Chapter 15, Problem 1MP

Dominique Fouque owns and operates Dominique’s Doll House. She has a small shop in which she sells new and antique dolls. She is particularly well known for her collection of antique Ken and Barbie dolls. A completed spreadsheet for 20-3 is shown on page 610. Fouque made no additional investments during the year and the long-term note payable is due in 20-9. No portion of the long-term note is due within the next year. Net credit sales for 20-3 were $38,000, and receivables on January 1 were $3,000.

REQUIRED

1. 1. Prepare a multiple-step income statement.
2. 2. Prepare a statement of owner’s equity.
3. 3. Prepare a balance sheet.
4. 4. Compute the following measures of performance and financial condition for 20-3:
   1. (a) Current ratio
   2. (b) Quick ratio
   3. (c) Working capital
   4. (d) Return on owner’s equity
   5. (e) Accounts receivable turnover and average number of days required to collect receivables
   6. (f) Inventory turnover and the average number of days required to sell inventory
5. 5. Prepare adjusting entries and indicate which should be reversed and why.
6. 6. Open an Income Summary account. Post adjusting and closing entries (prepared in 7) to this account.
7. 7. Prepare closing entries.
8. 8. Prepare reversing entries for the adjustments where appropriate.

To determine

Prepare a multiple income statement of DD.

Explanation of Solution

Multi-step income statement: The income statement represented in multi-steps with several subtotals, to report the income from principal operations, and separate the other expenses and revenues which affect net income, is referred to as multi-step income statement.

Prepare a multiple income statement of DD.

DD
Income Statement
For Year Ended December 31, 20-3
Particulars	Amount	Amount	Amount	Amount
Revenue from Sales:
Sales			$201,500
Less: Sales returns and allowances			$6,100
Net sales				$195,400
Less: Cost of goods sold:
Opening merchandise inventory		$31,300
Opening estimated returns inventory		$1,000
Purchases	$72,000
Less: Purchases returns and allowances	$750
Net purchases	$71,250
Add: Freight in	$1,200
Cost of goods purchased		$72,450
Goods available for sale			$104,750
Less: Ending merchandise inventory			$28,000
Ending estimated returns inventory			$1,100
Cost of goods sold				$75,650
Gross profit				$119,750
Less: Operating expenses:
Wages expense			$42,200
Advertising expense			$42,000
Office supplies expense			$600
Phone expense			$1,500
utilities expense			$7,600
Insurance expense			$400
Depreciation expense - Store Equipment			$5,000
Total operating expenses				$99,300
Income from operations				$20,450
Add: Other revenues:
Rent revenue				$5,700
Less: Other expenses:
Interest expense				$500
Net income				$25,650

Table (1)

To determine

Prepare statement of owners’ equity of DD.

Explanation of Solution

Statement of Owners’ equity: This statement reports the beginning stockholder's equity and all the changes which led to ending stockholder's equity. Additional capital, net income from income statement is added to and drawings or dividends are deducted from beginning stockholder's equity to arrive at the end result, closing balance of stockholder's equity.

Prepare statement of owners’ equity.

DD
Statement of Owner's Equity
For Year Ended December 31, 20-3
Particulars	Amount	Amount
DF's Opening capital		$95,800
Add: Additional investment		$0
Total investment		$95,800
Add: Net income for the year	$25,650
Less: Withdrawal for the year	$21,000
Increase in capital		$4,650
DF's Ending capital		$100,450

Table (2)

To determine

Prepare a balance sheet of DD.

Explanation of Solution

Balance sheet: Balance Sheet is one of the financial statements that summarize the assets, the liabilities, and the Shareholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Prepare a balance sheet of DD.

DD
Balance sheet
For Year Ended December 31, 20-3
Assets
Current assets:
Cash		$16,700
Accounts receivable		$3,200
Merchandise inventory		$28,000
Estimated returns inventory		$1,100
office supplies		$200
Prepaid insurance		$800
Total current assets			$50,000
Property, plant and Store Equipment:
Store Equipment		$95,000
Less: Accumulated depreciation		$20,000	$75,000
Total Assets			$125,000
Liabilities
Current liabilities:
Notes payable	$6,000
Accounts payable	$5,500
Customer refunds payable	$1,700
Wages payable	$200
sales tax payable	$850
Unearned show revenue	$300
Total current liabilities		$14,550
Long-term liabilities:
Notes payable		$10,000
Total liabilities			$24,550
Owner's Equity:
DD's capital			$100,450
Total liabilities and Owner's equity			$125,000

Table (3)

To determine

Calculate the following measures of performance and financial condition for 20-3:

1. (a) Current ratio
2. (b) Quick ratio
3. (c) Working capital
4. (d) Return on owners’ equity
5. (e) Accounts receivable and average collection period
6. (f) Inventory turnover and average number of days required to sell inventory

Explanation of Solution

(a)

Current ratio: The financial ratio which evaluates the ability of a company to pay off the debt obligations which mature within one year or within completion of operating cycle is referred to as current ratio. This ratio assesses the liquidity of a company.

Calculate current ratio.

$\begin{array}{ccc}\text{Current}\text{ratio}& =& \frac{\text{Current}\text{assets}}{\text{Current}\text{liabilities}}\\ & =& \frac{\$50,000}{\$14,550}\\ & =& 3.4\text{to}1\end{array}$

(b)

Calculate quick ratio.

Quick ratio: The financial ratio which evaluates the ability of a company to pay off the instant debt obligations is referred to as quick ratio. Quick assets are cash, marketable securities, and accounts receivables. This ratio assesses the short-term liquidity of a company.

$\begin{array}{ccc}\text{Quick}\text{ratio}& =& \frac{\text{Quick}\text{assets}}{\text{Current}\text{liabilities}}\\ & =& \frac{(\$16,700+\$3,200)}{\$14,550}\\ & =& 1.4\text{to}1\end{array}$

(c)

Calculate working capital.

Working capital: Working capital refers to the excess amount of current assets over its current liabilities of a business. It measures the excess funds that are required for the companies to carry out their day to day operations, excluding any new funds that have been invested during the year.

$\begin{array}{ccc}\text{Working}\text{capital}& =& \text{Current assets - Current liabilities}\\ & =& \$50,000-\$14,550\\ & =& \$35,450\end{array}$

(d)

Calculate the return on owner’s equity.

$\begin{array}{ccc}\text{Return on owner's equity}& =& \frac{\text{net}\text{income}}{\text{Average}\text{owner's}\text{equity}}\\ & =& \frac{\$25,650}{\left(\frac{\$95,800+\$100,450}{2}\right)}\\ & =& \frac{\$25,650}{\$98,125}\\ & =& 26.1\%\end{array}$

(e)

Calculate accounts receivable turnover.

$\begin{array}{ccc}\text{Accounts receivable turnover}& =& \frac{\text{net credit sales}}{\text{Average}\text{accounts receivable}}\\ & =& \frac{\$38,000}{\left(\frac{(\$3,000+\$3,200}{2}\right)}\\ & =& \frac{\$38,000}{\$3,000}\\ & =& 12.26\text{times}\end{array}$

Calculate average collection period.

$\begin{array}{ccc}\text{Average collection perios}& =& \frac{\text{365}}{\text{Accounts receivable turnover}}\\ & =& \frac{365}{12.26\text{times}}\\ & =& 29.8\text{days}\end{array}$

(f)

Calculate inventory turnover.

$\begin{array}{ccc}\text{Inventory turnover}& =& \frac{\text{Cost of goods sold}}{\text{Average}\text{inventory}}\\ & =& \frac{\$75,650}{\left(\frac{(\$32,300+\$29,100)}{2}\right)}\\ & =& \frac{\$75,650}{\$30,700}\\ & =& 2.46\text{times}\end{array}$

Calculate average number of days required to sell inventory.

$\begin{array}{ccc}\text{Average number of days to sell inventory})& =& \frac{\text{365}}{\text{Accounts turnover}}\\ & =& \frac{365}{2.46\text{times}}\\ & =& 148.4\text{days}\end{array}$

To determine

Open an income summary account, and post adjusting entries and closing entries in the income summary account.

Explanation of Solution

Adjusting entries: Adjusting entries are those entries which are recorded at the end of the year, to update the income statement accounts (revenue and expenses) and balance sheet accounts (assets, liabilities, and stockholders’ equity) to maintain the records according to accrual basis principle.

Prepare adjusting entries.

Date	Account titles and Explanation	Debit	Credit
December 31	Income summary	$31,300
	Merchandise inventory		$31,300
December 31	Merchandise inventory	$28,000
	Income summary		$28,000
December 31	Sales returns and allowances	$200
	Customer refunds payable		$200
December 31	Income summary	$1,000
	Estimated returns inventory		$1,000
December 31	Estimated returns inventory	$1,100
	Income summary		$1,100
December 31	Office supplies expense	$600
	Office Supplies		$600
December 31	Insurance expense	$400
	Prepaid insurance		$400
December 31	Depreciation expense - Store equipment	$5,000
	Accumulated depreciation - Store equipment		$5,000
December 31	Wages expense	$200
	Wages payable		$200
December 31	Unearned show revenue	$700
	Rent revenue		$700

Table (4)

Prepare income summary account.

INCOME SUMMARY ACCOUNT
Date	Item	Debit	Credit	Balance
				Debit	Credit
December 31	Adjusting entry	$31,300		$31,300
December 31	Adjusting entry		$28,000		($3,300)
December 31	Adjusting entry	$1,000			($4,300)
December 31	Adjusting entry		$1,100		($3,200)
December 31	Closing entry		$207,950		$204,750
December 31	Closing entry	$179,100			$25,650
December 31	Closing entry	$25,650

Table (5)

To determine

Prepare closing entries of DD.

Explanation of Solution

Closing entries: The journal entries prepared to close the temporary accounts to Retained Earnings account are referred to as closing entries. The revenue, expense, and dividends accounts are referred to as temporary accounts because the information and figures in these accounts is held temporarily and consequently transferred to permanent account at the end of accounting year.

Prepare closing entries of DD.

Date	Account titles and Explanation	Debit	Credit
December 31	Rent Revenue	$5,700
	Sales	$201,500
	Purchase returns and allowances	$750
	Income summary		$207,950
December 31	Income summary	$179,100
	Sales returns and allowances		$6,100
	Purchases		$72,000
	Rent expense		$42,000
	Freight in		$1,200
	Wages expense		$42,200
	Office supplies expense		$600
	Phone expense		$1,500
	Utilities expense		$7,600
	Insurance expense		$400
	Depreciation expense - Store Equipment		$5,000
	Interest expense		$500
December 31	Income summary	$25,650
	DD's Capital		$25,650
December 31	DD's Capital	$21,000
	DD's Drawings		$21,000

Table (6)

To determine

Prepare reversing entries for the adjustments where appropriate.

Explanation of Solution

Reversing entry: Entries made on the first day of the next accounting cycle, and it abridges the recording transactions in the different period. It is an opposite of adjusting entry.

Prepare reversing entries.

Date	Account titles and Explanation	Debit	Credit
January 1 -20-4	Wages payable	$200
	Wages expense		$200

Table (7)