Financial Accounting

Accounting – Text & Cases – 13 Edition

CHAPTER 3

Basic Accounting Concepts: The Income Statement

Problem 3 – 1

N. Klein & Company had the following transactions in June. Using the matching concept,
decide which of these transactions represented expenses for June.

a) Received orders for goods with prices totaling $25,000; goods to be delivered in July.
b) Paid office staff $9,750 for work performed in June.

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c) Products in inventory costing $1,725 were found to be obsolete.

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d) Sold goods with a cost of $25,000 in June.

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e) Paid $750 for radio advertising in June.

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f) Purchased additional inventory for $27,000.
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Solution –
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a) Not an expense for June - not incurred

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b) Expense for June

c) Expense / loss for June
d) Expense for June
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e) Expense for June

f) Not an expense for June - asset acquired
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Problem 3 – 2
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The Hosmer Company had June sales of $275,000. The cost of goods sold was $164,000 and
other cash expenses were:
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Rent $ 3,300 Taxes $ 1,375

Salaries 27,400 Other 50,240

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 Financial Accounting

Required:

What were the company’s (a) revenues, (b) expenses, and (c) net income in June?

Solution –

(a) Revenues = $275,000

(b) Expenses – Cost of goods sold $164,000

Rent 3,300
Salaries 27,400
Taxes 1,375
Other 50,240

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246,315

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(c) Net income = $28,685 rs e
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Problem 3 – 3
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What is the cost of goods sold for the period, given the following information?
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Purchased for the period $ 78,000

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Beginning inventory 27,000

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Ending inventory 31,000

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Solution –
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Beginning inventory $27,000

Purchases 78,000
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Available for sale 1,05,000

Ending inventory ($31,000)
Cost of goods sold $74,000

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 Financial Accounting

Problem 3 – 4

Worden Corporation has the following income statement for the year:

Worden Corporation
Income Statement
For the Year Ended December 31
Sales revenues $85,000
Expenses:
Cost of goods sold $45,000
Selling and administrative expenses 25,000
Income taxes 6,000
Total expenses $76,000

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Net Income $9,000

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Required:

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a) Calculate
1) Gross margin (in dollars).
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2) Gross margin percentage.

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3) Profit margin percentage.

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b) Interpret the results of the above calculations.

Solution – This would be done in detail during ratio analysis.

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a. (1) Sales $85,000

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Less: Cost of goods sold (45,000)

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Gross margin $40,000

(2) 47 percent gross margin ($40,000 / $85,000)

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(3) 11 percent profit margin (9000/85000)

b. The Worden Corporation had a tax rate of 40 percent ($6,000 / $15,000) on its pretax profit
that represented 17.7 percent of its sales ($15,000 / $85,000). The company’s operating
expenses were 82.3 percent of sales ($70,000 / $85,000) and its cost of goods sold was 53
percent of sales. The company’s gross margin was 47 percent of sales ($40,000 / $85,000).

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 Financial Accounting

Problem 3 – 5

What expenses items are associated with the following transactions? When and how is the
income statement affected by each one?

a. Purchased equipment for $40,000 that has a useful life of five years/
b. Purchased land for $135,000.
c. Purchased $7,000 worth of inventory on December 19. On December 27 sold one half
of the inventory for $6,000. On January 8, sold the remainder for $6,200. The company
uses the calendar year for its fiscal year.
d. On January 1, subscribed to a magazine for two years. The cost was $72.

Solution:

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a. Depreciation. Each year for the next 5 years depreciation will be charged to income.

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b. No income statement charge. Land is not depreciated.

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c. Cost of goods sold of $3,500 would be charged and sales revenue would be $6000.
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$3,500 would be charged to next year’s income whereas sales revenue would be $6200.
d. Subscription expense $36 charged to current year. $36 charged to next year.
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Alternatively, $72 charged to current year on grounds $72 is immaterial.

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Problem 3 – 6

The Pierson Computer purchased a two-year fire insurance policy, paying the $30,000
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premium in October 2011. The policy was dated October 1, 2011, and expired on September
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30, 2013. With respect to this policy, what were the expenses applicable to 2011, 2012, 2013,
and what was the asset value (prepaid insurance) as of December 31, 2011, 2012, 2013?
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Solution –

Asset value:
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October 1, 2011 $30,000

December 31, 2011 26,250
December 31, 2012 11,250
December 31, 2013 0

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 Financial Accounting

Expenses:

2011 $3,750 ($1,250 x 3 months)

2012 $15,000 ($1,250 x 12 months)

2013 $11,250 ($1,250 x 9 months)

One month’s insurance charge is $1,250 ($30, 000 / 24 months)

Problem 3 – 7

QED Electronics Company had the following transactions during April while conducting its
television and stereo repair business.

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1) A new repair truck was purchased for $19,000.

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2) Parts with a cost of $1,600 were received and used during April.

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3) Service revenue for the month was $33,400, but only $20,500 was cash sales.
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Typically, only 95 percent of sales on account are realized.
4) Interest expense on loans outstanding was $880.
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5) Wage costs for the month totaled $10,000; however, $1,400 of this had not yet been
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paid to the employees.

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6) Parts inventory from the beginning of the month was depleted by $2,100.
7) Utility bills totaling $1,500 were paid. $700 of this amount was associated with
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March’s operations.
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8) Depreciation expense was $2,700.

9) Selling expenses were $1,900.
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10) A provision for income taxes was established at $2,800, of which $2,600 had been paid
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to the federal government.

11) Administrative and miscellaneous expenses were recorded at $4,700.
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Required:

Prepare a detailed April income statement.

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 Financial Accounting

Solution –

QED Electronics Company

Income Statement for the month of April
Expenses Amount ($) Incomes Amount ($)
Bad debts 645 Sales 33,400
Interest 880
Wages 10,000
Parts (1,600 + 2,100) 3,700
Utilities 800
Depreciation 2,700
Selling 1,900

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Administrative 4,700

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Provision for taxes 2,800

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28,125 33,400

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Difference (Profit) 5,275
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Truck purchase has no income statement effect. It is an asset.
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Sales are recorded as earned, not when cash is received.

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Bad debt = 5% of credit sales = 5% of (33,400 – 20,500) = 645.

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Wages expense is recognized as incurred, not when paid.

March’s utility bill is an expense of March when the obligation was incurred.
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Income tax provision relates to pretax income. Must be matched with related income.
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Case: Dispensers of California, Inc.

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Peter Hynes created a working model of a new and improved commercial paint spray, which
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he had patented. The patent had a legal life of 16 years remaining. Hynes was eager to exploit
his patent commercially, but he had no funds of his own. Several of Hynes’ friends, who had
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used prototypes of Hynes’ paint spray, offered to invest in a new corporation with a
capitalization of $200,000 par value capital stock to further develop, manufacture, and market
the spray and its related equipment. Before making their investment, the investors asked Hynes
to prepare a profit plan projecting the company’s revenues and expenses for the company’s
initial year of operation along with an end-of-first-year balance sheet.

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 Financial Accounting

Hynes agreed to prepare the requested information incorporating the following projected
transactions:

1) In return for signing his patent over to the new company, which was to be called
Dispensers of California, Inc., Hynes would receive 60% of the company’s capital
stock. For their part, the investors would contribute $80,000 cash for a 40% interest in
the company.
2) Incorporation costs, $2,500.
3) Equipment to be used in assembling the paint sprays dispensers, $85,000.
4) Out-of-pocket labor and development costs to redesign the paint spray dispenser to
facilitate more efficient assembling, $25,000.
5) Component part purchases, $212,100.

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6) Short-term loan from local bank, $30,000. (Loan to be repaid before the end of the year

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with $500 interest.)

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7) Manufacturing payroll, $145,000.

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8) Other manufacturing costs (excluding component part costs), $62,000.
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9) Selling, general, and administration costs, $63,000.
10) Ending component parts inventory cost, $15,100.
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11) Sales, $598,500 (all received in cash.)

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12) All incorporation and product redesign costs expensed as incurred.

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13) Depreciation, $8,500. (Hynes estimated the useful life of the equipment was 10 years,
with no salvage value.)
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14) Patent cost charged to income over a six-year period (Hynes anticipated technology
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developments incorporating digital flow controls would significantly reduce the current
products sales in about six years’ time.)
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15) No inventory of unsold or partially completed dispensers at year end.

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16) Cash dividends, $5,000.

17) Income tax expense, $22,500 (due to be paid during the next year.)
18) All amounts due to employees, suppliers, and others, except for income taxes, paid in
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cash. (Hynes made this assumption because he wanted to present a “conservative”

balance sheet to the investors.)

Question:

Prepare Profit and Loss Account and Balance Sheet.

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 Financial Accounting

Solution:

Dispensers of California, Inc.

Profit and Loss A/c
Expenses Amount ($) Revenues Amount ($)
Cost of goods sold Sales 598,500
Components 197,000
Mfg. payroll 145,000
Other Mfg. 62,000
Depreciation 8,500 412,500
Selling, general &
administration 63,000

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Patent amortization 20,000

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Redesign costs 25,000

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Incorporation costs 2,500

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Interest rs e 500
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Tax expense 22,500
546,000 598,500
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Difference (Profit) 52,500

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Net Profit 52500

Less: Dividend 5000

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Retained Earnings 47500

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Dispensers of California, Inc.

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Projected Year-end Balance Sheet

Equity & Liabilities Amount ($) Assets Amount ($)
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Capital stock 200,000 Cash 78,400

Retained earnings 47,500 Components inventory 15,100
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Taxes payable 22,500 Equipment (net) 76,500

Patent (net) 100,000
270,000 270,000

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