Chapter 9, Problem 20AP

Requirement a.

To determine

Record the transactions of Year 1 in general journal.

Explanation of Solution

Sales tax payable: The Company collects the tax from the customer when the sale is made in cash or an account, and periodically deposits the collections to the state’s department of revenue. Many states are implementing sales taxes on purchases made on the internet. Sales taxes are computed as percentage of the sales price.

Prepare journal entries for Company WE.

Event	Account title and Explanation	Post ref.	Amount $
			Debit	Credit
Year 1
1.	Cash		50,000
	Note payable			50,000
	( To record the cash received from the issue of short term note )
2.	Cash		137,800
	Service revenue			130,000
	Sales tax payable (1)			7,800
	( To record the cash receipts by rendering service)
3.	Operating expense		62,000
	Cash			62,000
	( To record the cash paid for operating expenses)
4.	Sales tax payable (2)		6,600
	Cash			6,600
	( To record the cash paid for sales tax payable)
5.	Interest expense (3)		2,250
	Interest payable			2,250
	( To recognize the accrued interest at the end of the year)

Table (1)

Event 1. To record the cash receipts from issue of notes:

• Cash is an asset and there is an increase in the value of an asset. Hence, debit the cash by $50,000.
• Notes payable is a liability and there is an increase in the value of liability. Hence, credit the notes payable by $50,000.

Event 2. To record the cash receipts by rendering service:

• Cash is an asset and there is an increase in the value of an asset. Hence, debit the cash by $137,800.
• Service revenue is a component of stockholder’s equity and there is an increase in the value of revenue. Hence, it is credited by $130,000.
• Sales tax payable is a liability and there is an increase in the value of liability. Hence, credit the sales tax payable by $7,800.

Event 3. To record the operating expense paid for cash:

• Operating expense (expense) is a component of stockholder’s equity and there is an increase in the value of expense. Hence, debit the operating expense by $62,000.
• Cash is an asset and there is a decrease in the value of an asset. Hence, credit the cash by $62,000.

Event 4. To record the payment of sales tax for cash:

• Sales tax payable is a liability and there is a decrease in the value of liability. Hence, debit the sales tax payable by $6,600.
• Cash is an asset and there is a decrease in the value of an asset. Hence, credit the cash by $6,600.

Event 5. To recognize the accrued interest:

• Interest expense is a component of stockholders equity and there is an increase in the value of expense. Hence, debit the fine by $2,250.
• Interest expense payable is a liability and there is an increase in the value of liability. Hence, credit the fine payable by $2,250.

Working Note:

Determine the sales tax payable on the service rendered.

$\begin{array}{c}\text{Sales tax payable}=\left(\begin{array}{l}\text{Value of }\\ \text{service provided }\end{array}\right)\times \text{Rate of tax}\\ \text{=\$130,000}\times 6\%\\ =\$7,800\end{array}$ (1)

Determine the sales tax due for the year.

$\begin{array}{c}\text{Sales tax payable}=\left(\begin{array}{l}\text{Value of }\\ \text{service provided }\end{array}\right)\times \text{Rate of tax}\\ \text{=\$110,000}\times 6\%\\ =\$6,600\end{array}$ (2)

Determine the interest on note payable.

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Value of }\\ \text{note payable }\end{array}\right)\times \left(\begin{array}{l}\text{Rate }\\ \text{of tax}\end{array}\right)\times \frac{\text{Number of months outstanding}}{\text{Months in a year}}\\ \text{=\$50,000}\times 6\%\times \frac{9}{12}\\ =\$2,250\end{array}$ (3)

Requirement b.

To determine

Post the transactions to T-accounts.

Explanation of Solution

Post the transactions to T-accounts.

Cash
1.	$50,000	3.	$62,000
2.	$137,800	4.	$6,600
Balance	$119,200

Sales tax Payable
4.	$6,600	2.	$7,800
		Balance	$1,200

Interest Payable
		5.	$2,250
		Balance	$2,250

Notes Payable
		1.	$50,000
		Balance	$50,000

Service Revenue
		2.	$130,000
		Balance	$130,000

Operating Expense
3.	$62,000
Balance	$62,000

Interest Expense
5.	$2,250
Balance	$2,250

Requirement c.

To determine

Prepare income statement, statement of changes in stockholders’ equity, balance sheet, and statement of cash flows for Company WE for Year 1.

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 WE for the year ended December 31, Year 1.

Company WE
Statement of income
For the year ended December 31, Year 1
Particulars	Amount $	Amount $
Service Revenue		130,000
Expenses:
Operating Expenses	62,000
Total operating expense		(62,000)
Operating income		68,000
Interest expense		(2,250)
Net income		65,750

Table (2)

Hence, the net income of Company WE for the year ended December 31, Year 1 is $65,750.

Prepare the statement of changes in stockholders’ equity of Company WE for the year ended December 31, Year 1.

Company WE
Statement of changes in stockholders' equity
For the year ended December 31, Year 1
Particulars	Amount $	Amount $
Common Stock		0
Beginning retained earnings	0
Add/Less: Net Income (Loss)	65,750
Ending Retained Earnings		65,750
Total stockholder's equity		65,750

Table (3)

Hence, the total stockholders’ equity of Company WE for the year ended December 31, Year 1 is $67,750.

Prepare the balance sheet of Company WE as on December 31, Year 1.

Company WE
Balance sheet
As on December 31, Year 1
Assets	Amount $	Amount $
Cash		119,200
Total Assets		119,200
Liabilities and stockholders' equity
Liabilities
Sales tax Payable	1,200
Interest Payable	2,250
Notes  Payable	50,000
Total Liabilities		53,450
Stockholders’ Equity
Retained Earnings	66,750
Total Stockholders’ Equity		65,750
Total liabilities and stockholders' equity		119,200

Table (4)

Hence, the total of assets and liabilities and stockholders’ equity of Company WE as on December 31, Year 1 is $119,200.

Prepare the statement of cash flows of Company WE for the year ended December 31, Year 1.

Company WE
Statement of cash flows
For the year ended December 31, Year 1
Particulars	Amount $	Amount $
Cash flow from operating activities:
Inflow from Customers	130,000
Inflow from Sales Tax	7,800
Outflow for Expenses	(62,000)
Outflow for Sales Tax	(6,600)
Net Cash Flow from Operating Activities		69,200
Cash Flows From Investing Activities:
Net Cash Flow From Investing Activities		0
Cash Flows From Financing Activities:
Inflow from loan	50,000
Net Cash Flow From Financing Activities		50,000
Net Change in Cash		119,200
Add: Beginning Cash Balance		0
Ending Cash Balance		119,200

Table (5)

Requirement d.

To determine

Close the temporary accounts to retained earnings.

Explanation of Solution

Temporary accounts: Temporary accounts include all income statements accounts, and dividend account which are closed at the end of each year because they are used to track the financial results only in the current year.

Prepare journal entries to record the closing of temporary accounts.

Date	Account title and Explanation	Post ref.	Amount $
			Debit	Credit
Year 1
December 31	Service Revenue		130,000
	Retained Earnings			130,000
	( To record the closing entries for revenue account)
December 31	Retained Earnings		64,250
	Operating Expense			62,000
	Interest Expense			2,250
	( To record the closing for expenses account)

Table (6)

Post the closing entries to the T-accounts.

Cash
Balance	$119,200

Sales tax Payable
		Balance	$1,200

Interest Payable
		Balance	$2,250

Notes Payable
		Balance	$50,000

Retained earnings
Closing balance	$64,250	Closing balance	$130,000
		Balance	$65,750

Service Revenue
Closing balance	$130,000	Balance	$130,000
		Balance	$0

Operating Expense
Balance	$62,000	Closing balance	$62,000
Balance	$0

Interest Expense
Balance	$2,250	Closing balance	$2,250
Balance	$0

Requirement e.

To determine

Prepare a post-closing trial balance for the year ended December 31, Year 1.

Explanation of Solution

Post-closing trial balance: The post-closing trial balance is a summary of all ledger accounts, and it shows the debit and the credit balances after the closing entries are journalized and posted.  The post-closing trial balance contains only permanent (balance sheet) accounts, and the debit and the credit balances of permanent accounts should agree.

 Prepare the post-closing trial balance of Company WE for the year ended December 31, Year 1.

Company WE
Post-closing trial balance
For the year ended December 31,Year 1
Particulars	Amount $	Amount $
Cash	119,200
Sales Tax Payable		1,200
Interest Payable		2,250
Notes Payable		50,000
Retained Earnings		65,750
Totals	$119,200	$119,200

Table (7)

Requirement f.

To determine

Repeat Requirements a through e for Year 2.

Explanation of Solution

Sales tax payable: The Company collects the tax from the customer when the sale is made in cash or an account, and periodically deposits the collections to the state’s department of revenue. Many states are implementing sales taxes on purchases made on the internet. Sales taxes are computed as percentage of the sales price.

Prepare journal entries for Company WE for Year 2.

Event	Account title and Explanation	Post ref.	Amount $
			Debit	Credit
Year 2
1.	Sales tax payable		1,200
	Cash			1,200
	( To record the payment of  sales tax of the previous year )
2.	Cash		213,060
	Service revenue			201,000
	Sales tax payable (4)			12,060
	( To record the cash receipts by rendering service)
3a.	Interest expense (5)		750
	Interest payable			750
	( To recognize the accrued interest at the end of the year)
3b.	Interest payable		3,000
	Notes payable		50,000
	Cash			53,000
	( To record the payment of notes payable along with interest)
4.	Operating expense		102,500
	Cash			102,500
	( To record the cash paid for operating expenses)
5.	Sales tax payable (6)		11,100
	Cash			11,100
	( To record the cash paid for sales tax payable)

Table (8)

Event 1. To record the payment of sales tax of the previous year:

• Sales tax payable is a liability and there is a decrease in the value of liability. Hence, debit the sales tax payable by $1,200.
• Cash is an asset and there is a decrease in the value of an asset. Hence, credit the cash by $1,200.

Event 2. To record the sales for cash:

• Cash is an asset and there is an increase in the value of an asset. Hence, debit the cash by $213,060.
• Service revenue is a component of stockholder’s equity and there is an increase in the value of revenue. Hence, it is credited by $201,000.
• Sales tax payable is a liability and there is an increase in the value of liability. Hence, credit the sales tax payable by $12,060.

Event 3a. To record the accrued interest recognized:

• Interest expense (expense) is a component of stockholders equity and there is an increase in the value of expense. Hence, debit the fine by $750.
• Interest payable is a liability and there is an increase in the value of liability. Hence, credit the fine payable by $750.

Event 3b. To record the payment of notes payable along with interest:

• Interest payable is a liability and there is a decrease in the value of liability. Hence, credit the fine payable by $3,000.
• Notes payable is a liability and there is a decrease in the value of liability. Hence, debit the notes payable by $50,000.
• Cash is an asset and there is a decrease in the value of an asset. Hence, credit the notes payable by $53,000.

Event 4. To record the operating expense paid for cash:

• Operating expense (expense) is a component of stockholder’s equity and there is an increase in the value of expense. Hence, debit the operating expense by $102,500.
• Cash is an asset and there is a decrease in the value of an asset. Hence, credit the cash by $102,500.

Event 5. To record the payment of sales tax for cash:

• Sales tax payable is a liability and there is a decrease in the value of liability. Hence, debit the sales tax payable by $11,100.
• Cash is an asset and there is a decrease in the value of an asset. Hence, credit the cash by $11,100.

Working Note:

Determine the sales tax payable on the service rendered.

$\begin{array}{c}\text{Sales tax payable}=\left(\begin{array}{l}\text{Value of }\\ \text{service provided }\end{array}\right)\times \text{Rate of tax}\\ \text{=\$201,000}\times 6\%\\ =\$12,060\end{array}$ (4)

Determine the interest on note payable.

$\begin{array}{c}\text{Interest expense}=\left(\begin{array}{l}\text{Value of }\\ \text{note payable }\end{array}\right)\times \left(\begin{array}{l}\text{Rate }\\ \text{of tax}\end{array}\right)\times \frac{\text{Number of months outstanding}}{\text{Months in a year}}\\ \text{=\$50,000}\times 6\%\times \frac{3}{12}\\ =\$750\end{array}$ (5)

Determine the sales tax due for the year.

$\begin{array}{c}\text{Sales tax payable}=\left(\begin{array}{l}\text{Value of }\\ \text{service provided }\end{array}\right)\times \text{Rate of tax}\\ \text{=\$185,000}\times 6\%\\ =\$11,100\end{array}$ (6)

Post the transactions to T-accounts fort Year 2.

Cash
Balance	$119,200	1.	$1,200
2.	$213,060	3b.	$53,000
		4.	$102,500
		5.	$11,100
Balance	$164,460

Sales tax Payable
1.	$1,200	Balance	$1,200
5.	$11,100	2.	$12,060
		Balance	$960

Interest Payable
		Balance	$2,250
3b.	$3,000	3a.	$750
		Balance	$0

Notes Payable
		Balance	$50,000
3b.	$50,000
		Balance	$0

Retained earnings
		Balance	$65,750

Service Revenue
		2.	$201,000
		Balance	$201,000

Operating Expense
4.	$102,500
Balance	$102,500

Interest Expense
3a.	$750
Balance	$750

Prepare the income statement for Company WE for the year ended December 31, Year 2.

Company WE
Statement of income
For the year ended December 31, Year 2
Particulars	Amount $	Amount $
Service Revenue		201,000
Expenses:
Operating Expenses	102,500
Total operating expense		(102,500)
Operating income		98,500
Interest expense		(750)
Net income		97,750

Table (9)

Hence, the net income of Company WE for the year ended December 31, Year 2 is $97,750.

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

Company WE
Statement of changes in stockholders' equity
For the year ended December 31, Year 2
Particulars	Amount $	Amount $
Common Stock		0
Beginning retained earnings	65,750
Add/Less: Net Income (Loss)	97,750
Ending Retained Earnings		163,500
Total stockholder's equity		163,500

Table (10)

Hence, the total stockholders’ equity of Company WE for the year ended December 31, Year 2 is $163,500.

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

Company WE
Balance sheet
As on December 31, Year 2
Assets	Amount $	Amount $
Cash		164,460
Total Assets		164,460
Liabilities and stockholders' equity
Liabilities
Sales tax Payable	960
Total Liabilities		960
Stockholders’ Equity
Retained Earnings	163,500
Total Stockholders’ Equity		163,500
Total liabilities and stockholders' equity		164,460

Table (11)

Hence, the total of assets and liabilities and stockholders’ equity of Company WE as on December 31, Year 2 is $164,460.

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

Company WE
Statement of cash flows
For the year ended December 31, Year 2
Particulars	Amount $	Amount $
Cash flow from operating activities:
Cash reeipts from Customers	$201,000
Inflow from Sales Tax	12,060
Cash paid for Expenses	(102,500)
Cash paid for Sales Tax expense	(12,300)
Cash paid for Interest exepnse	(3,000)
Net Cash Flow from Operating Activities		95,260
Cash Flows From Investing Activities:
Net Cash Flow From Investing Activities		0
Cash Flows From Financing Activities:
Repayment of loan	(50,000)
Net Cash Flow From Financing Activities		(50,000)
Net Change in Cash		45,260
Add: Beginning Cash Balance		119,200
Ending Cash Balance		164,460

Table (12)

Prepare journal entries to record the closing of temporary accounts.

Date	Account title and Explanation	Post ref.	Amount $
			Debit	Credit
Year 1
December 31	Service Revenue		201,000
	Retained Earnings			201,000
	( To record the closing entries for revenue account)
December 31	Retained Earnings		103,250
	Operating Expense			102,500
	Interest Expense			750
	( To record the closing for expenses account)

Table (13)

Post the closing entries to the T-accounts.

Cash
Balance	$164,460

Sales tax Payable
		Balance	$960

Retained earnings
		Balance	$65,750
Closing balance	$103,250	Closing balance	$201,000
		Balance	$163,500

Service Revenue
Closing balance	$201,000	Balance	$201,000
		Balance	$0

Operating Expense
Balance	$102,500	Closing balance	$102,500
Balance	$0
Interest Expense
Balance	$750	Closing balance	$750
Balance	$0

Prepare the post-closing trial balance of Company WE for the year ended December 31, Year 2.

Company WE
Post-closing trial balance
For the year ended December 31,Year 2
Particulars	Amount $	Amount $
Cash	164,460
Sales Tax Payable		960
Retained Earnings		163,500
Totals	$164,460	$164,460

Table (14)