Chapter 4, Problem 4.19E

Reporting a Correct Income Statement with Earnings per Share to Include the Effects of Adjusting Entries and Evaluating Total Asset Turnover as an Auditor

Jay, Inc., a party rental business, completed its first year of operations on December 31. Because this is the end of the annual accounting period, the company bookkeeper prepared the following tentative income statement:

Income Statement
Rental revenue	$109,000
Expenses:
Salaries and wages expense	26,500
Maintenance expense	12,000
Rent expense	8,800
Utilities expense	4,300
Gas and oil expense	3,000
Miscellaneous expenses (items not listed elsewhere)	1,000
Total expenses	55,600
Income	$ 53.400

You are an independent CPA hired by the company to audit the company's accounting systems and review the financial statements. In your audit, you developed additional data as follows:

1. a. Wages for the last three days of December amounting to $730 were not recorded or paid.
2. b. Jay estimated telephone usage at $440 for December, but nothing has been recorded or paid.
3. c. Depreciation on rental autos, amounting to $24,000 for the current year, was not recorded.
4. d. Interest on a $15,000. one-year. 8 percent note payable dated October I of the current year was not recorded. The 8 percent interest is payable on the maturity date of the note.
5. e. Maintenance expense excludes $1,100. representing the cost of maintenance supplies used during the current year.
6. f. The Unearned Rental Revenue account includes $4,100 of revenue to be earned in January of next year.
7. g. The income tax expense is $5,800. Payment of income tax will be made next year.

Required:

1. 1. For items (a) through (g), what adjusting entry should Jay record at December 31? If none is required, explain why.
2. 2. Prepare a corrected income statement for the current year in good form, including earnings per share (rounded to two decimal places), assuming that 7.000 shares of stock are outstanding all year. Show computations.
3. 3. Assume the beginning of the year balance for Jay's total assets was $58,020 and its ending balance for total assets was $65,180. Compute the total asset turnover ratio (rounded to two decimal places) based on the corrected information. What does this ratio suggest? If the average total asset turnover ratio for the industry is 2.31, what might you infer about Jay, Inc.?

To determine

Prepare Adjusting entry for the items (a) to (g) for the Incorporation J at December 31.

Answer to Problem 4.19E

Prepare adjusting entry for the items (a) to (g) for the Incorporation J at December 31:

Date		Account Title and Explanation	Debit ($)	Credit ($)
	a.	Salaries and wages expense (+E, -SE)	730
		Salaries and wages payable (+L)		730
		(To record salaries and wages expense)
	b.	Utilities expense (+E, -SE)	440
		Utilities payable  (+L)		440
		(To record utilities expenses)
	c.	Depreciation expense (+E, -SE)	24,000
		Accumulated depreciation- (+xA, -A)		24,000
		(To record the accumulated depreciation)
	d.	Interest expense (+E, -SE) (1)	300
		Interest payable (+L)		300
		(To record interest payable)
	e.	Maintenance expense (+E, -SE)	1,100
		Maintenance supplies (-A)		1,100
		(To record maintenance expense)
	f.	No adjustment is needed because the revenue will not be earned until January of next year.
	g.	Income tax expense (+E, -SE)	5,800
		Income tax payable (+L)		5,800
		(To record income tax expense)

Table (1)

Explanation of Solution

Adjusting entries:

Adjusting entries are those entries which are made at the end of the accounting period, to record the revenues in the period of which they have been earned and to record the expenses in the period of which have been incurred, as well as to update all the balances of assets and liabilities accounts on the balance sheet, and to ascertain accurate amount of net income (loss) on the income statement to maintain the records according to the accrual basis principle.

(a)

• Salaries and wages expense is the expense account which is a component of stockholders’ equity. There is an increase in the expense which decreases the stockholders’ equity. Hence, debit salaries and wages expense with $730.
• Salaries and wages payable is a liability. There is an increase in liability. Hence, credit salaries and wages payable with $730.

(b)

• Utilities expense is the expense account which is a component of stockholders’ equity. There is an increase in the expense which decreases the stockholders’ equity. Hence, debit utilities expense with $440.
• Utilities payable is a liability. There is an increase in liability. Hence, credit utilities payable with $440.

(c)

• Depreciation expense is an expense account which is a component of stockholders’ equity. There is an increase in expense account which decreases the stockholders’ equity. Hence, debit depreciation expense with $24,000.
• Accumulated depreciation is a contra-asset. There is a decrease in the asset. Hence, credit accumulated depreciation with $24,000.

(d)

• Interest expense is the expense account which is a component of stockholders’ equity. There is an increase in the expense which decreases the stockholders’ equity. Hence, debit interest expense with $300.
• Interest payable is a liability. There is an increase in liability. Hence, credit interest payable with $300.

Working notes:

Calculation of interest expense:

$\begin{array}{c}\text{Interest expense= Principal amount }\times \text{ Annual rate }\times \text{Number of months}\\ \text{= \$15,000 }\times \frac{8}{100}\times \frac{3}{12}\\ =\$300\end{array}$ (1)

(e)

• Maintenance expense is the expense account which is a component of stockholders’ equity. There is an increase in the expense which decreases the stockholders’ equity. Hence, debit interest expense with $1,100.
• Maintenance supplies are asset. There is a decrease in asset. Hence, credit maintenance supplies with $1,100.

(f)

No adjustment is needed because the revenue will not be earned until January of next year.

(g)

• Income tax expense is an expense account which is a component of stockholders’ equity. There is an increase in expense account which decreases the stockholders’ equity. Hence, debit income tax expense with $5,800.
• Income tax payable is a liability. There is a increase in the liability. Hence, credit income tax payable with $5,800.

To determine

Prepare a corrected income statement for the current year including earnings per share.

Explanation of Solution

Prepare a corrected income statement for the current year including earnings per share:

Incorporation J
Income Statement
For the Current Year Ended December 31
Particulars	Amount ($)
Operating Revenue:
Rental revenue	$109,000
Operating Expenses:
Salaries and wages  (1)	$27,230
Maintenance expense (2)	13,100
Rent expense	8,800
Utilities expense (3)	4,740
Gas and oil expense	3,000
Depreciation expense	24,000
Miscellaneous expenses	1,000
Total expenses	81,870
Operating Income	27,130
Other Item:
Interest expense (4)	300
Pretax income	26,830
Income tax expense	5,800
Net income	$  21,030
Earnings per share (5)	$3.00

Table (2)

The income statement of the Incorporation J shows the net income with $21,030.

Working notes:

Calculation of salaries and wages expenses:

$\text{Salaries and wages expenses (\$26,500 +\$730) = \$27,230}$ (1)

Calculation of maintenance expenses:

$\text{Maintenance expenses (\$12,000 + \$1,100) = \$13,100}$ (2)

Calculation of utilities expenses:

$\text{Utilities expenses (\$4,300 +\$440) = \$4,740}$ (3)

Calculation of interest expense:

$\begin{array}{c}\text{Interest expense= Principal amount }\times \text{ Annual rate }\times \text{Number of months}\\ \text{= \$15,000 }\times \frac{8}{100}\times \frac{3}{12}\\ =\$300\end{array}$ (4)

Calculation of Earnings per share:

$\begin{array}{c}\text{Earnings}\text{per}\text{share = }\frac{\text{Net}\text{income }}{\text{Average number of shares of stock outstanding during the period }}\\ =\frac{\$21,030}{7,000\text{shares}}\\ =\$3.00\end{array}$ (5)

To determine

Compute the total asset turnover ratio based on the corrected information and to say what does this ratio suggests and to infer about the Incorporation J.

Explanation of Solution

Total asset turnover ratio:

Total asset turnover ratio is used to determine the asset’s efficiency towards sales.

Calculation of total asset turnover ratio:

$\begin{array}{c}\text{Total asset turnover ratio }=\frac{\text{Sales}\text{revenues}}{\text{Average total assets}}\\ =\frac{\$109,000}{\frac{(\$58,020+\$65,180)}{2}}\\ =\frac{\$109,000}{\$61,600}\\ =1.77\end{array}$

The total asset turnover ratio represents that, for every $1 of assets, Incorporation J The total asset turnover ratio represents that, for every $1 of assets, and Incorporation J earns $1.77 in rental revenue. This ratio is lower than the industry average total asset turnover of 2.31, which implies the Incorporation J is less effective at utilizing assets to generate revenue than the average company in the industry.