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, 2015
Particulars	Amount
Sales revenue	$7,250,000
Less: Cost of Goods sold	$4,930,000
Gross profit	$2,320,000
Less: Selling and administrative expenses	$1,411,429
Income before interest expense and income taxes	$908,571
Less: Interest expense	$80,000
Income before income taxes	$828,571
Less: Income tax expense (30%)	$248,571
Net income	$580,000

Table (1)

Working notes:

 Calculate sales revenue.

$\begin{array}{c}\text{Sales revenue = }\frac{\text{Net income}}{\text{Return on sales}}\\ =\frac{\$580,000}{8\%}\\ =\$7,250,000\end{array}$ (1)

Calculate gross profit.

$\begin{array}{c}\text{Gross profit = Sales revenue }\times \text{Gross profit percentage}\\ \text{=}\text{\$7,250,000}\times \text{32\%}\\ \text{=}\text{\$2,320,000}\end{array}$ (2)

Calculate cost of goods sold.

$\begin{array}{c}\text{Cost of goods sold = Sales revenue }-\text{Gross profit}\\ \text{=}\text{\$7,250,000}-\$2,320,000\\ =\$4,930,000\end{array}$ (3)

Calculate income before income taxes.

$\begin{array}{c}\text{Income before income taxes = Net income }\times \frac{1}{0.70}\\ =\$580,000\times \frac{1}{0.70}\\ =\$828,571\end{array}$ (4)

Calculate Income tax expense.

$\begin{array}{c}\text{Income tax expense = Income before income taxes }\times \text{Income tax percent}\\ \text{= \$828,571}\times \text{30\%}\\ \text{= \$248,571}\end{array}$ (5)

Calculate Income before interest expense and income taxes.

$\begin{array}{c}\begin{array}{l}\text{Income before interest }\\ \text{expense and income taxes}\end{array})\text{ = Income before income taxes + Interest expenses}\\ \text{= \$828,571}\text{+\$80,000}\\ \text{= \$908,571}\end{array}$ (6)

Calculate Selling and administrative expenses.

$\begin{array}{c}\begin{array}{l}\text{Selling and }\\ \text{administrative expenses}\end{array})\text{ = }\left(\begin{array}{l}\text{Gross profit }-\text{Income before }\\ \text{interest expense and income taxes}\end{array}\right)\\ =\$2,320,000-\$908,571\\ =\$1,411,429\end{array}$ (7)

Prepare Balance sheet of Company O as follows:

Company O
Balance Sheet
December 31, 2015
Cash	$857,500	Current liabilities	$100,000
Accounts Receivable	$952,500	8% Bonds payable	$1,000,000
Inventory	$1,048,000	Common stock	$3,950,000
Equipment (net)	$3,142,000	Retained earnings	$950,000
Total Assets	$6,000,000	Total liabilities and Stockholders' equity	$6,000,000

Table (2)

Working notes:

Calculate accounts receivable.

$\begin{array}{c}\text{Accounts receivable turnover = }\frac{\text{Sales revenue}}{\text{Average accounts receivable}}\\ 8=\frac{\$7,250,000}{\left(\$860,000+x\right)÷2}\\ 8\times \left(\$860,000+x\right)÷2=\$7,250,000\\ \left(\$860,000+x\right)÷2=\frac{\$7,250,000}{8}\end{array}$

$\begin{array}{c}\left(\$860,000+x\right)÷2=\$906,250\\ \left(\$860,000+x\right)=\$906,250\times 2\\ x=\$1,812,500-\$860,000\\ x=\$952,500\end{array}$

Hint: ‘x’ denotes ending accounts receivable.

(8)

Calculate inventory.

$\begin{array}{c}\text{Inventory turnover = }\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ 5=\frac{\$4,930,000}{\left(\$924,000+x\right)÷2}\\ 5\times \left(\$924,000+x\right)÷2=\$4,930,000\\ \left(\$924,000+x\right)÷2=\frac{\$4,930,000}{5}\end{array}$

$\begin{array}{c}(\$924,000+x)÷2=\$986,000\\ (\$924,000+x)=\$986,000\times 2\\ x=\$1,972,000-\$924,000\\ x=\$1,048,000\end{array}$

Hint ‘x’ denotes ending inventory.

(9)

Calculate cash.

$\begin{array}{c}\text{Quick ratio}\text{=}\frac{\text{Cash +}\text{Accounts receivables}}{\text{Current liabilites}}\\ 0.95=\frac{x+\$952,500}{\$100,000}\\ 0.95\times \$100,000=x+\$952,500\\ \$95,000=x+\$952,500\end{array}$

$\begin{array}{c}x=\$952,500-\$95,000\\ x=\$857,500\end{array}$

Hint ‘x’ denotes cash.

(10)

Calculate equipment.

$\begin{array}{c}\text{Equipment = Total assets }-\left(\text{Cash + Accounts receivable + Inventory}\right)\\ =\$6,000,000-\left(\$857,500+\$952,500+\$1,048,000\right)\\ =\$3,142,000\end{array}$

Calculate common stock.

$\begin{array}{c}\text{Return on common stockholders' equity}\text{=}\frac{\text{Net income}}{\text{Average common stockholders' equity}}\\ 16\%=\frac{\$580,000}{\left(\$3,300,000+x\right)÷2}\\ 16\%\times \left(\$3,300,000+x\right)÷2=\$580,000\\ \left(\$3,300,000+x\right)÷2=\frac{\$580,000}{16\%}\end{array}$

$\begin{array}{c}\left(\$3,300,000+x\right)x÷2=\$3,625,000\\ x=\left(\$3,625,000\times 2\right)-\$3,300,000\\ x=\$3,950,000\end{array}$ (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.

$\begin{array}{c}\text{Current liabilites =}\left(\begin{array}{l}\text{Total liabilites and stockholders' equity }-\\ \left(\text{Bonds payable +}\text{Common stock + Retained earnings}\right)\end{array}\right)\\ =\$6,000,000-\left(\$1,000,000+\$3,950,000+\$950,000\right)\\ =\$100,000\end{array}$ (13)