Chapter 7, Problem 15AE

a.

To determine

Prepare general journal entries for each of the transactions and post them to T-accounts.

Explanation of Solution

Credit card sales: Credit card is an electronic card, which allows the credit card holders to buy something on credit conveniently, and without paying immediate cash.

Percentage of sales method: Credit sales are recorded by debiting (increasing) accounts receivable account. The bad debts is a loss incurred out of credit sales, hence uncollectible accounts can be estimated as a percentage of credit sales or total sales. It is a method of estimating the bad debts (expected loss on extending credit), by multiplying the expected percentage of uncollectible with the total amount of net credit sale (or total sales) for a specific period. Under percentage of sales method, estimated bad debts would be treated as a uncollectible accounts expense of the particular period.

Prepare journal entries for Company NS.

Event	Account title and Explanation	Post ref.	Amount
			Debit	Credit
Year 1
1.	Cash		$20,000
	Common stock			$20,000
	(To record the issuance of common stock )
2.	Merchandise inventory		$85,000
	Accounts payable			$85,000
	(To record the purchase of inventory on account)
3a.	Accounts receivable		$160,000
	Sales revenue			$160,000
	(To record the sales on account)
3b.	Cost of goods sold		$91,000
	Merchandise inventory			$91,000
	(To record the cost of merchandise sold on account)
4.	Allowance for doubtful acccounts		$900
	Accounts receivable			$900
	(To record the write off of uncollectible)
5.	Notes receivable		$18,000
	Cash			$18,000
	(To record the acceptance of note)
6.	Operating expenses		$19,000
	Cash			$19,000
	(To record the cash paid for operating expenses)
7.	Cash		$161,000
	Accounts receivable			$161,000
	(To record the cash collected from accounts receivable)
8.	Accounts payable		$92,000
	Cash			$92,000
	(To record the cash paid to accounts payable)
9.	Dividends		$5,000
	Cash			$5,000
	(To record the payment of dividends)
10a.	Accounts receivable		$6,720
	Credit Card Expense $\left(\$7,000\times 4\%\right)$		$280
	Sales revenue			$7,000
	(To record the credit card sales)
10b.	Cost of goods sold		$4,000
	Merchandise inventory			$4,000
	(To record the cost of merchandise sold on credit card)
11.	Uncollectible accounts expense (1)		$1,600
	Allowance for doubtful accounts			$1,600
	(To record the uncollectible accounts expense)
12.	Interest receivable (2)		$480
	Interest revenue			$480
	(To record the accrual of interest income)

Table (2)

Working Note:

Determine the amount of uncollectible account expense.

$\begin{array}{c}\begin{array}{l}\text{Uncollectible account }\\ \text{expense}\end{array}\}=\left(\text{Sales on account}\right)\times \left(\begin{array}{l}\text{Estimated rate }\\ \text{of percentage}\end{array}\right)\\ =\$160,000\times 1\%\\ =\$1,600\end{array}$ (1)

Determine the amount of interest income for December 31, Year 1.

The interest on note is earned for 4 months which is from September 01, Year 1 to December 31, Year 1.

$\begin{array}{c}\text{Amount of interest}=\text{Principal}\times \text{Interest Rate}\times \frac{\text{Number of months earned}}{\text{Months in a year}}\\ \text{=\$18,000}\times \frac{8}{100}\times \frac{4}{12}\\ =\$480\end{array}$ (2)

b.

To determine

Prepare T-accounts and record the beginning balances and the transactions of Year 2 in T-accounts.

Explanation of Solution

Prepare T-accounts and record the beginning balances and the transactions of Year 2 in T-accounts.

Cash
Balance	$9,000	5.	$18,000
1.	$20,000	6.	$19,000
7.	$161,000	8.	$92,000
		9.	$5,000
Balance	$56,000

Accounts Receivable
Balance	$41,000	4.	$900
3a.	$160,000	7.	$161,000
Balance	$39,100

Allowance for Doubtful Accounts
		Balance	$2,500
4.	$900	11.	$1,600
		Balance	$3,200

Merchandise Inventory
Balance	$78,000	3b.	$91,000
2.	$85,000	10b.	$4,000
Balance	$68,000

Accounts Receivable – Credit Card
10a.	$6,720
Balance	$6,720

Interest Receivable
12. (2)	$480
Balance	$480

Notes Receivable
5.	$18,000
Balance	$18,000

Accounts Payable
		Balance	$21,000
8.	$92,000	2.	$85,000
		Balance	$14,000

Common Stock
		Balance	$50,000
		1.	$20,000
		Balance	$70,000

Retained earnings
		Balance	$54,500

Dividends
9.	$5,000
Balance	$5,000

Sales Revenue
		3a.	$160,000
		10a.	$7,000
		Balance	$167,000

Cost of Goods Sold
3b.	$91,000
10b.	$4,000
Balance	$95,000

Operating Expenses
6.	$19,000
Balance	$19,000

Uncollectible Accounts Expense
11.	(1) $1,600
Balance	$1,600

Credit Card Expense
10a. $\left(\$7,000\times 4\%\right)$	$280
Balance	$280

Interest revenue
		12.	(2) $480
		Balance	$480

c.

To determine

Prepare income statement, statement of changes in stockholders’ equity, balance sheet, and statement of cash flows for Company LGS for Year 2.

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.

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.

Statement of changes in the stockholders’ equity: This statement reflects whether the components of stockholders’ equity have increased or decreased during the period.

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.

Prepare the income statement for Company LGS for the year ended December 31, Year 1.

Company LGS
Statement of income
For the year ended December 31,  Year 2
Particulars	Amount	Amount
Service revenue		$167,000
Less: Cost of goods sold		($95,000)
Gross margin		$72,000
Operating expenses
Operating expense	$19,000
Uncollectible accounts expense	$1,600
Credit card expense	$280
Total operating expenses		($20,880)
Operating income		$51,120
Interest revenue		$480
Net income		$51,600

Table (3)

Hence, the net income of Company LGS for the year ended December 31, Year 2 is $51,600.

Prepare the statement of changes in stockholders’ equity of Company LGS for the year ended December 31, Year 2.

Company LGS
Statement of changes in stockholders' equity
For the year ended December 31, Year 2
Particulars	Amount	Amount
Beginning Common Stock	$50,000
Add: Stock Issued	$20,000
Ending Common Stock		$70,000
Beginning retained earnings	$54,500
Add/Less: Net Income (Loss)	$51,600
	$106,100
Less: Dividends paid	($5,000)
Ending Retained Earnings		$101,100
Total stockholder's equity		$171,100

Table (4)

Hence, the total stockholders’ equity of Company LGS for the year ended December 31, Year 2 is $171,100.

Prepare the balance sheet of Company LGS as on December 31, Year 2.

Company LGS
Balance sheet
As on December 31, Year 2
Assets	Amount	Amount
Cash		$56,000
Accounts Receivable	$39,100
Less: Allowance for doubtful accounts	($3,200)	$35,900
Merchandise Inventory		$68,000
Accounts receivable – Credit cards		$6,720
Interest receivable		$480
Notes receivable		$18,000
Total Assets		$185,100
Liabilities and stockholders' equity
Liabilities
Accounts payable	$14,000
Total Liabilities		$14,000
Stockholders’ Equity
Common Stock	$70,000
Retained Earnings	$101,100
Total Stockholders’ Equity		$171,100
Total liabilities and stockholders' equity		$185,100

Table (5)

Hence, the total of assets and liabilities and stockholders’ equity of Company LGS as on December 31, Year 2 is $185,100.

Prepare the statement of cash flows of Company LGS for the year ended December 31, Year 2.

Company LGS
Statement of cash flows
For the year ended December 31, Year 2
Particulars	Amount	Amount
Cash flow from operating activities:
Cash Receipts from Customers	$161,000
Outflow for inventory	($92,000)
Outflow for expenses	($19,000)
Net Cash Flow from Operating Activities		$50,000
Cash Flows From Investing Activities:
Issued note receivables	($18,000)
Net Cash Flow From Investing Activities		($18,000)
Cash Flows From Financing Activities:
Cash Receipts from Stock Issue	$20,000
Cash paid for dividends	($5,000)
Net Cash Flow From Financing Activities		$15,000
Net Change in Cash		$47,000
Add: Beginning Cash Balance		$9,000
Ending Cash Balance		$56,000

Table (6)

Hence, the net change in cash of Company LGS during Year 2 is $47,000.