
1.
Record the six
1.

Answer to Problem 4.8CP
Record the six adjusting entries required on December 31, 2017:
Date | Account Title and Explanation | Debit ($) | Credit ($) | |
a. | Supplies expense (+E, -SE) ($4,000−$1,800) | 2,200 | ||
Supplies (-A) | 2,200 | |||
(To record supplies expenses) | ||||
b. | Insurance expense (+E, -SE) ($6,0002) | 3,000 | ||
Prepaid insurance (-A) | 3,000 | |||
(To record insurance expense) | ||||
c. | 8,000 | |||
8,000 | ||||
(To record the accumulated depreciation) | ||||
d. | Salaries expense (+E, -SE) | 3,200 | ||
Salaries payable (+L) | 3,200 | |||
(To record the payment of salaries) | ||||
e. | Transportation revenue (-R, -SE) | 7,000 | ||
Unearned transportation revenue (+L) | 7,000 | |||
(To record collection of unearned transportation revenue) | ||||
f. | Income tax expense (+E, -SE) | 5,110 | ||
Income tax payable (+L) | 5,110 | |||
(To record income tax expense) |
Table (1)
Explanation of Solution
Adjusting entries:
Adjusting entries are the
a.
- Supplies expense is an expense account which is a component of
stockholders equity. There is an increase in the expense which decreases the stock holders’ equity. Hence, debit supplies expense with $2,200. - Supplies are asset. There is a decrease in the asset. Hence, credit asset with $2,200.
b.
- Insurance expense is an expense account which is a component of stockholders equity. There is an increase in the expense which decreases the stock holders’ equity. Hence, debit insurance expense with $3,000.
- Prepaid insurance is an asset. There is a decrease in the asset. Hence, credit asset with $3,000.
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 $8,000.
- Accumulated depreciation is a contra-asset. There is a decrease in the asset. Hence, credit accumulated depreciation with $8,000.
d.
- Salaries expense is an expense account which is a component of stockholders equity. There is an increase in the expense which decreases the stock holders’ equity. Hence, debit salaries expense with $3,200.
- Salaries payable is a liability. There is an increase in the liability. Hence, credit salaries payable with $3,200
e.
- Transportation revenue is revenue which is a component of stockholders’ equity. There is a decrease in the revenue account which decreases the stockholders’ equity. Hence, debit transportation revenue with $7,000.
- Unearned transportation revenue is a liability. There is an increase in the liability. Hence, credit unearned transportation revenue with $7,000
f.
- Income tax expense is an expense account which is a component of stock holders’ equity. There is an increase in the expense account which decreases the stockholders’ equity. Hence, debit interest expense with $5,110.
- Income tax payable is a liability. There is an increase in the liability. Hence, credit, interest payable with $5,110.
Working notes:
Calculation of income tax expense:
Pretax income = Transportation revenues −Expenses=[ ($85,000−$7,000)−($47,000+$2,200+$3,000+$8,000+$3,200)]=[$78,000−$63,400]=$14,600
Income tax expense = Pretax income ×income tax rate=$14,600×35%=$5,110
2.
Prepare the preceding statements after taking into account the adjusting entries.
2.

Explanation of Solution
Prepare the preceding statements after taking into account the adjusting entries:
Corporation SM | |||||
Corrections to 2017 Financial Statements | |||||
Changes | |||||
2017 Income Statement: | Amounts Reported ($) | Debit | Credit | Corrected Amounts ($) | |
Revenue: | |||||
Transportation revenue | 85,000 | e | 7,000 | 78,000 | |
Less: Expenses | |||||
Salaries expense | 17,000 | d | 3,200 | 20,200 | |
Supplies expense | 12,000 | a | 2,200 | 14,200 | |
Other expenses | 18,000 | 18,000 | |||
Insurance expense | 0 | b | 3,000 | 3,000 | |
Depreciation expense | 0 | c | 8,000 | 8,000 | |
Income tax expense | 0 | f | 5,110 | 5,110 | |
Total expenses | 47,000 | 68,510 | |||
Net income | 38,000 | 9,490 |
Table (2)
Corporation SM | |||||
Corrections to 2017 Financial Statements | |||||
Changes | |||||
December 31, 2017, Balance Sheet | Amounts Reported ($) | Debit | Credit | Corrected Amounts ($) | |
Assets: | |||||
Current Assets: | |||||
Cash | 2,000 | 2,000 | |||
Receivables | 3,000 | 3,000 | |||
Supplies | 4,000 | a | 2,200 | 1,800 | |
Prepaid insurance | 6,000 | b | 3,000 | 3,000 | |
Total current assets | 15,000 | 9,800 | |||
Equipment | 40,000 | 40,000 | |||
Less: Accumulated depreciation | 0 | c | 8,000 | ||
Remaining assets | 27,000 | 27,000 | |||
Total assets | 82,000 | 68,800 | |||
Liabilities: | |||||
Current Liabilities: | |||||
Accounts payable | 9,000 | 9,000 | |||
Salaries payable | 0 | d | 3,200 | 3,200 | |
Unearned transportation revenue | 0 | e | 7,000 | 7,000 | |
Income tax payable | 0 | f | 5,110 | 5,110 | |
Total current liabilities | 9,000 | 24,310 | |||
Stockholders' Equity | |||||
Common stock | 35,000 | 35,000 | |||
| 38,000 | 9,490 | |||
Total stockholders' equity | 73,000 | 44,490 | |||
Total liabilities and stockholders' equity | 82,000 | 68,800 |
Table (3)
3.
Enter the amounts in the omission of the adjusting entries.
3.

Explanation of Solution
Enter the amounts in the omission of the adjusting entries:
Omission of the adjusting entries caused:
- (a) Net income to be overstated by $28,510.
- (b) Total assets to be overstated by $13,200.
- (c) Total liabilities to be understated by $15,310.
4.
Calculate Earnings per share and total asset turnover ratio for both unadjusted and adjusted balances and to explain the causes of the differences and the impact of the changes on financial analysis.
4.

Explanation of Solution
Calculation of earnings per share:
For Unadjusted:
Earnings per share = Net incomeAverage number of shares of stock outstanding during the period=$38,00010,000shares=$3.80per share
For adjusted:
Earnings per share = Net incomeAverage number of shares of stock outstanding during the period=$9,49010,000shares=$0.95per share
Calculation of total asset turnover:
For Unadjusted:
Total asset turnover ratio =Sales revenuesAverage total assets=$85,000[0+$82,000]2=2.073
For Adjusted:
Total asset turnover ratio =Sales revenuesAverage total assets=$78,000[0+$68,800]2=2.267
Explain the causes of the differences and the impact of the changes on financial analysis:
Both ratios were affected by presence of the adjustments with net income, revenue, and assets decreasing.
- For earnings per share, the numerator net income has been decreased while the denominator did not, resulting in a significantly lower figure.
- For the total asset turnover ratio, both the numerator and denominator have been decreased, but the denominator average total assets have been decreased more than the numerator revenues, causing an increase in the ratio.
5.
Write a letter to the company explaining the results of the adjustments regarding analysis and decision about the loan.
5.

Explanation of Solution
Write a letter to the company explaining the results of the adjustments regarding analysis and decision about the loan as given below:
To
The Stockholders of Corporation SM
We regret to inform you that your plea for a $30,000 loan has been disavowed.
Our analysis showed that various adjustments were essential to the original set of financial statements provided to us. The original financial statements overstated the net income for 2017 by $28,510 ($38,000 − $9,490). This overstatement has been caused due to the erroneously including the amount $7,000 as revenue collected in advance that had not been earned in 2017. Additionally, all of the expenses incurred were also understated and income tax expense had been wrongly excluded.
Total assets amounting to $13,200 ($82,000 − $68,800) were also overstated. Supplies worth $2,200, prepaid insurance amounting to $3,000, and the net book value of the equipment amounting to $8,000 were also overstated because the annual depreciation expense was not recognized appropriately. Though, the total liabilities were also understated by $15,310.
An assessment of key financial ratios shows that the adjustments adversely affected the earnings per share, even though the total asset turnover increased from 2.073 to 2.267. However, the adjusted ratios should be compared with the other start-up companies that are operating the same industry.
We entail that there should be sufficient collateral pledged against the loan before we can approve it. The current market value of the equipment should be able to provide additional collateral against which the loan could be protected. Your personal investments may also be considered feasible collateral if you are agreeable to sign an agreement pledging these assets as a collateral for the loan. This is a common requirement for similar and small start-up businesses.
If you would like us to reassess your application, kindly provide us the current market values of any assets that you would pledge as collateral.
Regards,
XYZ
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