Chapter 8, Problem 31BP

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.

Use a horizontal statements model to show the effect of the transactions on the elements of financial statements as follows:

Incorporation A
Horizontal Statements Model
Event		Assets	=	Liabilities	+	Equity		Net Income		Cash Flow
Year 1
1		+		NA		+		NA		+ FA
2		+-		NA		NA		NA		− ΙΑ
3		+-		NA		NA		NA		− ΙΑ
4		+		NA		+		+		+ OA
5		−		NA		−		−		− ΟΑ
6		−		NA		−		−		NA
7		NA		NA		+-		NA		NA
Year 2
1		−		NA		−		−		− ΟΑ
2		−		NA		−		−		− ΟΑ
3		+		NA		+		+		+ OA
4		−		NA		−		−		− ΟΑ
5		−		NA		−		−		NA
6		NA		NA		+-		NA		NA
Year 3
1		+-		NA		NA		NA		− ΙΑ
2		−		NA		−		−		− ΟΑ
3		+		NA		+		+		+ OA
4		−		NA		−		−		NA
5		NA		NA		+-		NA		NA

Table (1)

b.

To determine

Record the transactions in general journal form and post them to T-accounts.

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.

Accounting rules for Journal entries:

• To record increase balance of account: Debit assets, expenses, losses and credit liabilities, capital, revenue and gains.
• To record decrease balance of account: Credit assets, expenses, losses and debit liabilities, capital, revenue and gains.

Record the transactions in general journal form as follows:

Event	Account title and Explanation	Post ref	Debit  (in $)	Credit (in $)
Year 1
1.	Cash		80,000
	Common Stock			80,000
	(To record the issue of the common stock)
2.	Computer		35,000
	Cash			35,000
	(To record the purchase of Computer)
3.	Computer		2,450
	Cash			2,450
	(To record the purchase of Computer)
4.	Cash		65,000
	Service Revenue			65,000
	(To record  the service revenue)
5.	Computer Service Expense		1,500
	Cash			1,500
	(To record computer service expense  expense)
6.	Depreciation Expense		14,980
	Accumulated Depreciation  (1)			14,980
	(To record depreciation expense )
7.	Service revenue		65,000
	Computer Service Expense			1,500
	Depreciation Expense			14,980
	Retained earnings			48,520
	(To close the revenue and expenses accounts to the retained earnings account)
Year 2
1.	Maintenance Expense		1,000
	Cash			1,000
	(To record maintenance expense)
2.	Maintenance Expense		1,500
	Cash			1,500
	(To record maintenance expense)
3.	Cash		68,000
	Service Revenue			68,000
	(To record  the service revenue)
4.	Computer Service Expense		1,500
	Cash			1,500
	(To record computer service expense)
5.	Depreciation Expense		8,988
	Accumulated Depreciation			8,988
	(To record depreciation expense )
6.	Service revenue		68,000
	Computer maintenance expense			2,500
	Computer Service Expense			1,500
	Depreciation Expense			8,988
	Retained earnings			55,012
	(To close the revenue and expenses accounts to the retained earnings account)
Year 3
1.	Accumulated depreciation		6,000
	Cash			6,000
	(To record accumulated depreciation)
2.	Computer Service Expense		1,200
	Cash			1,200
	(To record computer service expense)
3.	Cash		70,000
	Service Revenue			70,000
	(To record  the service revenue)
4.	Depreciation Expense		9,741
	Accumulated Depreciation			9,741
	(To record depreciation expense )
5.	Service revenue		70,000
	Computer Service Expense			1,200
	Depreciation Expense			9,741
	Retained earnings			59,059
	(To close the revenue and expenses accounts to the retained earnings account)

Table (1)

Working note:

Determine the depreciation rate applied each year.

Useful life = 5 years

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

Calculate the depreciation expense using Double-declining-balance method.

Calculate the depreciation expense for Year 1.

$\begin{array}{c}\text{Depreciation for Year 1}=\left(\begin{array}{l}\text{Beginning book value }\\ \text{× Depreciation rate}\end{array}\right)\\ =\$37,450\times \frac{40}{100}\\ =\$14,980\end{array}$

Calculate the depreciation expense for Year 2.

$\begin{array}{c}\text{Depreciation for Year 2}=\left(\begin{array}{l}\left(\begin{array}{l}\text{Beginning book value }\\ \text{– Depreciation for Year 1}\end{array}\right)\\ \times \text{Depreciation rate}\end{array}\right)\\ =\left(\left(\$37,450-\$14,980\right)\times \frac{40}{100}\right)\\ =\$8,988\end{array}$

Calculate the depreciation expense for Year 3.

$\begin{array}{c}\text{Depreciation for Year 3}=\left(\begin{array}{l}\left(\begin{array}{l}\text{Beginning book value }\\ \text{– }\left(\begin{array}{l}\text{Depreciation for Year 1+}\\ \text{Depreciation for Year 2}\end{array}\right)\end{array}\right)\\ \times \text{Depreciation rate}\end{array}\right)\\ =\left(\left(\$37,450-\left(\$14,980+\$8,988\right)\right)\times \frac{50}{100}\right)\\ =\$55,000-\$17,968\times \frac{50}{100}\\ =\$9,741\end{array}$

Post the transactions to T-accounts as follows:

Cash (Year 1)
1.	80,000	2.	35,000
4.	65,000	3.	2,450
		5.	1,500
Balance            106,050

Cash (Year 2)
3.	68,000	1.	1,000
		2.	1,500
		4.	1,500
Balance            170,050

Cash (Year 3)
3.	70,000	1.	6,000
		2.	1,200
Balance            232,850

Common Stock (Year 1)
		1.	80,000
		Balance        80,000

Computer (Year 1)
2.	35,000
3.	2,450
Balance              37,450

Accumulated Depreciation (Year 1)
		6.	14,980
		Balance        14,980

Accumulated Depreciation (Year 2)
		5.	8,988
		Balance        23,968

Accumulated Depreciation (Year 3)
1.	6,000	4.	9,741
		Balance        27,709

Common Stock (Year 1)
		1.	80,000
		Balance        80,000

Retained Earnings (Year 1)
		7.	48,520
		Balance        48,520

Retained Earnings (Year 2)
		6.	55,012
		Balance      103,532

Retained Earnings (Year 3)
		5.	59,059
		Balance      162,591

Service Revenue (Year 1)
7.	65,000	4.	65,000
		Balance                 0

Service Revenue (Year 2)
6.	68,000	3.	68,000
		Balance                 0

Service Revenue (Year 3)
5.	70,000	3.	70,000
		Balance                 0

Maintenance Expense (Year 2)
1.	1,000
2.	1,500	6.	2,500
Balance                       0

Computer Service Expense (Year 1)
5.	1,500	7.	1,500
Balance                       0

Computer Service Expense (Year 2)
4.	1,500	6.	1,500
Balance                       0

Computer Service Expense (Year 3)
2.	1,200	5.	1,200
Balance                       0

Depreciation Expense (Year 1)
6.	14,980	7.	14,980
Balance                       0

Depreciation Expense (Year 2)
5.	8,988	6.	8,988
Balance                       0

Depreciation Expense (Year 3)
4.	9,741	5.	9,741
Balance                       0

c.

To determine

Use a vertical model to present financial statements for Year 1, Year 2, and Year 3.

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 Year 1, Year 2, and Year 3 as follows:

Incorporation A
Financial Statements
For the year ended December 31
Income Statements
	Year 1	Year 2	Year 3
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 A
Financial Statements
Balance Sheet as of December 31
	Year 1	Year 2	Year 3
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 A
Statement of Cash Flows
For the Year Ended December 31
Particulars	Year 1 (in $)	Year 2 (in $)	Year 3 (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)