University of the West Indies

MS15D - Financial Accounting

Tutorial # 3

Accounting Differences with Sole Proprietorship, Partnerships and Corporations
 

1. Problem C.2, page 1114

Show below are the amounts from the stockholders’ equity section of the balance sheets of Lowell Corporation for the years ended December 31, 2001 and 2002:

 Required: 

1. Calculate the amount of additional investment that the stockholders made during 2002.
2. Assuming that the corporation declared and paid $10,000 in dividends during 2002, calculate the amount of net income earned by the corporation during 2002.
3. Explain the significance of the $200,000 balance of retained earnings at December 31, 2002.

2. Problem C.3, page 1114

Guenther and Firmin, both of whom are CPAs, form a partnership, with Guenther investing $100,000 and Firmin, $80,000.  They agree to share net income as follows:

1.      Salary allowances of $80,000 to Guenther and $60,000 to Firmin.

2.      Interest allowances at 15% of beginning capital account balances.

3.      Any partnership earnings in excess of the amount required to cover the interest and salary allowances to be divided 60% to Guenther and 40% to Firmin.

The partnership net income for the first year of operations amounted to $247,000 before interest and salary allowances.  Show how this $247,000 should be divided between the two partners.  Use a three-column schedule of the type illustrated on page 1111 or as shown on page 3 of your 'Accounting differences' notes or as shown here.  List on separate lines the amounts of interest, salaries, and the residual amount divided.

3. Problem C.6, page 1115

William Bost organized Frontier Western Wear, Inc., early in 2001.  On January 15, the corporation issued to Bost and other investors 40,000 shares of capital stock at $20 per share. After the revenue and expense accounts (except Income Taxes Expense) were closed into the Income Summary account at the end of 2001, the account showed a before-tax profit of $120,000.  The income tax rate for the corporation is 40%.  No dividends were declared during the year.

On March 15, 2002, the board of directors declared a cash dividend of 50 cents per share, payable on April 15.

Instructions

a.      Prepare the journal entries for 2001 to (1) record the issuance of the common stock, (2) record the Income tax liability at December 31, and (3) close the Income Taxes Expense account.

b.      Prepare the journal entries in 2002 for the declaration of the dividend on March 15 and payment of the dividend on April 15.

c.       Operations in 2002 resulted in an $18,000 net loss.  Prepare the journal entries to close the Income Summary and Dividends accounts at December 31, 2002.

d.      Prepare the stockholders’ equity section of the balance sheet at December 31, 2002.  Include a separate supporting schedule showing your determination of retained earnings at that date.

4. Problem C.8, page 1116

California Eyeshades is a retail store owned solely by Paul Turner.  During the month of November, the equity accounts were affected by the following events:

        Nov. 9     Turner invested an additional $15,000 in the business.

        Nov. 15   Turner withdrew $1,500 for his salary for the first two weeks of the month.

        Nov. 30   Turner withdrew $1,500 for his salary for the second two weeks of the month.

        Nov. 30   California Eyeshades distributed $1,000 of earnings to Turner.

Instructions

a.      Assuming that the business is organized as a sole proprietorship:

1.      Prepare the journal entries to record the above events in the accounts of California Eyeshades. 

2.      Prepare the closing entries for the month of November.  Assume that after closing all of the revenue and expense accounts, the Income Summary  account has a balance of $5,000.

b.      Assuming that the business is organized as a corporation:

1.      Prepare the journal entries to record the above events in the accounts of California Eyeshades.  Assume that the distribution of earnings on November 30 was payment of a dividend that was declared on November 20.

2.   Prepare the closing entries for the month of November.  Assume that after closing all of the revenue and expense accounts (except Income Taxes Expense) the Income Summary account has a balance of $2,000.  Before preparing the closing entries, prepare the entries to accrue income taxes for the month and to close the Income Taxes Expense account to the Income Summary account. Assume that the corporate income tax rate is 30%.

c.        Explain the causes of the differences in net income between California Eyeshades as a sole proprietorship and California Eyeshades as a corporation.

Accounting for Merchandising Activities

5. Exercise 6.12 – Comparison of Inventory Systems – Page 252

Sky probe sells state-of-the-art telescopes to individuals and organizations interested in studying the solar system. At December 31 last year, the company’s inventory amounted to $250,000. During the first week of January this year, the company made only one purchase and one sale. These transactions were as follows:

Jan 2   Sold one telescope costing $90,000 to Central State University for cash, $117,000.

Jan 5   Purchased merchandise on account from Lunar Optics, $50,000. Terms, net 30 days.

Instructions

a.       Prepare Journal entries to record these transactions assuming that Sky Probe uses the perpetual inventory system. Use separate entries to record the sales revenue and the cost of goods sold on January 2.

b.      Compute the balance on the inventory account on January 7.

c.       Prepare journal entries to record the two transactions, assuming that Sky Probe uses the periodic inventory system

d.      Compute the cost of goods sold for the first week of January assuming use of a periodic inventory system. Use your answer to part b as the ending inventory.

e.       Which inventory system do you believe that a company such as Sky Probe would probably use? Explain your reasoning.

6. Exercise 6.13 – Periodic Inventory System – Page 252

Mountain Mabel’s is a small general store located just outside of Yellowstone National Park. The store uses a periodic inventory system. Every January 1, Mabel and her husband close the store and take a complete physical inventory while watching the Rose Parade on television, Last year, the inventory amounted to $6,240; this year it totaled $4,560. During the current year, the business recorded sales of $150,000 and purchases of $74,400.

Instructions

a.       Compute the cost of goods sold for the current year

b.      Explain why a small business such as this might use the periodic inventory system

c.       Explain some of the disadvantages of the periodic system to a larger business, such as a Sears store

7. Problem 6.2 - Perpetual Inventory System and an Inventory Subsidiary Ledger – Page 253

Office Solutions sells fax machines, copiers, and other types of office equipment. On May 10, the company purchased for the first time a new plain-paper fax machine manufactured by Mitsui Corporation. Transactions relating to this product during May and June were as follows:

May 10           Purchased five P-500 fax machines on account from Mitsui Corporation, at a cost of $300 each. Payment due in 30 days.

May 23           Sold four P-500 fax machines on account to Foster & Cole, stockbrokers; sales price, $500 per machine. Payment due in 30 days.

May 24           Purchased an additional seven P-500 fax machines on account Mitsui. Cost, $300 per machine; payment due in 30 days.

June 9             Paid $1,500 cash to Mitsui Corporation for the fax machines purchased on May 10.

June 19           Sold two P-500 fax machines to Tri–State Reality for cash. Sales price, $525 per machine.

June 22           Collected $2,000 from Foster & Cole in full settlement of the credit sale on May 23.

Instructions

a.       Prepare journal entries to record these transactions in the accounting records of Office Solutions., (The company uses a perpetual system)

b.      Post the appropriate information from these journal entries to an inventory subsidiary ledger account (like the one illustrated on page 227 or as the one shown on slide 17 of your power point notes or as shown here).

c.       How many Mitsui P-500 fax machines were in inventory on May 31? From what accounting record did you obtain the answer to this question?

d.      Describe the types of information contained in any inventory subsidiary ledger account and explain how this information may be useful to various company personnel in conducting daily business operations.

8. Problem 6.4 – Comparison of Net Cost and Gross Price Methods – Page 254

Lamprino Appliance uses a perpetual inventory system. The following are three recent merchandising transactions:

June 10           Purchased 10 televisions from Mitsui Industries on account. Invoice price, $300 per unit, for a total of $3,000. The terms of purchase were 2/10, n/30.

June 15           Sold one of these televisions for $450 cash.

June 20           Paid the account payable to Mitsui Industries within the discount period.

Instructions

a.       Prepare journal entries to record these transactions assuming that Lamprino records purchases of merchandise at:

1.      Net Cost

2.      Gross invoice price

b.      Assume that Lamprino did not pay Mitsui Industries within the discount period but instead paid the full invoice price on July 10. Prepare journal entries to record this payment assuming that the original liability had been recorded at :

1.      Net Cost

2.      Gross invoice price

c.       Assume that you are evaluating the efficiency of Lamprino’s bill-paying procedures. Which accounting method - net cost or gross invoice price – provides you with the most useful information? Explain

9. Problem 6.6 – A Comprehensive Problem – Page 255

CPI sells computer peripherals. At December 31, 2001, CPI’s inventory amounted to $500,000. During the first week in January 2002, the company made only one purchase and one sale. These transactions were as follows:

Jan 2   Purchased 20 modems and 80 printers from Sharp. The total cost of these machines was $25,000, terms 3/10, n/60.

Jan 6   Sold 30 different types of products on account to Pace Corporation. The total sales price was $10,000, terms 5/10, n/90. The total cost of these 30 units to CPI was $6,100 (net of the purchase discount)

CPI has a full-time accountant and a computer-based accounting system. It records sales at the gross sales price and purchases at net cost and maintains subsidiary ledgers for accounts receivable, inventory, and accounts payable.

Instructions

a.       Briefly describe the operating cycle of a merchandising company. Identify the assets and liabilities directly affected by this cycle.

b.      Prepare journal entries to record these transactions, assuming that CPI uses a perpetual inventory system.

c.       Explain the information in part b that should be posted to subsidiary ledger accounts.

d.      Compute the balance in the Inventory controlling account at the close of business on January 6.

e.       Prepare journal entries to record the two transactions, assuming that CPI uses a periodic inventory system.

f.        Compute the cost of goods sold for the first week of January assuming use of the periodic system. (Use your answer to part d as the ending inventory)

g.       Which type of inventory system do you think CPI most likely would use? Explain your reasoning.

h.       Compute the gross profit margin on the January 6 sales transactions.