Chapter 9, Problem 27BP

a.

To determine

Show the effects of each of the transactions on the elements of the financial statements, using a horizontal statements model like the one shown next. Use (+) for increase, (−) for decrease, and NA for not affected.

Explanation of Solution

Accounting equation: Accounting equation is an accounting tool expressed in the form of equation, by creating a relationship between the resources or assets of a company, and claims on the resources by the creditors and the owners. Accounting equation is expressed as shown below.

$\text{Assets}=\text{ Liabilities}+\text{Stockholders' equity}$

Show the effect of each event on the financial statements using a horizontal statement model.

Table (1)

Note:

OA refers to operating activities.

FA refers to financing activities.

NA refers to does not affected.

b.

To determine

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

Explanation of Solution

Prepare journal entries for Company A.

Date	Account title and Explanation	Post ref.	Amount $
			Debit	Credit
Year 1
1.	Cash		37,600
	Discount on Notes Payable $\left(\$40,000\times 6\%\right)$		2,400
	Notes payable			40,000
	( To record the issuance of discount note)
2.	Cash		130,000
	Service Revenue			130,000
	( To record the services rendered for cash)
3.	Selling and administration expense		98,000
	Cash			98,000
	( To record the payment of selling and administration expense )
4.	Interest Expense (2)		1,800
	Discount on Notes Payable			1,800
	( To record the amortized interest expense on discount notes)
5.	Service Revenue		130,000
	Retained Earnings			130,000
	( To record the closing entries for revenue account)
5a.	Retained Earnings		99,800
	Selling and Administration Expenses			98,000
	Interest Expense			1,800
	( To record the closing of expense account)
Year 2
1.	Cash		215,000
	Service Revenue			215,000
	( To record the services rendered for cash)
2.	Selling and administration expense		151,000
	Cash			151,000
	( To record the payment of selling and administration expense )
3a.	Interest Expense (3)		600
	Discount on Notes Payable			600
	( To record the amortized interest expense on discount notes)
3b.	Notes payable		40,000
	Cash			40,000
	( To record the payment of note payable)
4a.	Service Revenue		215,000
	Retained Earnings			215,000
	( To record the closing entries for revenue account)
4b.	Retained Earnings		151,600
	Selling and Administration Expenses			151,000
	Interest Expense			600
	( To record the closing of expense account)

Table (2)

Working Note:

Determine the amount of discount on notes payable

$\begin{array}{c}\text{Discount expense}=\left(\begin{array}{l}\text{Face value of}\\ \text{ notes payable}\end{array}\right)\times \left(\begin{array}{l}\text{Rate of }\\ \text{interest}\end{array}\right)\\ \text{=}\$40,000\times 6\%\\ =\$2,400\end{array}$ (1)

Determine the amount of accrued interest expense.

The interest on note is accrued for 9 months which is from April 01, Year 1 to December 31, Year 1.

$\begin{array}{c}\text{Accrued interest expense}=\text{Principal}\times \text{Rate of interest}\times \text{Time outstanding}\\ \text{=\$40,000}\times \frac{6}{100}\times \frac{9}{12}\\ =\$1,800\end{array}$ (2)

Determine the amount of accrued interest expense.

The interest on note is accrued for 3 months which is from January 01, Year 2 to March 31, Year 2.

$\begin{array}{c}\text{Accrued interest expense}=\text{Principal}\times \text{Rate of interest}\times \text{Time outstanding}\\ \text{=\$40,000}\times \frac{6}{100}\times \frac{3}{12}\\ =\$600\end{array}$ (3)

Post the transactions to T-accounts.

Cash
Year 1		3.	$98,000
1.	$37,600
2.	$130,000
Balance	$69,600
Year 2
1.	$215,000	2.	$151,000
		3b.	$40,000
Balance	$93,600

Notes Payable
Year 1
		1.	$40,000
		Balance	$40,000
Year 2
3b.	$40,000
		Balance	$0

Discount on Notes Payable
Year 1
1.	$2,400	4.	$1,800
Balance	$600
Year 2
		3a.	$600
Balance	$0

Retained Earnings
Year 1
5a.	$99,800	5a.	$130,200
		Balance	$30,200
Year 2
4b.	$151,600	4a.	$215,000
		Balance	$93,600

Service Revenue
Year 1
5a.	$130,000	5a.	$130,200
		Balance	$0
Year 2
4b.	$215,000	4a.	$215,000
		Balance	$0

Selling and administration expense
Year 1
3.	$98,000	5b.	$98,000
Balance	$0
Year 2
4b.	$151,000	4b.	$151,000
		Balance	$0

Interest expense
Year 1
4.	$1,800	5b.	$1,800
Balance	$0
Year 2
4b.	$600	4b.	$600
Balance	$0

c.

To determine

Prepare income statement, statement of changes in stockholders’ equity, balance sheet, and statement of cash flows for Company B for Year 1 and 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 B for the year ended December 31, Year 1 and Year 2.

Company B
Statement of income
For the year ended December 31, Year 1 and Year 2
Particulars	Amount $
	Year 1	Year 2
Service Revenue	130,000	215,000
Total revenues	130,000	215,000
Expenses:
Selling and Administration expenses	98,000	151,000
Interest Expense	1,800	600
Total operating expense	(99,800)	(151,600)
Net income	30,200	63,400

Table (3)

Hence, the net income of Company B for the year ended December 31, Year 1 and Year 2 is $30,200 and $63,400 respectively.

Prepare the statement of changes in stockholders’ equity of Company B for the year ended December 31, Year 1 and Year 2.

Company B
Statement of changes in stockholders' equity
For the year ended December 31, Year 1 and Year 2
Particulars	Amount $
	Year 1	Year 2
Beginning Common Stock	0	0
Add: Stock Issued	0	0
Ending Common Stock	0	0
Beginning Retained Earnings	0	30,200
Plus: Net Income	30,200	63,400
Ending Retained Earnings	30,200	93,600
Total stockholder's equity	30,200	93,600

Table (4)

Hence, the total stockholders’ equity of Company B for the year ended December 31, Year 1 and Year 2 is $30,200 and $93,600 respectively.

Prepare the balance sheet of Company B as on December 31, Year 1 and Year 2.

Company B
Balance sheet
As on December 31, Year 1 and Year 2
Assets	Amount $
	Year 1	Year 2
Cash	69,600	93,600
Total Assets	69,600	93,600
Liabilities
Notes Payable	$40,000	0
Less: Discount on Notes Payable	(600)	0
Total Liabilities	39,400	0
Stockholders’ Equity
Common Stock		0
Retained Earnings	30,200	93,600
Total Stockholders’ Equity	30,200	93,600
Total liabilities and stockholders' equity	69,600	93,600

Table (5)

Hence, the total of assets and liabilities and stockholders’ equity of Company B as on December 31, Year 1 and Year 2 is $69,600 and $93,600.

Prepare the statement of cash flows of Company B for the year ended December 31, Year 1 and Year 2.

Company B
Statement of cash flows
For the year ended December 31, Year 1
Particulars	Amount $
	Year 1	Year 2
Cash flow from operating activities:
Cash Receipts from Customers	130,000	215,000
Cash payments for expenses	(98,000)	(151,000)
Cash paid for interest	(0)	(2,400)
Net Cash Flow from Operating Activities	32,000	61,600
Cash Flows From Investing Activities:	0	0
Net Cash Flow From Investing Activities	0	0
Cash Flows From Financing Activities:
Issuance of note payable	37,600
Repayment of note payable		(37,600)
Net Cash Flow From Financing Activities	37,600	(37,600)
Net Change in Cash	69,600	24,000
Add: Beginning Cash Balance	0	69,600
Ending Cash Balance	69,600	93,600

Table (6)