Chapter 2, Problem 2.3AP

Recording Transactions in T-Accounts, Preparing the Balance Sheet, and Evaluating the Current Ratio

Ethan Allen Interiors, Inc., is a leading manufacturer and retailer of home furnishings in the United States and abroad. The following is adapted from Ethan Allen’s recent annual financial report (fiscal year ending on June 30). Amounts are in thousands.

Cash and cash equivalents	$ 78,519	Accounts payable	$26,958
Short-term investments	12,909	Accrued expenses payable	127,639
Accounts receivable	15,036	Long-term debt (includes the
Inventories	141,692	current portion of $19)	165,032
Prepaid expenses and other current assets	20,372	Other long-term liabilities	27,009
		Common stock ($0.01 par value)	484
Property, plant, and equipment	294,853	Additional paid-in capital	359,728
Intangibles	45,128	Retained earnings	501,908
Other assets	19,816	Other stockholders’ equity items	(580,433)

Assume that the following events occurred in the first quarter ended September 30 of the next fiscal yean

1. a. Issued 1,600 additional shares of stock for $1,020 in cash.
2. b. Purchased $3,400 in additional intangibles for cash.
3. c. Ordered $43,500 in wood and other raw materials for the manufacturing plants.
4. d. Sold equipment at its cost for $4,020 cash.
5. e. Purchased $2,980 in short-term investments for cash.
6. f. Purchased property, plant, and equipment: paid $1,830 in cash and signed additional long-term notes for $9,400.
7. g. Sold at cost other assets for $310 cash.
8. h. Declared $300 in dividends.

Required:

1. 1. Create T-accounts for each of the accounts on the balance sheet, including a new account Dividends Payable: enter the balances at June 30 as the beginning balances for the quarter.
2. 2. Record each of the transactions for the first quarter ended September 30 in the T-accounts (including referencing) and determine the ending balances.
3. 3. Explain your response to event (c).
4. 4. Prepare a trial balance at September 30.
5. 5. Prepare a classified balance sheet at September 30.
6. 6. Compute the current ratio for the quarter ended September 30. What does this suggest about Ethan Allen Interiors. Inc.?

To determine

Open the T-accounts for each of the balance sheet accounts, and enter the beginning balance for the current year.

Explanation of Solution

T-account:

T-account refers to an individual account, where the increases or decreases in the value of specific asset, liability, stockholder’s equity, revenue, and expenditure items are recorded.

This account is referred to as the T-account, because the alignment of the components of the account resembles the capital letter ‘T’.’ An account consists of the three main components which are as follows:

1. (a) The title of the account
2. (b) The left or debit side
3. (c) The right or credit side

T-accounts for each of the balance sheet accounts are as follows:

Cash and Cash Equivalents
Beg.	78,519

Short-Term Investments
Beg.	12,909

Inventories
Beg.	141,692

Accounts Receivable
Beg.	15,036

Prepaid Expenses and Other Current Assets
Beg.	20,372

Property, Plant, and Equipment
Beg.	294,853

Intangibles
Beg.	45,128

Other Assets
Beg.	19,816

Accounts Payable
		26,958	Beg.

Accrued Expenses Payable
		127,639	Beg.

Long-Term  Debt
		165,032	Beg.

Other Long-Term Liabilities
		27,009	Beg.

Common Stock
		484	Beg.

Additional  Paid-in Capital
		359,728	Beg.

Retained  Earnings
		501,908	Beg.

Other Stockholders’ Equity Items
Beg.	580,433

To determine

Prepare the T-account for the given balance sheet accounts, and to determine the ending balance of each account.

Explanation of Solution

T-account:

T-account refers to an individual account, where the increases or decreases in the value of specific asset, liability, stockholder’s equity, revenue, and expenditure items are recorded.

This account is referred to as the T-account, because the alignment of the components of the account resembles the capital letter ‘T’.’ An account consists of the three main components which are as follows:

1. (a) The title of the account
2. (b) The left or debit side
3. (c) The right or credit side

T-accounts for each of the balance sheet accounts are as follows:

Cash and Cash Equivalents
Beg.	78,519
(a)	1,020	3,400	(b)
(d)	4,020	2,980	(e)
(g)	310	1,830	(f)
	75,659

Short-Term Investments
Beg.	12,909
(e)	2,980
	15,889

Accounts Receivable
Beg.	15,036
	15,036

Inventories
Beg.	141,692
	141,692

Prepaid Expenses and Other Current Assets
Beg.	20,372
	20,372

Property, Plant, and Equipment
Beg.	294,853
(f)	11,230	4,020	(d)
	302,063

Intangibles
Beg.	45,128
(b)	3,400
	48,528

Other Assets
Beg.	19,816
		310	(g)
	19,506

Accounts Payable
		26,958	Beg.
		26,958

Accrued Expenses Payable
		127,639	Beg.
		127,639

Dividends Payable
.		0	Beg
		300	(h)
		300

Long-Term  Debt
		165,032	Beg.
		9,400	(f)
		174,432

Other Long-Term Liabilities
		27,009	Beg.
		27,009

Common Stock
		484	Beg.
		16	(a)
		500

Additional  Paid-in Capital
		359,728	Beg.
		1,004	(a)
		360,732

Retained  Earnings
		501,908	Beg.
(h)	300
		501,608

Other Stockholders’ Equity Items
Beg.	580,433
	580,433

To determine

Explain the response for event (c).

Explanation of Solution

Business transaction:

Business transaction is a record of any economic activity, resulting in the change in the value of the assets, the liabilities, and the stockholder’s equities, of a business. Business transaction is also referred to as financial transaction.

In this case, ordered wood and other raw material is not creating any impact on assets, liabilities and stockholder’s equity of the business, because it is not a business transaction.

To determine

Prepare the trial balance of Company E at September 30.

Explanation of Solution

Trial balance:

Trial balance is the summary of accounts, and their debit and credit balances at a given time. It is usually prepared at end of the accounting period.  Debit balances are listed in left column and credit balances are listed in right column.  The totals of debit and credit column should be equal.  Trial balance is useful in the preparation of the financial statements.

Trial balance of Company E is as follows:

Company E
Trial Balance
At September 30
(in thousands of dollars)
Particulars	Debit ($)	Credit ($)
Cash and cash equivalents	75,659
Short-term investments	15,889
Accounts receivable	15,036
Inventories	141,692
Prepaid expenses and other current assets	20,372
Property, plant, and equipment	302,063
Intangibles	48,528
Other assets	19,506
Accounts payable		26,958
Accrued expenses payable		127,639
Dividends payable		300
Long-term debt (current portion, $19)		174,432
Other long-term liabilities		27,009
Common stock		500
Additional paid-in capital		360,732
Retained earnings		501,608
Other stockholders’ equity items	580,433
Totals	1,219,178	1,219,178

Table (1)

Therefore, the total of debit, and credit columns of trial balance is $1,219,178 and agree.

To determine

Prepare a classified balance sheet of Company E at September 30.

Explanation of Solution

Classified balance sheet:

This is the financial statement of a company which shows the grouping of similar assets and liabilities under subheadings.

Classified balance sheet of Company E on September 30 is as follows:

Company E
Balance Sheet
At September 30
(in thousands of dollars)
Assets	$	$
Current assets
Cash and cash equivalents	75,659
Short-term investments	15,889
Accounts receivable	15,036
Inventories	141,692
Prepaid expenses and other current assets	20,372
Total current assets		268,648
Property, plant, and equipment		302,063
Intangibles		48,528
Other assets		19,506
Total Assets		638,745
Liabilities and stockholder's equity
Liabilities
Current liabilities
Accounts payable	26,958
Accrued expenses payable	127,639
Dividends payable	300
Current portion of long-term debt	19
Total current liabilities		154,916
Long-term debt		174,413
Other long-term liabilities		27,009
Total Liabilities		356,338
Stockholders’ Equity
Common stock ($0.01 par value)		500
Additional paid-in capital		360,732
Retained earnings		501,608
Other stockholders’ equity items		(580,433)
Total Stockholders’ Equity		282,407
Total Liabilities and Stockholders’ Equity		638,745

Table (2)

Therefore, the total assets of Company E are $638,745, and the total liabilities and stockholders’ equity is $638,745.

To determine

Calculate the current ratio of Company E and evaluate the ratio.

Explanation of Solution

Current Ratio:

A part of liquidity ratios, current ratio reflects the ability to oblige the short term debts of a company. It is calculated based on the current assets and current liabilities; a company has in an accounting period. A current ratio is a useful tool for analysis of financials of a company.

Calculate the current ratio of Company E as follows:

Here,

Current assets = $268,648

Current liabilities= $154,916

$\begin{array}{c}\text{Current ratio=}\frac{\text{Current assets}}{\text{Current liabilities}}\\ \text{=}\frac{\$268,648}{\$154,916}\\ \text{=1}\text{.73}\end{array}$

Therefore, the current ration of Company E is 1.73

Current ratio of Company E has sufficient liquidity, because for every one dollar of current liabilities, Company E has more than one dollar of current assets.