=\frac{x+\$980,000}{\$300,000}\\ 0.90\times \$300,000=x+\$980,000\\ \$270,000=x+\$980,000\end{array}$

$\begin{array}{c}x=\$980,000-\$270,000\\ x=\$710,000\end{array}$

Hint ‘x’ denotes cash.

(10)

Calculate equipment.

$\begin{array}{c}\text{Equipment = Total assets }-\left(\text{Cash + Accounts receivable + Inventory}\right)\\ =\$5,900,000-\left(\$710,000+\$890,000+\$980,000\right)\\ =\$3,320,000\end{array}$

Calculate common stock.

$\begin{array}{c}\text{Return on common stockholders' equity}\text{=}\frac{\text{Net income}}{\text{Average common stockholders' equity}}\\ 16\%=\frac{\$560,000}{\left(\$3,300,000+x\right)÷2}\\ 16\%\times \left(\$3,300,000+x\right)÷2=\$560,000\\ \left(\$3,300,000+x\right)÷2=\frac{\$560,000}{16\%}\end{array}$

$\begin{array}{c}\left(\$3,300,000+x\right)x÷2=\$3,500,000\\ x=\left(\$3,500,000\times 2\right)-\$3,300,000\\ x=\$3,700,000\end{array}$ (11)

Calculate bonds payable.

$\begin{array}{c}\text{Bonds payable = Interest expense}\times \frac{\text{1}}{0.08}\\ =\$80,000\times \frac{1}{0.08}\\ =\$1,000,000\end{array}$ (12)

Calculate current liabilities.

$\begin{array}{c}\text{Current liabilites =}\left(\begin{array}{l}\text{Total liabilites and stockholders' equity }-\\ \left(\text{Bonds payable +}\text{Common stock + Retained earnings}\right)\end{array}\right)\\ =\$5,900,000-\left(\$1,000,000+\$3,700,000+\$900,000\right)\\ =\$300,000\end{array}$ (13)