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 work sheet for 20-3 is shown on page 612. 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 $35,300, and receivables on January 1 were $2,500.

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
      1. (e) Accounts receivable turnover and average number of days required to collect receivables
   5. (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. Prepare closing entries.
7. 7. Prepare reversing entries for the adjustments where appropriate.

To determine

Prepare a multi-step income statement of DD House.

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 statement of multi-step income statement.

DD
Income Statement
For Year Ended December 31, 20-3
Particulars	Amount	Amount	Amount
Revenue from sales:
Sales		$130,500
Less: sales returns and allowances		$900
Net sales			$129,600
Cost of goods sold:
Merchandise inventory, Jan. 1, 20-3		$22,300
Purchases	$72,000
Less: Purchases discounts	$750
Net purchases	$71,250
Add freight-in	1,200
Cost of goods purchased		72,450
Goods available for sale		$94,750
Less: march. inventory, Dec. 31, 20-3		24,600
Cost of goods sold			$70,150
Gross profit			$59,450
Operating expenses:
Wages expense		$42,200
Rent expense		$6,000
Office supplies expense		$600
Phone expense		$1,500
Utilities expense		$7,600
Insurance expense		$400
Depreciation expense—store equipment		$5,000
Total operating expenses			$63,300
Income (loss) from operations			($3,850)
Other revenues:
Rent revenue		$25,700
Other expenses:
Interest expense		($500)	$25,200
Net income			$21,350

Table (1)

To determine

Prepare a statement of owners’ equity of DD house.

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 an owners’ equity statement.

DD
Statement of Owner’s Equity
For Year Ended December 31, 20-3
Particulars	Amount	Amount
DF's, capital, January 1, 20-3		$75,800
Net income for the year	$21,350
Less: withdrawals for the year	$21,000
Add: Increase in capital		$350
DF's, capital, December 31, 20-3		$76,150

Table (2)

To determine

Prepare a balance sheet of DD House.

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.

DD
Balance Sheet
For Year Ended December 31, 20-3
	Amount	Amount
Assets
Current assets:
Cash	$5,200
Accounts receivable	$3,200
Merchandise inventory	$24,600
Office supplies	$200
Prepaid insurance	$800
Total current assets		$34,000
Property, plant, and equipment:
Store equipment	$85,000
Less accumulated depreciation	$20,000	$65,000
Total assets		$99,000
Liabilities
Current liabilities:
Notes payable	$6,000
Accounts payable	$5,500
Wages payable	$200
Sales tax payable	$850
Unearned rent revenue	$300
Total current liabilities		$12,850
Long-term liabilities:
Long-term note payable		$10,000
Total liabilities		$22,850
Owner’s Equity
DF's, capital		$76,150
Total liabilities and owner’s equity		$99,000

Table (3)

To determine

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 owners’ 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.

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.

$\begin{array}{c}\text{Current ratio =}\frac{\text{Current assets}}{\text{Current liabilites}}\\ =\frac{\$34,000}{\$12,850}\\ =2.65\text{to 1}\end{array}$

(b)

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.

Calculate quick ratio.

$\begin{array}{c}\text{Quick ratio =}\frac{\text{Quick assets}}{\text{Current liabilites}}\\ =\frac{\left(\$5,200+3,200\right)}{\$12,850}\\ =0.65\text{to 1}\end{array}$

(c)

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.

Calculate working capital.

$\begin{array}{c}\text{Working capital =}\text{Current assets }-\text{Current liabilites}\\ =\$34,000-\$12,850\\ =\$21,150\end{array}$

(d)

Calculate return on owners’ equity.

$\begin{array}{c}\text{Return on owners' equity =}\frac{\text{Net income}}{\text{Average owner's equity}}\\ =\frac{\$21,350}{\left(\frac{\left(\$75,800+\$76,150\right)}{2}\right)}\\ =\frac{\$21,350}{\$75,975}\\ =28.1\%\end{array}$

(e)

Calculate accounts receivable turnover and average collection period.

$\begin{array}{c}\text{Accounts receivable turnover =}\frac{\text{Net credit sales}}{\text{Average receivables}}\\ =\frac{\$35,300}{\left[\frac{\left(\$2,500+\$3,200\right)}{2}\right]}\\ =\frac{\$35,300}{\$2,850}\\ =12.39\text{times}\end{array}$

$\begin{array}{c}\text{Average collection period =}\frac{365}{\text{Accounts receivable turnover}}\\ =\frac{365}{12.39\text{times}}\\ =29.46\text{times}\end{array}$

(f)

Calculate inventory turnover and average days to sell inventory.

$\begin{array}{c}\text{Inventory turnover}\text{=}\frac{\text{Cost of goods sold}}{\text{Average inventory}}\\ =\frac{\$70,150}{\left[\frac{\left(\$22,300+\$24,600\right)}{2}\right]}\\ =\frac{\$70,150}{\$23,450}\\ =2.99\text{times}\end{array}$

$\begin{array}{c}\text{Average number of days to}\text{sell inventory =}\frac{365}{\text{Inventory turnover}}\\ =\frac{365}{2.99\text{times}}\\ =122.07\text{days}\end{array}$

To determine

Prepare adjusting entries and indicate which should be reversed and why.

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	a.	Income summary	$22,300
		Merchandise inventory		$22,300
December 31	b.	Merchandise inventory	$24,600
		Income summary		$24,600
December 31	c.	Office supplies expense	$600
		Office supplies		$600
December 31	d.	Insurance expense	$400
		Prepaid insurance		$400
December 31	e.	Depreciation expense - Store equipment	$5,000
		Accumulated depreciation - Store equipment		$5,000
December 31	f.	Unearned rent revenue	$700
		Rent revenue		$700
December 31	g.	Wages expense	$200
		Wages payable		$200

Table (4)

Indicate the adjusting entry that should be reversed.

1. a. Never reverse adjustments for merchandise inventory.
2. b. Never reverse adjustments for merchandise inventory.
3. c. No. No asset or liability with a zero balance has been increased.
4. d. No. No asset or liability with a zero balance has been increased.
5. e. Never reverse adjustments for depreciation.
6. f. No. No asset or liability with a zero balance has been increased.
7. g. Yes. A liability with a zero balance has been increased.

To determine

Prepare closing entries.

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.

Date	Account titles and Explanation	Debit	Credit
December 31	Sales	$130,500
	Rent revenue	$25,700
	Purchase discounts	$750
	Income summary		$156,950
	Income summary	$137,900
	Sales returns and allowances		$900
	Purchases		$72,000
	Freight in		$1,200
	Wages expense		$42,200
	Rent expense		$6,000
	Office supplies expense		$600
	Phone expense		$1,500
	Utilities expense		$7,600
	Insurance expense		$400
	Depreciation expense - store equipment		$5,000
	Interest expense		$500
	Income summary	$21,350
	DF's Capital		$21,350
	DF's Capital	$21,000
	DF's Drawings		$21,000

Table (5)

To determine

Prepare reversing entry.

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 entry

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

Table (6)