Chapter 9, Problem 21E

1.

To determine

Prepare journal entry to record each transactions of FF.

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.

Prepare journal entry to record each transactions of FF as follows:

Date	Account titles and Explanation	Debit	Credit
January 1	Cash	$100,000
	Notes payable		$100,000
	(To record issuance of long-term notes payable)
January 4	Cash	$31,000
	Accounts receivable		$31,000
	(To record cash received on account)
January 11	Accounts payable	$11,000
	Cash		$11,000
	(To record cash paid on account)
January 15	Salaries expense	$28,900
	Cash		$28,900
	(To record payment of salaries)
January 30	Cash	$65,000
	Accounts receivable	$130,000
	Sales revenue		$195,000
	(To record inventory sold for cash and on account)
	Cost of goods sold	$112,500
	Inventory		$112,500
	(To record cost of inventory sold)
January 31	Interest expense	$583
	Notes payable	$1,397
	Cash		$1,980
	(To record payment of monthly instalment on long-term note)

Table (1)

2.

To determine

Prepare adjusting entry as on January 31.

Explanation of Solution

Adjustment entries:

Adjusting entries are those entries which are made at the end of the year to update all the balances in the financial statements to show the true financial information and to maintain the records according to accrual basis principle.

Prepare adjusting entry as on January 31.

a.

Prepare adjusting entry to record depreciation expense.

Date	Account titles and Explanation	Debit	Credit
January 31	Depreciation expenses (1)	$800
	Accumulated depreciation		$800
	(To record adjusting entry for depreciation expenses)

Table (2)

Working note:

Calculate depreciation expense.

$\begin{array}{c}\text{Depreciation expense}\text{of buildings}\text{=}\frac{\text{Book}\text{value of buildings }-\text{Residual value}}{\text{Estimated life time}}\\ =\frac{\$120,000-\$24,000}{10\text{years}\times \text{12}\text{months}}\\ =\frac{\$96,000}{120\text{months}}\\ =\$800\end{array}$ (1)

• Depreciation expense is a component of stockholders’ equity, and it is increased. Therefore, debit depreciation expense account for $800.
• Accumulated depreciation is a contra asset, and it is increased. Therefore, credit accumulated depreciation account for $800.

b.

Prepare adjusting entry to record allowance for uncollectible accounts.

Date	Account titles and Explanation	Debit	Credit
January 31	Bad debt expense	$2,300
	Allowance for uncollectible accounts		$2,300
	(To adjust estimated uncollectible accounts)

Table (3)

Working note:

Calculate allowance for uncollectible accounts.

$\begin{array}{c}\text{Allowance for uncollectible accounts=}\left[\begin{array}{l}\left(\begin{array}{l}\text{Accounts receivable}\times \\ \text{Percentage of estimation }\\ \text{which will not be collected}\end{array}\right)+\\ \left(\begin{array}{l}\text{Remaining accounts receivable(3) }\times \\ \text{Percentage of estimation }\\ \text{which will not be collected}\end{array}\right)-\\ \left(\begin{array}{l}\text{Credit balance in allowance for }\\ \text{uncollectible accounts as on January 1, 2021}\end{array}\right)\end{array}\right]\\ =\left[\left(\$3,000\times 50\%\right)+\left(\$130,000\text{(3)}\times 2\%\right)-\$1,800\right]\\ =\left[\left(\$1,500\right)+\left(\$2,600\right)-\$1,800\right]\\ =\$2,300\end{array}$ (2)

Calculate the remaining accounts receivable.

$\begin{array}{c}\text{Remaining accounts receivable=}\left[\begin{array}{l}\text{Accounts rceivable as on January 1, 2021+}\\ \text{Services provided on account}-\\ \mathrm{Re}\text{ceived cash on accounts receivable}-\\ \text{Writting of accounts receivable as uncollectible}\end{array}\right]\\ =\left[\$34,000+\$130,000-\$31,000-\$3,000\right]\\ =\$130,000\end{array}$ (3)

• Bad debt expense is a component of stockholders’ equity and it is increased. So, debit bad debt expense for $2,300 and,
• Allowance for uncollectible accounts is a contra asset account and it is increased. So, credit allowance for uncollectible accounts for $2,300.

c.

Prepare adjusting entry to record salaries payable.

Date	Account titles and Explanation	Debit	Credit
January 31	Salaries expense	$26,100
	Salaries payable		$26,100
	(To adjust salaries payable)

Table (4)

• Salaries expense is a component of stockholders’ equity, and it is increased. Therefore, debit salaries expense account for $26,100.
• Salaries payable is a current liability, and it is increased. Therefore, credit salaries payable account for $26,100.

d.

Prepare adjusting entry to record income taxes.

Date	Account titles and Explanation	Debit	Credit
January 31	Income tax expense	$8,000
	Income tax payable		$8,000
	(To adjust income taxes)

Table (5)

• Income tax expense is a component of stockholders’ equity, and it is increased. Therefore, debit income tax expense account for $8,000.
• Income tax payable is a current liability, and it is increased. Therefore, credit income tax payable account for $8,000.

3.

To determine

Prepare an adjusted trail balance as of January 31, 2021.

Explanation of Solution

Adjusted trial balance:

Adjusted trial balance is a summary of all the ledger accounts, and it contains the balances of all the accounts after the adjustment entries are journalized, and posted.

Prepare an adjusted trail balance as of January 31, 2021

FF
Adjusted Trial Balance
As of December 31, 2021
Accounts	Debit	Credit
Cash	$165,320
Accounts Receivable	$133,000
Allowance for Uncollectible Accounts		$4,100
Inventory	$39,500
Land	$67,300
Buildings	$120,000
Accumulated Depreciation		$10,400
Accounts Payable		$6,700
Salaries Payable		$26,100
Income Tax Payable		$8,000
Notes Payable (Current)		$17,411
Notes Payable (Long-term)		$81,192
Common Stock		$200,000
Retained Earnings		$155,400
Sales Revenue		$195,000
Cost of Goods Sold	$112,500
Salaries Expense	$55,000
Bad Debt Expense	$2,300
Depreciation Expense	$800
Interest Expense	$583
Income Tax Expense	$8,000
Totals	$704,303	$704,303

Table (6)

Working notes:

Calculate adjusted ending balance amount for each accounts.

Accounts	Ending Balance		Beginning balance, entries during January , and adjusting entries
Cash	$165,320	=	$\left[\begin{array}{l}11,200+100,000+31,000\\ -11,000-28,900+65,000-1,980\end{array}\right]$
Accounts Receivable	133,000	=	$\left(34,000-31,000+130,000\right)$
Allow for Uncollectible  Accounts	4,100	=	$\left(1,800+2,300\right)$
Inventory	39,500	=	$\left(152,000-112,500\right)$
Land	67,300	=	67,300
Buildings	120,000	=	120,000
Accumulated Depreciation	10,400	=	$\left(9,600+800\right)$
Accounts Payable	6,700	=	$\left(17,700-11,000\right)$
Salaries Payable	26,100	=	26,100
Income Tax Payable	8,000	=	8,000
Notes Payable (Current)	17,411	=	17,411
Notes Payable (Long-term)	81,192	=	$\left(100,000–1,397-17,411\right)$
Common Stock	200,000	=	200,000
Retained Earnings	155,400	=	155,400
Sales Revenue	195,000	=	195,000
Cost of Goods Sold	112,500	=	112,500
Salaries Expense	55,000	=	$\left(28,900+26,100\right)$
Bad Debt Expense	2,300	=	2,300
Depreciation Expense	800	=	800
Interest Expense	583	=	583
Income Tax Expense	8,000	=	8,000

Table (7) (4)

4.

To determine

Prepare a multi-step income statement for the period ended as on January 31, 2021.

Explanation of Solution

Prepare a multi-step income statement for the period ended as on January 31, 2021 as follows:

FF
Multiple-Step Income Statement
For the year month ended January 31, 2021
Particulars	Amount	Amount
Sales revenue	$195,000
Cost of goods sold	$112,500
Gross profit		$82,500
Salaries expense	$55,000
Bad debt expense	$2,300
Depreciation expense	$800
Total operating expenses		$58,100
Operating income		$24,400
Interest expense		$583
Income before taxes		$23,817
Income tax expense		$8,000
Net income		$15,817

Table (8)

Therefore, Net income of FF is $15,817.

5.

To determine

Prepare classified balance sheet as on January 31, 2021.

Explanation of Solution

Prepare classified balance sheet as on January 31, 2021 as follows:

Figure (1)

Working note:

Calculate retained earnings.

$\begin{array}{c}\text{Ending retained earnings =}\text{Opening retained earnings + Net income }-\text{Dividends}\\ \text{= \$155,400+\$15,817}-\$0\\ =\$171,217\end{array}$ (5)

6.

To determine

Record the closing entries of FF.

Explanation of Solution

Closing entries:

The journal entries prepared to close the temporary accounts to Retained Earnings account are referred to as closing entries. The revenue, expense, and dividends accounts are referred to as temporary accounts because the information and figures in these accounts is held temporarily and consequently transferred to permanent account at the end of accounting year.

Prepare revenue closing entry.

Date	Account titles and Explanation	Debit	Credit
January 31	Sales revenue	$195,000
	Retained earnings		$195,000
	(To close revenue accounts)

Table (9)

• Sales revenue is a component of stockholders’ equity, and it is decreased. Therefore, debit sales revenue account for $195,000.
• Retained earnings are a component of stockholders’ equity, and it is increased. Therefore, credit retained earnings account for $195,000.

Prepare expense closing entry.

Date	Account titles and Explanation	Debit	Credit
January 31	Retained earnings	$179,183
	Cost of goods sold		$112,500
	Salaries expense		$55,000
	Bad debt expense		$2,300
	Depreciation expense		$800
	Interest expense		$583
	Income tax expense		$8,000
	(To close expense accounts)

Table (10)

• Retained earnings are a component of stockholders’ equity, and it is decreased. Therefore, debit retained earnings account for $179,183.
• Cost of goods sold is a component of stockholders’ equity, and it is increased. Therefore, credit cost of goods sold account for $112,500.
• Salaries expense is a component of stockholders’ equity, and it is increased. Therefore, credit salaries expense account for $55,000.
• Bad debts expense is a component of stockholders’ equity, and it is increased. Therefore, credit Bad debts expense account for $2,300.
• Depreciation expense is a component of stockholders’ equity, and it is increased. Therefore, credit Depreciation expense account for $800.
• Interest expense is a component of stockholders’ equity, and it is increased. Therefore, credit Interest expense account for $583.
• Income tax expense is a component of stockholders’ equity, and it is increased. Therefore, credit Income tax expense account for $8,000.

7.a.

To determine

Calculate debt to equity ratio, and find outout whether the average debt to equity ratio of FF is more or less leveraged than other companies in the same industry, if the industries debt to equity ratio is 1.0.

Explanation of Solution

Calculate debt to equity ratio.

$\begin{array}{c}\text{Debt to equity ratio}=\frac{\text{Total liabilites}}{\text{Total stockholders' equity}}\\ =\frac{\$139,403}{\$371,217}\\ =0.38\end{array}$

FF debt equity ratio (0.38) is less leveraged than the same industry average (1.0). Therefore, FF has lesser proportion of liabilities compares with the stockholders’ equity.

b.

To determine

Calculate the times interest earned ratio and find out whether the company has more or less ability to meet interest payments than other companies in the same industry, if the average times interest earned ratio for the same industry is 20 times.

Explanation of Solution

Calculate times interest earned ratio.

$\begin{array}{c}\text{Times interest earned ratio}\text{=}\frac{\text{Net income + Interest expense + Tax expense}}{\text{Interest expense}}\\ =\frac{\$15,817+\$583+\$8,000}{\$583}\\ =41.9\text{times}\end{array}$

FF times interest earned ratio (41.9 times) is more than industry average ratio (20 times). Therefore, FF is more able to meet interest payments than other companies in the same industry.

c.

To determine

Ascertain whether FF is likely to receive higher or lower interest rate than the average borrowing rate in the industry.

Explanation of Solution

Based on the debt to equity ratio and the times interest earned ratio, ratio, Freedom Fireworks would more likely receive a lower interest rate than the average borrowing rate in the industry. Freedom Fireworks carries less debt than the industry average and is better able to meet interest payments than the average company in the industry.