Chapter 6, Problem 28P

a.

To determine

Use a horizontal statements model to show the effect of the transactions on the elements of financial statements.

Explanation of Solution

Financial Statements:

Financial statements are complete record of all the financial transactions that take place in the business during a particular financial year. They report important financial information such as assets, liabilities, revenues and expenses of the company to the internal and external users for taking necessary decision. They help them to know the financial status of the business for a particular period.

Record the transactions in a horizontal statements model:

Table (1)

Working note 1: Determine the depreciation rate applied each year.

Useful life = 5 years

$\begin{array}{c}\text{Depreciation rate = }\frac{\text{100\%}}{\text{5 years}}\text{ × 2}\\ \text{= 40\%}\end{array}$

Working note 2: Calculate the depreciation expense using Double-declining-balance method.

Calculate the depreciation expense for 2014.

$\begin{array}{c}\text{Depreciation for 2014}=\left(\begin{array}{l}\text{Beginning book value }\\ \text{× Depreciation rate}\end{array}\right)\\ =\$37,450\times \frac{40}{100}\\ =\$14,980\end{array}$

Working note 3: Calculate the depreciation expense for 2015.

$\begin{array}{c}\text{Depreciation for 2015}=\left(\begin{array}{l}\left(\begin{array}{l}\text{Beginning book value }\\ \text{– Depreciation for 2014}\end{array}\right)\\ \times \text{Depreciation rate}\end{array}\right)\\ =\left(\left(\$37,450-\$14,980\right)\times \frac{40}{100}\right)\\ =\$8,988\end{array}$

Working note 4: Calculate the depreciation expense for 2016.

$\begin{array}{c}\text{Depreciation for 2016}=\left(\begin{array}{l}\left(\begin{array}{l}\text{Beginning book value }\\ \text{– }\left(\begin{array}{l}\text{Depreciation for 2014+}\\ \text{Depreciation for 2015}\end{array}\right)\end{array}\right)\\ \times \text{Depreciation rate}\end{array}\right)\\ =\left(\left(\$37,450-\left(\$14,980+\$8,988\right)\right)\times \frac{50}{100}\right)\\ =\$55,000-\$17,968\times \frac{50}{100}\\ =\$9,741\end{array}$

b.

To determine

Use a vertical model to present financial statements for 2014, 2015, and 2016.

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.

Statement of changes in stockholders' equity:

Statement of changes in stockholders' equity records the changes in the owners’ equity during the end of an accounting period by explaining about the increase or decrease in the capital reserves of shares.

Balance Sheet:

Balance sheet summarizes the assets, the liabilities, and the stockholder’s equity of a company at a given date. It is also known as the statement of financial status of the business.

Statement of cash flows:

Statement of cash flow is a financial statement that shows the cash and cash equivalents of a company for a particular period of time. It shows the net changes in cash, by reporting the sources and uses of cash as a result of operating, investing, and financing activities of a company.

Use a vertical model to present financial statements for 2014, 2015, and 2016 as follows:

Incorporation E
Financial Statements
For the year ended December 31
Income Statements
	2014	2015	2016
Service Revenue	$65,000	$68,000	$70,000
Expenses:
Maintenance Expense	0	(2,500)	0
Computer Service Expense	(1,500)	(1,500)	(1,200)
Depreciation Expense	(14,980)	(8,988)	(9,741)
Total Expenses	(16,480)	(12,988)	(10,941)
Net Income	$48,520	$55,012	$59,059
Statement of Changes in Stockholder's Equity
Beginning Common Stock	0	$80,000	$80,000
Add: Stock Issued	80,000	0	0
Ending Common Stock	80,000	80,000	80,000
Beginning Retained Earnings	0	48,520	103,532
Add: Net Income	48,520	55,012	59,059
Ending Retained Earnings	48,520	103,532	162,591
Total Stockholders’ Equity	$128,520	$183,532	$242,591

Table (2)

Incorporation E
Financial Statements
Balance Sheet as of December 31
	2014	2015	2016
Assets
Cash	$106,050	$170,050	$232,850
Computer	37,450	37,450	37,450
Less: Accumulated Depreciation	(14,980)	(23,968)	(27,709)
Total Assets	$128,520	$183,532	$242,591
Liabilities	$0	$0	$0
Stockholders’ Equity
Common Stock	80,000	80,000	80,000
Retained Earnings	48,520	103,532	162,591
Total Stockholders’ Equity	$128,520	$183,532	$242,591
Total Liabilities and Stockholders' Equity	$128,520	$183,532	$242,591

Table (3)

Incorporation E
Statement of Cash Flows
For the Year Ended December 31
Particulars	2014 (in $)	2015 (in $)	2016 (in $)
Cash Flows From Operating Activities:
Inflow from revenue	65,000	68,000	70,000
Outflow for expenses	(1,500)	(4,000)	(1,200)
Net Cash Flow from operating activities	63,500	64,000	68,800
Cash Flows From Investing Activities:
Outflow to purchase Computer	(37,450)	0	(6,000)
Net Cash Flow from investing activities	(37,450)	0	(6,000)
Cash Flows From Financing Activities:
Inflow from stock issue	80,000	0	0
Net Cash Flow from financing activities	80,000	0	0
Net Increase in Cash	106,050	64,000	62,800
Add: Beginning Cash Balance	0	106,050	170,050
Ending Cash Balance	$106,050	$170,050	$232,850

(Table 4)