Chapter 8, Problem 2CP

a.

To determine

Prepare a bank reconciliation statement and the necessary journal entries of Company M as of December 31, 2018.

Explanation of Solution

Journal entry:

Journal entry is a set of economic events which can be measured in monetary terms. These are recorded chronologically and systematically.

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

Bank reconciliation:

Bank statement is prepared by bank. The company maintains its own records from its perspective. This is why the cash balance per bank and cash balance per books seldom agree. Bank reconciliation is the statement prepared by company to remove the differences and disagreement between cash balance per bank and cash balance per books.

Prepare a bank reconciliation statement and the necessary journal entries of Company M as of December 31, 2018 as follows:

Bank reconciliation statement:

Company M
Bank Reconciliation
December 31, 2018
Particulars	$	$
Balance per bank statement, December 31, 2018		46,975
Add: Deposits in transit not recorded by bank		16,500
		63,475
Less: Outstanding checks
No. 508	5,500
No. 511	7,500
No. 521	8,000	21,000
Adjusted cash balance		42,475
Balance per depositor's records, December 31, 2018		45,000
Less:
Bank service charge	25
NSF check from Iggy Smarts	2,500	2,525
Adjusted cash balance		42,475

Table (1)

• The deposits which are not recorded by the bank are referred to as deposits in transit. Since the deposits in transit are not reflected on the bank statement, the company should add deposits in transit to cash balance per bank, while preparation of bank reconciliation statement.
• Outstanding checks are the checks that are issued by the company, but not yet paid by the bank. When the check is issued for payment, the company deducts the cash balance immediately. But the bank deducts only when the cash is paid for the issued check. So, company deducts the cash balance per bank to remove the differences.
• Banks deduct the service charge for the services rendered like lock box rental, or printed checks. But the company is not aware of such deductions. So, company deducts the cash balance per books while bank reconciliation preparation.
• While bank reconciliation, the NSF check should be deducted from the cash balance per book. This is because the bank could not collect funds from the customer’s bank due to lack of funds. But being recorded as Accounts Receivable previously, the balance should be deducted from books, to increase the Accounts Receivable account.

Therefore, the true cash balance of Company M as of December 31, 2018 is $42,475.

Necessary jounal entries for the bank reconciliation statement:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Bank Service Charges		25
	Accounts Receivable		2,500
	Cash			2,525
	(To record bank service charges for December and the NSF check received from Musician I)

Table (2)

• Bank service charge is an expense account, and it decreases the value of stockholder’s equity by $25. Therefore, debit the bank service expense account with $25.
• Accounts receivable is an asset account, and it increases the value of assets by $2,500. Therefore, debit the accounts receivable account with $2,500.
• Cash is an asset account, and it decreases the value of assets by $2,525. Therefore, credit the cash account with $2,525.

b.

To determine

Prepare the adjusting entries for the marketable securities.

Explanation of Solution

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 the adjusting entries for the marketable securities as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Marketable Securities		2,500
	Unrealized Holding Gain on Investments (1)			2,500
	(To record increased amount of  reported value of marketable securities from $25,000 to $27,500)

Table (3)

• Marketable securities are asset account, and it increases the value of assets by $2,500. Therefore, debit the marketable securities account with $2,500.
• Unrealized holding gain on investment is a revenue account, and it increases the value of stockholder’s equity by $2,500. Therefore, credit the unrealized holding gain on investment account with $2,500.

Working note:

Calculate the unrealized gain on the investment:

$\begin{array}{c}\text{Unrealized gain = }\left[\begin{array}{l}\text{Market value of sectuires on December 31, 2018}-\\ \text{The value of marketable securities reported in the trial balance}\end{array}\right]\\ =\$27,500-\$25,000\\ =\$2,500\end{array}$ (1)

c.

To determine

Prepare the adjusting entry for the uncollectible accounts expense at the end of the accounting year.

Explanation of Solution

Prepare the adjusting entry for the uncollectible accounts expense at the end of the accounting year as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Uncollectible Accounts Expense (2)		3,500
	Allowance for Doubtful Accounts			3,500
	(To record uncollectible accounts expense for December)

Table (4)

• Uncollectible accounts expense is an expense account, and it decreases the value of stockholder’s equity by $3,500. Therefore, debit the uncollectible accounts expense account with $3,500.
• Allowance for doubtful account is a contra- asset account, and it increases the value of allowance for doubtful account by $3,500. Therefore, credit the allowance for doubtful account with $3,500.

Working note:

Calculate the value of uncollectable accounts receivable expense

$\begin{array}{c}\begin{array}{l}\text{Uncollectable accounts}\\ \text{ receivable expense}\end{array}\}\text{ = }\left[\begin{array}{l}\text{Allowance for doublful accounts on December 31, 2018}-\\ \text{Allowane for doubtfull accounts reported in the trial balance}\end{array}\right]\\ =\$8,500-\$5,000\\ =\$3,500\end{array}$ (2)

d.

To determine

Prepare the journal entry for the guitars missing from the company’s inventory at the end of the accounting year.

Explanation of Solution

Prepare the journal entry for the guitars missing from the company’s inventory at the end of the accounting year as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Cost of Goods Sold		1,350
	Inventory			1,350
	(To record inventory shrinkage of missing guitars)

Table (5)

• Cost of goods sold is an expense account, and it decreases the value of stockholder’s equity by $1,350. Therefore, debit the cost of goods sold account with $1,350.
• Inventory is an asset account, and it decreases the value of assets by $1,350. Therefore, credit the inventory account with $1,350.

e.

To determine

Prepare the adjusting entry for the office supplies used during the December.

Explanation of Solution

Prepare the adjusting entry for the office supplies used during the December as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Office Supplies Expense (3)		300
	Office Supplies			300
	(To record office supplies used in December)

Table (6)

• Office supplies expense is an expense account, and it decreases the value of stockholder’s equity by $300. Therefore, debit the office supplies expense account with $300.
• Office supplies are asset account, and it decreases the value of assets by $300. Therefore, credit the inventory account with $300.

Working note:

Calculate the value of office supplies expense

$\begin{array}{c}\text{Office supplies expense = }\left[\begin{array}{l}\text{Office supplies reported in the trial balance }-\\ \text{Office supplies on hand on December 31, 2018}\end{array}\right]\\ =\$1,200-\$900\\ =\$300\end{array}$ (3)

f.

To determine

Prepare the adjusting entry for the insurance expense incurred during the December.

Explanation of Solution

Prepare the adjusting entry for the insurance expense incurred during the December as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Insurance Expense (4)		600
	Prepaid Insurance			600
	(To record insurance policies expired during December)

Table (7)

• Insurance expense is an expense account, and it decreases the value of stockholder’s equity by $600. Therefore, debit the insurance expense account with $600.
• Prepaid insurance is an asset account, and it decreases the value of assets by $600. Therefore, credit the prepaid insurance account with $600.

Working note:

Calculate the value of insurance expense

$\begin{array}{c}\text{Insurance expense expense = }\frac{\text{Prepaid insurance reported in the trial balance}}{\text{Remaining outstanding months}}\\ =\frac{\$6,600}{11\text{ months}}\\ =\$600\end{array}$ (4)

g.

To determine

Prepare the journal entry of the depreciation expense incurred during the December.

Explanation of Solution

Prepare the journal entry of the depreciation expense incurred during the December as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Depreciation Expense		5,000
	Accumulated Depreciation			5,000
	(To record depreciation expense for December)

Table (8)

• Depreciation expense is an expense account, and it decreases the value of stockholder’s equity by $5,000. Therefore, debit the depreciation expense account with $5,000.
• Accumulated depreciation is a contra-asset account, and it increases the value of accumulated depreciation account by $5,000. Therefore, credit the accumulated depreciation with $5,000.

h.

To determine

Prepare the adjusting entry for the sales revenue earned during the December.

Explanation of Solution

Prepare the adjusting entry for the sales revenue earned during the December as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Unearned Customer Deposits		3,200
	Sales (5)			3,200
	(To record revenue earned from advance special orders)

Table (9)

• Unearned customer deposits are liability account, and it decreases the value of liabilities by $3,200. Therefore, debit the unearned customer deposit account with $3,200.
• Sales are revenue account, and it increases the value of stockholder’s equity by $3,200. Therefore, credit the sales account with $3,200.

Working note:

Calculate the advance revenue received for the special orders

$\begin{array}{c}\text{Revenue earned = }\left[\begin{array}{l}\text{Unearned customer deposits in the trial balance }-\\ \text{Unearned customer deposits balance on December 31, 2018}\end{array}\right]\\ =\$8,000-\$4,800\\ =\$3,200\end{array}$ (5)

i.

To determine

Prepare the adjusting entry for the income tax expense during the December.

Explanation of Solution

Prepare the adjusting entry for the income tax expense during the December as follows:

Date	Account Title and Explanation	Post Ref.	Debit ($)	Credit ($)
	Income Tax Expense (6)		6,000
	Income Tax Payable			6,000
	(To record accrued income taxes in December)

Table (10)

• Income tax expense is an expense account, and it decreases the value of stockholder’s equity by $6,000. Therefore, debit the income tax expense account with $6,000.
• Income tax payable is a liability account, and it increases the value of liabilities by $6,000. Therefore, credit the income tax payable account with $6,000.

Working note:

Calculate the income tax expense incurred at the end of the accounting year

$\begin{array}{c}\text{Income tax expense = }\left[\begin{array}{l}\text{Income tax expense balance on December 31, 2018 }-\\ \text{Income tax expense reported in the trial balance }\end{array}\right]\\ =\$81,000-\$75,000\\ =\$6,000\end{array}$ (6)

j.

To determine

Prepare the adjusted trial balance of Company M at December 31, 2018.

Explanation of Solution

Trial balance:

Trial balance is a summary of all the ledger accounts balances presented in a tabular form with two column, debit and credit. It checks the mathematical accuracy of the ledger postings and helps preparing the final accounts.

Prepare the adjusted trial balance of Company M at December 31, 2018 as follows:

Company M
Adjusted Trial Balance
As of December 31, 2018
Accounts (refer appropriate T-account balance)	$	$
Cash	42,475
Marketable securities	27,500
Accounts receivable	127,500
Allowance for doubtful accounts		8,500
Merchandise inventory	248,650
Office supplies	900
Prepaid insurance	6,000
Building and fixtures	1,791,000
Accumulated depreciation		805,000
Land	64,800
Accounts payable		70,000
Unearned customer deposits		4,800
Income taxes payable		81,000
Capital stock		1,000,000
Retained earnings		240,200
Unrealized holding gain on investments		8,500
Sales		1,603,200
Cost of goods sold	959,350
Bank service charges	225
Uncollectible accounts expense	12,500
Salary and wages expense	395,000
Office supplies expense	700
Insurance expense	7,000
Utilities expense	3,600
Depreciation expense	53,000
Income tax expense	81,000
Totals	3,821,200	3,821,200

Table (11)

Therefore, the total of debit, and credit columns of an adjusted trial balance of Company as of December 31, 2018 is $3,821,200 and agree.

Working note:

Cash
Op. Bal.	45,000	a.	2,525
Cl. Bal.	42,475

Marketable securities
Op. Bal.	25,000
b.	2,500
Cl. Bal.	27,500

Accounts receivable
Op. Bal.	125,000
a.	2,500
Cl. Bal.	127,500

Allowance for doubtful accounts
		Op. Bal.	5,000
		c.	3,500
		Cl. Bal.	8,500

Merchandise inventory
Op. Bal.	250,000	d.	1,350
Cl. Bal.	248,650

Office supplies
Op. Bal.	1,200	e.	300
Cl. Bal.	900

Prepaid insurance
Op. Bal.	6,600	f.	600
Cl. Bal.	6,000

Accumulated depreciation
		Op. Bal.	800,000
		g.	5,000
		Cl. Bal.	805,000

Unearned customer deposits
h.	3,200	Op. Bal.	8,000
		Cl. Bal.	4,800

Unearned customer deposits
		Op. Bal.	75,000
		i.	6,000
		Cl. Bal.	81,000

Bank service changes
Op. Bal.	200
a.	25
Cl. Bal.	225

Unrealized gain on investment
		Op. Bal.	6,000
		b.	2,500
		Cl. Bal.	8,500

Uncollectable accounts expense
Op. Bal.	9,000
c.	3,500
Cl. Bal.	12,500

Cost of goods sold
Op. Bal.	958,000
d.	1,350
Cl. Bal.	959,350

Office supplies expense
Op. Bal.	400
e.	300
Cl. Bal.	700

Insurance expense
Op. Bal.	6,400
e.	600
Cl. Bal.	7,000

Depreciation expense
Op. Bal.	48,000
g.	5,000
Cl. Bal.	53,000

Sales account
			Op. Bal.		1,600,000
			h.		3,200
			Cl. Bal.		1,603,200
Income tax expense
Op. Bal.		75,000
g.		6,000
Cl. Bal.		81,000

k.

To determine

Prepare an income statement, statement of retained earnings, and a balance sheet of Company M as of December 31, 2018.

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.

Retained earnings: Retained earnings are that portion of profits which are earned by a company but not distributed to stockholders in the form of dividends. These earnings are retained for various purposes like expansion activities, or funding any future plans.

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.

Prepare an income statement, statement of retained earnings, and a balance sheet of Company M as of December 31, 2018 as follows:

Income statement:

Company M
Income Statement
For the Year Ended December 31, 2018
Particulars	$	$
Sales		1,603,200
Cost of goods sold		959,350
Gross profit		643,850
Bank service charges	225
Uncollectible accounts expense	12,500
Salary and wages expense	395,000
Office supplies expense	700
Insurance expense	7,000
Utilities expense	3,600
Depreciation expense	53,000	472,025
Income before income tax		171,825
Less: Income taxes expense		81,000
Net income		90,825

Table (12)

Therefore, the net income of Company M for the year ended December 31, 2018 is $90,825.

Statement of retained earnings:

Statement of Retained Earnings
For the Year Ending December 31, 2018
Particulars	$
Retained earnings, January 1, 2018	240,200
Add: Net income (from income statement)	90,825
Ending Retained earnings, December 31, 2018	331,025

Table (13)

Therefore, the ending retained earnings on December 31, 2018 is $331,025.

Balance sheet:

Company M
Balance Sheet
As of December 31, 2018
Assets	$	$
Current assets:
Cash		42,475
Marketable securities		27,500
Accounts receivable	127,500
Less: Allowance for doubtful accounts	(8,500)	119,000
Merchandise inventory		248,650
Office supplies		900
Prepaid insurance		6,000
Total current assets (A)		444,525
Plant and equipment:
Building and fixtures	1,791,000
Less: Accumulated depreciation	(805,000)	986,000
Land		64,800
Total plant and equipment (B)		1,050,800
Total assets $\left(\text{A+B}\right)$		1,495,325
Liabilities
Current liabilities:
Accounts payable		70,000
Unearned customer deposits		4,800
Income taxes payable		81,000
Total current liabilities		155,800
Long-term liabilities:		-
Total liabilities (C)		155,800
Stockholders' Equity
Capital stock		1,000,000
Retained earnings (from statement of retained earnings)		331,025
Unrealized holding gain on investments		8,500
Total stockholders' equity (D)		1,339,525
Total Liabilities and Stockholders' Equity $\left(\text{C+D}\right)$		1,495,325

Table (14)

Therefore, the total assets of Company M are $1,495,325, and the total liabilities and stockholders’ equity is $1,495,325.

l.

To determine

Ascertain the average days on accounts receivable of Company M.

Explanation of Solution

Ascertain the average days on accounts receivable of Company M as follows:

$\begin{array}{c}\text{Days' sales in receivable}=\frac{\text{Days in accounting period}}{\text{Receivable turnover ratio (7)}}\\ =\frac{365}{\text{13}\text{.47 times}}\\ =27.1\text{ days}\end{array}$

Therefore, the average days on accounts receivable is 27.1 days.

Working note:

Calculate the value of receivable turnover ratio for outstanding inventories.

$\begin{array}{c}\text{Receivable turnover ratio = }\frac{\text{Net sales for the year ended}}{\text{Ending accounts receivable}}\\ =\frac{\$1,603,200}{\$119,000}\\ =13.47\text{times}\end{array}$ (7)

m.

To determine

Ascertain the average number of days that merchandise remains in the inventory before it was sold.

Explanation of Solution

Ascertain the average number of days that merchandise remains in the inventory before it was sold.

$\begin{array}{c}\text{Days' sales in inventory}=\frac{\text{Days in accounting period}}{\text{Inventory turnover}}\\ =\frac{365}{\text{3}\text{.9 times}}\\ =93.6\text{ days}\end{array}$

Therefore, the average number of days that merchandise remains in the inventory before it was sold is 93.6 days.

Working note:

Calculate the inventory turnover ratio

$\begin{array}{c}\text{Inventory turnover ratio = }\frac{\text{Cost of goods sold}}{\text{Ending inventory}}\\ =\frac{\$959,350}{\$248,650}\\ =3.9\text{ times}\end{array}$ (8)

n.

To determine

Ascertain the number of days that company M takes to convert the inventory into cash.

Explanation of Solution

Ascertain the number of days that company M takes to convert the inventory into cash as follows:

$\begin{array}{c}\text{Days in operating cycle =}\left[\begin{array}{l}\text{ Average days sales in inventory + }\\ \text{Average days receivables remain outstanding (2)}\end{array}\right]\\ \text{=93}\text{.6 days + 27}\text{.1 days}\\ \text{=120}\text{.7 days}\end{array}$

Therefore, the number of days that company M takes to convert the inventory into cash is 120.7 days.

o.

To determine

Comment the financial position of Company M from the perspective of a short-term creditor.

Explanation of Solution

Comment the financial position of Company M from the perspective of a short-term creditor as follows:

Short-term creditors give more attention to the inventory turnover measurement because this ratio indicates how quickly the company is able to sell its merchandise (convert into cash).

Inventory turnover ratio is the ratio which analyzes the number of times inventory is sold during the period. This ratio gauges the efficacy of inventory management. The larger ratio indicates that the company has more efficient inventory management.

In this case, inventory turnover ratio of Company M is 3.9 times, and it clearly shows that company M should increase the inventory management efficiently.