Chapter 5, Problem 1CP

a. 1 and 4

To determine

Prepare journal entries for the month of December and

Prepare adjusting entry for the month of December.

Explanation of Solution

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 equities.
• Credit, all increase in liabilities, revenues, and equities, all decrease in assets, and expenses.

Debit: The condensed form of a ledger is referred to as T-account. The left-hand side of this account is known as debit.

Credit: It refers to selling goods and services to the customers on account.

Adjusting entries:

Adjusting entries are those entries which are recorded at the end of the year, to update the income statement accounts (revenue and expenses) and balance sheet accounts (assets, liabilities, and stockholders’ equity) to maintain the records according to accrual basis principle.

Prepare journal entries for the December transactions as follows:

Date		Accounts title and Explanation	Post Ref.	Debit ($)	Credit ($)
2015
December	1	Cash		200,000
		Capital stock			200,000
		(To record the cash invested in the business)
December	1	Rental Equipment		240,000
		Cash			140,000
		Notes Payable			100,000
		(To record the Purchase of equipment from Rent-it and the Note payable is due for one year)
December	1	Prepaid Rent		12,000
		Cash			12,000
		(To record the payment of three months' rent in advance)
December	4	Office Supplies		1,000
		Accounts Payable			1,000
		(To record the purchase of supplies on account.)
December	8	Cash		8,000
		Unearned Rental Fees			8,000
		(To record the cash received in advance for equipment rental by the Construction Company)
December	12	Salaries Expense		5,200
		Cash			5,200
		(To record the Payment of salaries for first two weeks in December)
December	15	Cash		12,000
		Accounts Receivable		6,000
		Rental Fees Earned			18,000
		(To record the rental fees earned in first 15 days of December)
December	17	Maintenance Expense		600
		Accounts Payable			600
		(To record the purchase of repair parts on account from Incorporation)
December	23	Cash		2,000
		Accounts Receivable			2,000
		(To record the collection of an accounts receivable)
December	26	(No entry is required to record rental of backhoe.)
December	26	Salaries Expense		5,200
		Cash			5,200
		(To record the Payment of biweekly payroll)
December	27	Accounts Payable		600
		Cash			600
		(To record the payment of account payable)
				2,000
December	28	Dividends			2,000
		Dividends Payable
		(To record the Declared dividend of 12% per share payable on January 15, 2016)
December	29	(No entry is required to record lawsuit.)
December	29	Unexpired Insurance		9,600
		Cash			9,600
		(To record the Purchase of 12-month liability policy)
December	31	Utilities Expense		700
		Accounts Payable			700
		(To record the utilities incurred  for December)
December	31	Cash		15,600
		Accounts Receivable		4,400
		Rental Fees Earned			20,000
		(To record the rental fees earned in the second half of December)

Table (1)

Prepare adjusting entry for the month of December as follows:

General Journal (Adjusting)
December, 31 2015
Date		Accounts title and Explanation	Post Ref.	Debit ($)	Credit ($)
2015, December	31.	Rent Expense (1)		4,000
		Prepaid Rent			4,000
		(To record the rent expense for December)
December	31.	Interest Expense (2)		500
		Interest Payable			500
		(To record the interest expense accrued in December)
December	31.	Depreciation Expense (3)		2,500
		Accumulated Depreciation of Rental Equipment			2,500
		(To record the depreciation expense incurred for December)
December	31.	Office Supplies Expense (4)		400
		Office Supplies			400
		(To record the offices supplies used for December)
December	31.	Unearned Rental fees		3,700
		Rental fees earned			3,700
		(To record the conversion of unearned revenue into earned revenue in December)
December	31.	Accounts Receivable		1,500
		Rental fees earned			1,500
		(To record the revenue accrued at the end of December)
December	31.	Salaries Expense		1,400
		Salaries Payable			1,400
		(To record the accrued but unpaid salaries in December)
December	31.	Income Taxes Expense (5)		9,080
		Income Taxes Payable			9,080
		(To record the income taxes expense accrued in December)

Table (2)

Working notes:

Compute the amount of rent Expense:

$\begin{array}{c}\text{Rent Expense}=\frac{\text{Prepaidrent}}{\text{3 months}}\\ =\frac{\text{\$12,000}}{\text{3 months}}\\ =\$4,000\end{array}$ (1)

Compute the amount of interest Expense:

$\begin{array}{c}\text{Interest Expense}=\frac{\text{Amount borrowed}}{\text{12 months}}\times \text{Interest rate}\\ =\frac{\text{\$100,000}}{\text{12 months}}\times \frac{6}{100}\\ =\$500\end{array}$ (2)

Compute the amount of depreciation Expense:

$\begin{array}{c}\text{Office Depreciation Expense}=\frac{\text{Equipment}}{\text{96 months}}\\ =\frac{\text{\$240,000}}{\text{96 months}}\\ =\$2,500\end{array}$ (3)

Compute the amount of Office Supplies Expense:

$\begin{array}{c}\text{Office Supplies Expense}=\left[\begin{array}{l}\text{Office supplies in trial balance}-\\ \text{Office supplies on hand at December31}\end{array}\right]\\ =\$1,0\text{00}-\$600\\ =\$400\end{array}$ (4)

Compute the amount of income taxes Expense:

$\begin{array}{c}\text{Income taxes Expense}=\text{Income tax}-\text{Income tax expense}\\ =\$43,200-\$20,500\times \left[\frac{40}{100}\right]\\ =\$9,080\end{array}$ (5)

a. 2 and 5

To determine

Post the December transactions to the suitable ledger accounts.

Post the adjusting entries to the suitable ledger accounts.

Explanation of Solution

Posting transactions:

The process of transferring the journalized transactions into the accounts of the ledger is known as posting the transactions.

Cash
Date			Debit	Credit	Balance
December	1		200,000		200,000
	1			140,000	60,000
	1			12,000	48,000
	8		8,000		56,000
	12			5,200	50,800
	15		12,000		62,800
	23		2,000		64,800
	26			5,200	59,600
	27			600	59,000
	29			9,600	49,400
	31		15,600		65,000

Accounts Receivable
Date			Debit	Credit	Balance
December	15		6,000		6,000
	23			2,000	4,000
	31		4,400		8,400
	31		1,500		9,900

Prepaid Rent
Date			Debit	Credit	Balance
December	1		12,000		12,000
	31			4,000	8,000

Unexpired Insurance
Date			Debit	Credit	Balance
December	29		9,600		9,600

Office Supplies
Date			Debit	Credit	Balance
December	4		1,000		1,000
	31			400	600

Rental Equipment
Date			Debit	Credit	Balance
December	1		240,000		240,000

Accumulated Depreciation: Rental Equipment
Date			Debit	Credit	Balance
December	31		2,500		2,500

Notes Payable
Date			Debit	Credit	Balance
December	1		100,000		100,000

Accounts Payable
Date			Debit	Credit	Balance
December	4			1,000	1,000
	17			600	1,600
	27		600		1,000
	31			700	1,700

Interest Payable
Date			Debit	Credit	Balance
December	31		500		500

Salaries Payable
Date			Debit	Credit	Balance
December	31		1,400		1,400

Dividends Payable
Date			Debit	Credit	Balance
December	28		2,000		2,000

Unearned Rental Fees
Date			Debit	Credit	Balance
December	8			8,000	8,000
	31		3,700		4,300

Income Taxes Payable
Date			Debit	Credit	Balance
December	31			9,080	9,080

Capital stock
Date			Debit	Credit	Balance
December	1			200,000	200,000

Retained Earnings
Date			Debit	Credit	Balance
December	31	Income, 2015		13,620	13,620
	31	Dividends	2,000		11,620

Table (3)

a. 3 and 6

To determine

Prepare the unadjusted trial balance columns of a 10-column worksheet for the year ended December 31 and Complete the 10-column worksheet for the year ended December 31.

Explanation of Solution

Worksheet:

A worksheet is the summarized form of accounting information which is made in order to ensure that the accounts are made properly.

Figure (1)

b.

To determine

Prepare an income statement and statement of retained earnings and a balance sheet for the year ended December 31.

Answer to Problem 1CP

• Prepare the income statement of Company S as on December 31, 2015 as follows:

Company S
Income Statement
For the Year Ended December 31, 2015
Particulars	$	$
Revenues:
Rental fees earned		$43,200
Less: Expenses:
Salaries expense	$11,800
Maintenance expense	600
Utilities expense	700
Rent expense	4,000
Office supplies expense	400
Depreciation expense	2,500
Interest expense	500	20,500
Income before income taxes expense		$22,700
Less: Income taxes expense		9,080
Net income		$13,620

Table (4)

• Prepare the statement of retained earnings of Company S as on December 31, 2015 as follows:

Company S
Statement of retained earnings
For the Year Ended December 31, 2015
Particulars	$
Retained earnings as on January 1, 2015	0
Add: Net Income	13,620
Less: Dividend	2,000
Retained earnings as on December 31, 2015	11,620

Table (5)

• Prepare the Balance Sheet of Company S as on December 31, 2015 as follows:

Company S
Balance Sheet
December 31, 2015
Assets	$	$
Cash		$65,000
Accounts Receivable		9,900
Prepaid rent		8,000
Unexpired insurance		9,600
Office supplies		600
Rental equipment	240,000
Less: Accumulated depreciation	2,500	237,500
Total Assets		$330,600
Liabilities
Notes payable	$100,000
Accounts payable	1,700
Interest payable	500
Salaries payable	1,400
Dividends payable	2,000
Unearned rental fees	4,300
Income taxes payable	9,080
Total Liabilities		$118,980
Stockholders' Equity
Capital stock	$200,000
Retained earnings	11,620	$211,620
Total Stockholders' Equity
Total Liabilities and Stockholders' Equity		$330,600

Table (6)

Explanation of Solution

Income statement:

The financial statement which reports revenues and expenses from business operations and the result of those operations as net income or net loss for a particular time period is referred to as income statement.

Statement of retained earnings:

This statement reports the beginning retained earnings and all the changes which led to ending retained earnings. Net income from income statement is added to and dividends are deducted from beginning retained earnings to arrive at the end result, ending retained earnings.

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.

c.

To determine

Prepare the disclosures that are required to accompany the December 31 financial statements.

Answer to Problem 1CP

Note 1: Depreciation Policy

The Depreciation expense in the financial statements is calculated by using the straight-line method of depreciation. The estimated useful life of the rental equipment is 8 years.

Note 2: Maturity dates of liabilities

The notes payable of the company matures on November 30, 2016 and it is the single obligation of the company.  The maturity value of this note including interest, will amount to $106,000.

Note 3: Pending litigation

For $25,000 personal injury lawsuit the Company has been named as a co-defendant. The extent of legal and financial responsibility cannot be determined at this time.

Explanation of Solution

Straight-line depreciation method:

The depreciation method which assumes that the consumption of economic benefits of long-term asset could be distributed equally throughout the useful life of the asset, is referred to as straight-line method.

d.

To determine

Prepare the closing entries and post to ledger accounts.

Answer to Problem 1CP

Prepare the year-end closing entries of Company S as follows:

Date	Accounts title and Explanation	Post Ref.	Debit ($)	Credit ($)
2015,  December 31	Rent fees earned		43,200
	Income Summary			43,200
	(To record the closure of revenues account )
December 31	Income Summary		29,580
	Salaries Expense			11,800
	Maintenance Expense			600
	Utilities Expense			700
	Rent Expense			4,000
	Office Supplies Expense			400
	Depreciation Expense			2,500
	Interest Expense			500
	Income Taxes Expense			9,080
	(To record the closure of expense account to income summary)
December 31	Income Summary		13,620
	Retained earnings			13,620
	(To record the closure of net income from income summary to retained earnings)
December31	Retained earnings		2,000
	Dividends			2,000
	(To record the closure of dividend to retained earnings)

Table (7)

Post the closing entries to ledger accounts:

Retained Earnings
Date		Explanation	Debit	Credit	Balance
December	31	Income, 2015		13,620	13,620
	31	Dividends	2,000		11,620

Dividends
Date		Explanation	Debit	Credit	Balance
December	28		2,000		2,000
	31	To close		2,000	0

Income Summary
Date		Explanation	Debit	Credit	Balance
December	31	To close revenue accounts		43,200	43,200
	31	To close expense accounts	29,580		13,620
	31	To close	13,620		0

Rental Fees Earned
Date		Explanation	Debit	Credit	Balance
December	15			18,000	18,000
	31			20,000	38,000
	31			3,700	41,700
	31			1,500	43,200
	31	To close	43,200		0

Salaries Expense
Date		Explanation	Debit	Credit	Balance
December	12		5,200		5,200
	26		5,200		10,400
	31		1,400		11,800
	31	To close		11,800	0

Maintenance Expense
Date		Explanation	Debit	Credit	Balance
December	17		600		600
	30	To close		600	0

Utilities Expense
Date		Explanation	Debit	Credit	Balance
December	31		700		700
	31	To close		700	0

Rent Expense
Date		Explanation	Debit	Credit	Balance
December	31		4,000		4,000
	31	To close		4,000	0

Office Supplies Expense
Date		Explanation	Debit	Credit	Balance
December	31		400		400
	31	To close		400	0

Depreciation Expense
Date		Explanation	Debit	Credit	Balance
December	31		2,500		2,500
	31	To close		2,500	0

Interest Expense
Date		Explanation	Debit	Credit	Balance
December	31		500		500
	31	To close		500	0
Income taxes Expense
Date		Explanation	Debit	Credit	Balance
December	31		9,080		9,080
	31	To close		9,080	0

Table (8)

Explanation of Solution

• Revenue Earned are the revenue account. Since the amount of revenue is closed, and transferred to retained earnings account, they are debited.
• Office supply Expense, Depreciation Expense, Rent expenses, Salaries Expense, Insurance Expense, Interest Expense, Income and Taxes Expense are the expense accounts. Since the amounts of expenses are closed to retained earnings account, they are credited.
• Income Summary is a clearing account or temporary account used to close revenues and expenses to Retained Earnings account. Since Income Summary account has a credit balance, it is transferred to Retained Earnings account by debiting it. Therefore, debit Income Summary account with $13,620.
• Since Retained Earnings account’s amount has increased due to closing of Income Summary account to Retained Earnings account, stockholders’ equity amount has increased. Therefore, credit Retained Earnings account with $13,620.
• Closing entries are also passed in order to close the excess of expenses over the revenues, and the dividend account.

e.

To determine

Prepare an after-closing trial balance of Company S.

Answer to Problem 1CP

Prepare an after-closing trial balance of Company S as follows:

Company S
After-Closing Trial Balance
December 31, 2015
Particulars	$	$
Cash	$65,000
Accounts receivable	9,900
Prepaid rent	8,000
Unexpired insurance	9,600
Office supplies	600
Rental equipment	240,000
Accumulated depreciation: rental equipment		$2,500
Notes payable		100,000
Accounts payable		1,700
Interest payable		500
Salaries payable		1,400
Dividends payable		2,000
Unearned rental fees		4,300
Income taxes payable		9,080
Capital stock		200,000
Retained earnings		11,620
Totals	$333,100	$333,100

Table (9)

Explanation of Solution

Post-Closing Trial Balance:

After passing all the journal entries and the closing entries of the permanent accounts and then further posting them to each of the respective accounts, a post-closing trial balance is prepared which consists of a list of all the permanent accounts. A post-closing trial balance serves as an evidence to prove that the balance of the permanent accounts is equal.

f.

To determine

Describe whether the declined cash balance appears to be headed for insolvency in the near future.

Explanation of Solution

• The company does not appear to face any instant solvency problems. This is because during the month of December the company commenced cash with $200,000 and out of which it spent $140,000 on equipment and left only $60,000 to begin its operation. However, on the end of the month the company had $65,000 cash. Hence, the company generated $5,000 of cash flow from operations during its first month of operations.
• The notes payable of $100,000 is due on November 30, 2016 and it is the single obligation of the company and it does raise a potential concern about the solvency of the company. However, to satisfy this obligation, the business does not have sufficient liquid assets currently.
• On the other hand, the working capital of the company is negative by $25,880 $\left(\text{\$93,100}-\text{\$118,980}\right)$ and the current ratio of the company is only 0.78:1$\left(\frac{\text{\$93,100}}{\text{\$118,980}}\right)$. Thus if the company continues to generate only a least operating cash flows of $5,000 each month, then the remaining solvent should not pose a serious issue.

g.

To determine

Describe whether it would be ethical for Person D to maintain the accounting records for the company or whether it must be maintained by someone who is independent of the organization.

Explanation of Solution

Person D (the stockholder) can maintain the accounting records for the company and it is ethical. This is because, in most businesses, usually the accounting records are maintained either by owners or employees.

The concept of independence denotes auditing the financial statements, in which the auditor has to make an independent evaluation of the statements referred as fairness.” Independence does not apply to the routine maintenance of accounting records.