Chapter 2, Problem 5P

1.

To determine

Record the journal entries of Company D.

Explanation of Solution

Journal:

Journal is the method of recording monetary business transactions in chronological order. It records the debit and credit aspects of each transaction to abide by the double-entry system.

Rules of Debit and Credit:

Following rules are followed for debiting and crediting different accounts while they occur in business transactions:

• Debit, all increase in assets, expenses and dividends, all decrease in liabilities, revenues and stockholders’ equities.
• Credit, all increase in liabilities, revenues, and stockholders’ equities, all decrease in assets, expenses.

Journal entries of Company D ($ in million) are as follows:

a. Cash borrowed from banks:

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Cash (+A)		50
	Long-term liabilities (+L)			50
	(To record cash borrowed from bank)

Table (1)

• Cash is an assets account and it increased the value of asset by $50. Hence, debit the cash account for $50.
• Notes payable is a liability account, and it increased the value of liabilities by $50. Hence, credit the notes payable for $50.

b. Cash paid on note

Date	Accounts	Post Ref.	Debit ($)	Credit ($)
	Accounts receivable		300
	Cash			300
	(To record cash paid on note)

Table (2)

• Accounts receivable is an assets account and it increased the value of asset by $300. Hence, debit the accounts receivable account for $300.
• Cash is an assets account and it decreased the value of asset by $300. Hence, credit the cash account for $300.

c. Purchase of additional investment:

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Long-term investment (+A) (1)		2,600
	Short-term investment (+A) (2)		10,400
	Cash (-A)			13,000
	(To record purchase of investment)

Table (3)

• Long-term investment is an assets account and it increased the value of asset by $2,600. Hence, debit the long-term investment account for $2,600.
• Short-term investment is an assets account and it increased the value of asset by $10,400. Hence, debit the short-term investment account for $10,400.
• Cash is an assets account and it decreased the value of asset by $13,000. Hence, credit the cash account for $13,000.

Working note:

Calculate the value of long-term investment

$\begin{array}{c}\text{Long-term investment = Total investment value }\times \frac{1}{5}\\ =\$13,000\times \frac{1}{5}\\ =\$2,600\end{array}$ (1)

Calculate the value of short-term investment

$\begin{array}{c}\text{Long-term investment = }\left(\begin{array}{l}\text{Total investment value }-\\ \text{Long-term investment }\end{array}\right)\\ =\$13,000-\$2,600\\ =\$10,400\end{array}$ (2)

d. Property, plant and equipment purchased on account and in cash:

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Property, plant and equipment (+A)		2,285
	Cash (-A)			875
	Long-term liabilities (+L)			1,410
	(To record purchase of property, plant and equipment on account and in cash)

Table (4)

• Property, plant and equipment are an assets account and it increased the value of asset by $2,285. Hence, debit the property, plant and equipment account for $2,285.
• Cash is an assets account and it decreased the value of asset by $875. Hence, credit the cash account for $875.
•  Long-term liabilities are a liability account, and it increased the value of liabilities by $1,410. Hence, credit the long-term liabilities for $1,410.

e. Issuance of common stock:

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Cash (+A)		400
	Common stock (+SE)			10
	Additional paid-in capital (+SE)			390
	(To record the issuance of common stock)

Table (5)

• Cash is an assets account and it increased the value of asset by $400. Hence, debit the cash account for $400.
• Common stock is a component of stockholder’s equity and it increased the value of stockholder’s equity by $10. Hence, credit the common stock for $10.
• Additional paid-in capital is a component of stockholder’s equity and it increased the value of stockholder’s equity by $390. Hence, credit the additional paid-in capital for $390.

f. Cash paid to invest short-term investment:

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Short-term investment (+A)		11,000
	Cash (-A)			11,000
	(To record cash paid to short-term investment)

Table (5)

• Short-term investment is an assets account and it increased the value of asset by $11,000. Hence, debit the short-term investment account for $11,000.
• Cash is an assets account and it decreased the value of asset by $11,000. Hence, credit the cash account for $11,000.

g. Declared cash dividends:

Date	Accounts title and explanation	Ref.	Debit ($)	Credit ($)
	Retained earnings (-SE)		60
	Cash(-A)			60
	(To record dividends declared to the investors)

Table (6)

• Retained earnings are a component of stockholder’s equity and it decreased the value of stockholder’s equity by $60. Hence, debit retained earnings for $60.
• Dividends payable is a liability account and it increased the value of liability by $60. Hence, credit the dividends payable for $60.

Requirement – 2

To determine

To prepare: T-accounts for the given accounts.

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 the given accounts are as follows:

Cash
Beg.	13,852
(a)	50	300	(b)
(e)	400	13,000	(c)
(f)	11,000	875	(d)
		60	(g)
	11,067

Short-Term Investments
Beg.	966
(c)	10,400	11,000	(f)
	366

Receivables and other Assets
Beg.	9,803
(b)	300
	10,103

Inventories
Beg.	1,404
	1,404

Other Current Assets
Beg.	3,423
	3,423

Property, Plant, and Equipment
Beg.	2,124
(d)	2,285
	4,409

Long-Term Investments
Beg.	3,404
(c)	2,600
	6,004

Other Noncurrent Assets
Beg.	9,557
	9,557

Accounts Payable
		11,656	Beg.
		11,656

Other Short-term Obligations
		10,345	Beg.
		10,345

Long-Term Liabilities
		13,615	Beg.
		50	(a)
		1,410	(d)
		15,075

Common Stock
		34
		10	(e)
		44

Additional Paid-in Capital
		12,153	Beg.
		390	(e)
		12,543

Retained  Earnings
		28,236	Beg.
(g)	60
		28,176

Other Stockholders’ Equity Items
Beg.	31,506
	31,506

Requirement – 3

To determine

To prepare: The balance sheet of Company D at February 1, 2013.

Explanation of Solution

Balance Sheet:

Balance Sheet summarizes the assets, the liabilities, and the Stockholder’s equity of a Company Dt a given date. It is also known as the statement of financial status of the business.

Balance sheet of Company D is as follows:

Company D
Balance sheet
at February 1, 2013
(in millions)
Assets	$ (in millions)	$ (in million)
Current Assets:
Cash	11,067
Short-term investments	366
Accounts receivable	10,103
Inventories	1,404
Other current assets	3,423
Total current assets		26,363
Long-term investments		6,004
Property, plant and equipment		4,409
Other noncurrent assets		9,557
Total assets		46,333
Liabilities and Stockholders’ Equity
Current Liabilities:
Accounts payable	11,656
Other short-term obligation	10,345
Total current liabilities		22,001
Long-term debt		15,075
Total liabilities		37,076
Stockholders’ Equity:
Common stock		44
Additional paid-in capital		12,543
Retained earnings		28,176
Other stockholder’s equity items		(31,506)
Total stockholders’ equity		9,257
Total liabilities and stockholders’ equity		46,333

Table (7)

Therefore, the total assets of Company D are $46,333, and the total liabilities and stockholders’ equity is $46,333.

5.

To determine

Calculate the current ratio of Company D, and also suggest about the company.

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 of company. A current ratio is a useful tool for analysis of financials of a company.

Calculate the current ratio of Company D as follows:

Here,

Current assets = $26,363

Current liabilities= $22,001

$\begin{array}{c}\text{Current ratio=}\frac{\text{Current assets}}{\text{Current liabilities}}\\ \text{=}\frac{\text{ \$26,363}}{\text{\$22,001}}\\ \text{=1}\text{.20}\end{array}$

Therefore, the current ration of Company D is 1.20

Current ratio of Company D has high liquidity, because for every one dollar of current liabilities, Company C has more than one dollar of current assets.