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 ($)	Credit ($)
Year 1
December	1	Cash		240,000
		Capital stock			240,000
		(To record the cash invested in the business)
December	1	Rental Equipment		288,000
		Cash			168,000
		Notes Payable			120,000
		(To record the Purchase of equipment from Rent-it and the Note payable is due for one year)
December	1	Prepaid Rent		14,400
		Cash			14,400
		(To record the payment of three months' rent in advance)
December	4	Office Supplies		1,200
		Accounts Payable			1,200
		(To record the purchase of supplies on account.)
December	8	Cash		9,600
		Unearned Rental Fees			9,600
		(To record the cash received in advance for equipment rental by the Construction Company)
December	12	Salaries Expense		6,240
		Cash			6,240
		(To record the Payment of salaries for first two weeks in December)
December	15	Cash		14,400
		Accounts Receivable		7,200
		Rental Fees Earned			21,600
		(To record the rental fees earned in first 15 days of December)
December	17	Maintenance Expense		720
		Accounts Payable			720
		(To record the purchase of repair parts on account from Incorporation)
December	23	Cash		2,400
		Accounts Receivable			2,400
		(To record the collection of an accounts receivable)
December	26	(No entry is required to record rental of backhoe.)
December	26	Salaries Expense		6,240
		Cash			6,240
		(To record the Payment of biweekly payroll)
December	27	Accounts Payable		720
		Cash			720
		(To record the payment of account payable)
				2,400
December	28	Dividends			2,400
		Dividends Payable
		(To record the Declared dividend of 12% per share payable on January 15, Year 2)
December	29	(No entry is required to record lawsuit.)
December	29	Unexpired Insurance		11,520
		Cash			11,520
		(To record the Purchase of 12-month liability policy)
December	31	Utilities Expense		840
		Accounts Payable			840
		(To record the utilities incurred  for December)
December	31	Cash		18,720
		Accounts Receivable		5,280
		Rental Fees Earned			24,000
		(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 Year 1
Date		Accounts title and Explanation	Post Ref.	Debit ($)	Credit ($)
Year 1, December	31.	Rent Expense (1)		4,800
		Prepaid Rent			4,800
		(To record the rent expense for December)
December	31.	Interest Expense (2)		600
		Interest Payable			600
		(To record the interest expense accrued in December)
December	31.	Depreciation Expense (3)		3,000
		Accumulated Depreciation of Rental Equipment			3,000
		(To record the depreciation expense incurred for December)
December	31.	Office Supplies Expense (4)		480
		Office Supplies			480
		(To record the offices supplies used for December)
December	31.	Unearned Rental fees		4,440
		Rental fees earned			4,440
		(To record the conversion of unearned revenue into earned revenue in December)
December	31.	Accounts Receivable		1,800
		Rental fees earned			1,800
		(To record the revenue accrued at the end of December)
December	31.	Salaries Expense		1,680
		Salaries Payable			1,680
		(To record the accrued but unpaid salaries in December)
December	31.	Income Taxes Expense (5)		10,896
		Income Taxes Payable			10,896
		(To record the income taxes expense accrued in December)

Table (2)

Working notes:

Compute the amount of rent Expense:

$\begin{array}{c}\text{Rent Expense}=\frac{\text{Prepaidrent}}{\text{3 months}}\\ =\frac{\text{\$1,4400}}{\text{3 months}}\\ =\$4,800\end{array}$ (1)

Compute the amount of interest Expense:

$\begin{array}{c}\text{Interest Expense}=\frac{\text{Amount borrowed}}{\text{12 months}}\times \text{Interest rate}\\ =\frac{\text{\$120,000}}{\text{12 months}}\times \frac{6}{100}\\ =\$600\end{array}$ (2)

Compute the amount of depreciation Expense:

$\begin{array}{c}\text{Office Depreciation Expense}=\frac{\text{Equipment}}{\text{96 months}}\\ =\frac{\text{\$288,000}}{\text{96 months}}\\ =\$3,000\end{array}$ (3)

Compute the amount of Office Supplies Expense:

$\begin{array}{c}\text{Office Supplies Expense}=\left[\begin{array}{l}\text{Office supplies in trial balance}-\\ \text{Office supplies on hand at December31}\end{array}\right]\\ =\$1,\text{200}-\$720\\ =\$480\end{array}$ (4)

Compute the amount of income taxes Expense:

$\begin{array}{c}\text{Income taxes Expense}=\text{Income tax}-\text{Income tax expense}\\ =\$51,840-\$40,944\\ =\$10,896\end{array}$ (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		240,000		240,000
	1			168,000	72,000
	1			14,400	57,600
	8		9,600		67,200
	12			6,240	60,960
	15		14,400		75,360
	23		2,400		77,760
	26			6,240	71,520
	27			720	70,800
	29			11,520	59,280
	31		18,720		78,000

Accounts Receivable
Date			Debit	Credit	Balance
December	15		7,200		7,200
	23			2,400	4,800
	31		5,280		10,080
	31		1,800		11,880

Prepaid Rent
Date			Debit	Credit	Balance
December	1		14,400		14,400
	31			4,800	9,600

Unexpired Insurance
Date			Debit	Credit	Balance
December	29		11,520		11,520

Office Supplies
Date			Debit	Credit	Balance
December	4		1,200		1,200
	31			480	720

Rental Equipment
Date			Debit	Credit	Balance
December	1		288,000		288,000

Accumulated Depreciation: Rental Equipment
Date			Debit	Credit	Balance
December	31		3,000		3,000

Notes Payable
Date			Debit	Credit	Balance
December	1		120,000		120,000

Accounts Payable
Date			Debit	Credit	Balance
December	4			1,200	1,200
	17			720	1,920
	27		720		1,200
	31			840	2,040

Interest Payable
Date			Debit	Credit	Balance
December	31		600		600

Salaries Payable
Date			Debit	Credit	Balance
December	31		1,680		1,680

Dividends Payable
Date			Debit	Credit	Balance
December	28		2,400		2,400

Unearned Rental Fees
Date			Debit	Credit	Balance
December	8			9,600	9,600
	31		4,440		5,160

Income Taxes Payable
Date			Debit	Credit	Balance
December	31			10,896	10,896

Income Taxes Payable
Date			Debit	Credit	Balance
December	1			240,000	240,000

Retained Earnings
Date			Debit	Credit	Balance
December	31	Income, Year 1		16,344	16,344
	31	Dividends	2,400		13,944

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, Year 1 as follows:

Company S
Income Statement
For the Year Ended December 31, Year 1
Particulars	$	$
Revenues:
Rental fees earned		$51,840
Less: Expenses:
Salaries expense	$14,160
Maintenance expense	720
Utilities expense	840
Rent expense	4,800
Office supplies expense	480
Depreciation expense	3,000
Interest expense	600	24,600
Income before income taxes expense		$27,240
Less: Income taxes expense		10,896
Net income		$16,344

Table (4)

• Prepare the statement of retained earnings of Company S as on December 31, Year 1 as follows:

Company S
Statement of retained earnings
For the Year Ended December 31, Year 1
Particulars	$
Retained earnings as on January 1, Year 1	0
Add: Net Income	16,344
Less: Dividend	2,400
Retained earnings as on December 31, Year 1	13,944

Table (5)

• Prepare the Balance Sheet of Company S as on December 31, Year 1 as follows:

Company S
Balance Sheet
December 31, Year 1
Assets	$	$
Cash		$78,000
Accounts Receivable		11,880
Prepaid rent		9,600
Unexpired insurance		11,520
Office supplies		720
Rental equipment	288,000
Less: Accumulated depreciation	3,000	285,000
Total Assets		$396,720
Liabilities
Notes payable	120,000
Accounts payable	2,040
Interest payable	600
Salaries payable	1,680
Dividends payable	2,400
Unearned rental fees	5,160
Income taxes payable	10,896
Total Liabilities		$142,776
Stockholders' Equity
Capital stock	$240,000
Retained earnings	13,944	$253,944
Total Stockholders' Equity
Total Liabilities and Stockholders' Equity		$396,720

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, Year 2 and it is the single obligation of the company.  The maturity value of this note including interest, will amount to $127,200.

Note 3: Pending litigation

For $30,000 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 ($)	Credit ($)
Year 1,  December 31	Rent fees earned		51,840
	Income Summary			51,840
	(To record the closure of revenues account )
December 31	Income Summary		35,496
	Salaries Expense			14,160
	Maintenance Expense			720
	Utilities Expense			840
	Rent Expense			4,800
	Office Supplies Expense			480
	Depreciation Expense			3,000
	Interest Expense			600
	Income Taxes Expense			10,896
	(To record the closure of expense account to income summary)
December 31	Income Summary		16,344
	Retained earnings			16,344
	(To record the closure of net income from income summary to retained earnings)
December31	Retained earnings		2,400
	Dividends			2,400
	(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, Year 1		16,344	16,344
	31	Dividends	2,400		13,944

Dividends
Date		Explanation	Debit	Credit	Balance
December	28		2,400		2,400
	31	To close		2,400	0

Income Summary
Date		Explanation	Debit	Credit	Balance
December	31	To close revenue accounts		51,840	51,840
	31	To close expense accounts	35,496		16,344
	31	To close	16,344		0

Rental Fees Earned
Date		Explanation	Debit	Credit	Balance
December	15			21,600	21,600
	31			24,000	45,600
	31			4,440	50,040
	31			1,800	51,840
	31	To close	51,840		0

Salaries Expense
Date		Explanation	Debit	Credit	Balance
December	12		6,240		6,240
	26		6,240		12,480
	31		1,680		14,160
	31	To close		14,160	0

Maintenance Expense
Date		Explanation	Debit	Credit	Balance
December	17		720		720
	30	To close		720	0

Utilities Expense
Date		Explanation	Debit	Credit	Balance
December	31		840		840
	31	To close		840	0

Rent Expense
Date		Explanation	Debit	Credit	Balance
December	31		4,800		4,800
	31	To close		4,800	0

Office Supplies Expense
Date		Explanation	Debit	Credit	Balance
December	31		480		480
	31	To close		480	0

Depreciation Expense
Date		Explanation	Debit	Credit	Balance
December	31		3,000		3,000
	31	To close		3,000	0

Interest Expense
Date		Explanation	Debit	Credit	Balance
December	31		600		600
	31	To close		600	0

Income taxes Expense
Date		Explanation	Debit	Credit	Balance
December	31		10,896		10,896
	31	To close		10,896	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 $16,344.
• 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 $16,344.
• 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, Year 1
Particulars	$	$
Cash	$78,000
Accounts receivable	11,880
Prepaid rent	9,600
Unexpired insurance	11,520
Office supplies	720
Rental equipment	288,000
Accumulated depreciation: rental equipment		$3,000
Notes payable		120,000
Accounts payable		2,040
Interest payable		600
Salaries payable		1,680
Dividends payable		2,400
Unearned rental fees		5,160
Income taxes payable		10,896
Capital stock		240,000
Retained earnings		13,944
Totals	399,720	399,720

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 $240,000 and out of which it spent $168,000 on equipment and left only $72,000 to begin its operation. However, on the end of the month the company had $78,000 cash. Hence, the company generated $6,000 of cash flow from operations during its first month of operations.
• The notes payable of $120,000 is due on November 30, Year 2 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 $31,056 $\left(\text{\$111,720}-\text{\$142,776}\right)$ and the current ratio of the company is only 0.78:1$\left(\frac{\text{\$111,720}}{\text{\$142,776}}\right)$. Thus if the company continues to generate only a least operating cash flows of $6,000 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.