Chapter 3, Problem 8BP

1.

To determine

Prepare the income statement and the statement of retained earnings for the calendar year 2017 and the classified balance sheet at December 31, 2017.

Explanation of Solution

Income statement:

Income statement is a financial statement that shows the net income or net loss by deducting the expenses from the revenues and vice versa.

Prepare the income statement for the year ended 31^st December 2017.

Corporation A
Income statement
For the year ended December 31, 2017
Particulars	Amount ($)	Amount ($)
Revenues
Professional fees earned	56,900
Rent earned	4,500
Dividends earned	1,000
Interest earned	1,000
Total revenue		66,420
Expenses
Depreciation expense, Building	2,000
Depreciation expense, Equipment	1,000
Wages expense	18,500
Interest expense	1,550
Insurance expense	1,525
Rent expense	3,600
Supplies expense	1,000
Postage expense	410
Property taxes expense	4,825
Repairs expense	679
Telephone expense	521
Utilities expense	1,920
Total Expenses		37,530
Net income		28,890

Table (1)

Statement of Retained Earnings:

Statement of retained earnings shows, the changes in the retained earnings, and the income left in the company after payment of the dividends, for the accounting period.

Prepare the statement of retained earnings for the year ended 31^st December 2017.

Corporation A
Statement of Retained Earnings
For the year ended 31st December 2017
Particulars	Amount ($)	Amount ($)
Retained earnings, Beginning	62,800
Add: Net income	28,890
Subtotal	91,690
Less: Dividends	8,000
Retained earnings, Ending		83,690

Table (2)

Balance sheet:

This financial statement reports a company’s resources (assets) and claims of creditors (liabilities) and stockholders (stockholders’ equity) over those resources. The resources of the company are assets which include money contributed by stockholders and creditors. Hence, the main elements of the balance sheet are assets, liabilities, and stockholders’ equity.

Prepare the balance sheet as on 31^st December 2017.

Corporation A
Balance Sheet
As an December 31, 2017
Particulars	Amount($)	Amount($)
ASSETS
Current Assets:
Cash	7,400
Short-term investment	11,200
Supplies	4,600
Prepaid insurance	1,000
Total Current Assets		24,200
Equipment	24,000
Less: Accumulated depreciation, Equipment	4,000	20,000
Building	100,000
Accumulated depreciation, Building	10,000	90,000
Land		30,500
Total assets		164,700
LIABILITIES
Current Liabilities:
Accounts payable	3,500
Interest payable	1,750
Rent payable	400
Wages payable	1,280
Property tax payable	3,330
Unearned professional fees	750
Current portion of long-term note payable	8,400
Total current liabilities		19,410
Long-liabilities:
Long-term notes payable $\left(\$40,000-\$8,400\right)$		31,600
Total liabilities		51,010
Stockholders’ equity
Paid-in capital
Common stock	30,000
Retained earnings	83,690
Total Stockholders’ Equity		113,690
Total liabilities and Stockholders’ Equity		164,700

Table (3)

2.

To determine

Prepare the closing entries at December 31, 2017.

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 the closing entry for revenue accounts.

Date	Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
December 31	Professional fee earned		59,600
	Rent earned		4,500
	Dividends earned		1,000
	Interest earned		1,320
	Income summary			66,420
	(To close the revenues account)

Table (4)

In this closing entry, revenue accounts are closed by transferring the amount of revenue accounts to the income summary account in order to bring the revenue account balance to zero. Hence, debit the revenue accounts and credit income summary account.

Prepare the closing entry for expenses account.

Date	Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
December 31	Income summary		37,530
	Depreciation expense-Building			2,000
	Depreciation expense- Equipment			1,000
	Wages expense			18,500
	Interest expense			1,550
	Insurance expense			1,525
	Rent expense			3,600
	Supplies expense			1,000
	Postage expense			410
	Property taxes expense			4,825
	Repairs expense			679
	Telephone expense			521
	Utilities expense			1,920
	(To close the expenses account)

Table (5)

In this closing entry, expenses account is closed by transferring the amount of expenses to the income summary in order to bring the expenses account balance to zero. Hence, debit the income summary account and credit all expenses account.

Prepare closing entry for income summary account.

Date	Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
December 31	Income Summary		28,890
	Retained Earnings			28,890
	(To close the income summary account)

Table (6)

Closing entry of income summary account:

On December 31, total revenues are $66,420 and total expenses are $37,530. Close the Income Summary account to the Retained Earnings account.

$\begin{array}{c}\begin{array}{c}\text{Thus, net income on Income }\\ \text{Summary account}\end{array}\}=\text{Total Revenues}-\text{Total Expenses}\\ =\text{\$66,420}-\$37,530\\ =\$28,890\end{array}$

Therefore, credit balance of the Income Summary account of $4,300 is closed to Retained Earnings.

In this closing entry, income summary account is closed by transferring the amount of income summary (profit) to the retained earnings in order to bring the income summary account balance to zero. Hence, debit the income summary account and credit retained earnings account.

Prepare closing entry for dividend account.

Date	Accounts title and explanation	Post Ref.	Debit ($)	Credit ($)
December 31	Retained Earnings		8,000
	Dividends			8,000
	(To close the dividends account)

Table (7)

In this closing entry, dividend account is closed by transferring the amount of dividend to the retained earnings in order to bring the dividend account balance to zero. Hence, debit the retained earnings account and credit dividend account.

3.

To determine

Compute:

a. Return on assets

b. Debt ratio

c. Profit margin ratio

d. current ratio

Explanation of Solution

a. Return on asset ratio:

Return on assets indicates the company’s overall profitability by excluding specific sources of finance.  The Profitability is achieved through a high profit margin or a high turnover or a combination of both.

Formula for calculating the return on asset:

$\text{Return on assets}=\frac{\text{Net income}}{\text{Average total assets}}$

Compute the return on asset ratio:

$\begin{array}{c}\text{Return on assets}=\frac{\text{Net income}}{\text{Average total assets}}\\ =\frac{\$28,890}{\left(\frac{\$160,000+\$164,700}{2}\right)}\\ =0.178\end{array}$

Thus, the return on asset ratio is 0.178 or 17.8%.

b. Debt ratio:

Debt to asset ratio is the ratio between total asset and total liability of the company. Debt ratio reflects the finance strategy of the company. It is used to evaluate company’s ability to pay its debts. Higher debt ratio implies the higher financial risk.

Formula for calculating the debt ratio:

$\text{Debt ratio}=\frac{\text{Total assets}}{\text{Total liabilities}}$

Compute the debt ratio:

$\begin{array}{c}\text{Debt ratio}=\frac{\text{Total assets}}{\text{Total liabilities}}\\ =\frac{\$51,010}{\$164,700}\\ =0.31\end{array}$

Thus, the debt ratio is 0.31.

c. Profit margin ratio:

Net profit margin ratio:

Net profit is the financial ratio that shows the relationship between the net profit and net sales (Operating revenue). Net profit is the difference between total operating revenue and total operating expenses. It can be calculated by dividing net profit and net sales revenue.

Compute the net profit margin:

$\begin{array}{c}\text{Net profit margin ratio}=\frac{\text{Net income}}{\text{Total revenues }}\times 100\\ =\frac{\$28,860}{\$66,420}\times 100\\ =43.5\%\end{array}$

Hence, the profit margin ratio is 43.5%.

d. current ratio:

Current ratio

Current ratio is one of the liquidity ratios, which measures the capacity of the company to meet its short-term obligations using its current assets.

Calculate the current ratio:

$\begin{array}{c}\text{Current ratio}=\frac{\text{Current assets}}{\text{Current liabilities}}\\ =\frac{\$24,200}{\$19,410}\\ =1.25:1\end{array}$

Thus, the current ratio is 1.25:1.