hwchap011

Chapter 11 - Current Liabilities and Payroll Accounting

11-1

Chapter 11 Current Liabilities and Payroll Accounting

QUESTIONS

1. The three questions are: (1) Who must be paid? (2) When is payment due? (3) How much is to be paid?

2. A current liability is expected to be paid within one year or the company’s operating cycle, whichever is longer. Any liability that is not current is considered to be long term.

3. An estimated liability is an obligation to make a future payment, the exact amount of which is uncertain, but it is capable of being reasonably estimated.

4. The amount of the sale for the item only is $950 ($988/1.04).

5. The combined Social Security tax rate (assuming the maximum wage amount is not yet reached) is 12.4% (6.2% + 6.2%). The maximum level of earnings [wage base on which taxes are due] for 2010 is $106,800.

6. The Medicare tax rate is 1.45%. This rate is applied to all wages earned by an employee—no maximum limit exists.

7. An employee’s gross earnings along with the number of withholding allowances that an employee claims, as well as whether they are married or single, determine the amount deducted for federal income taxes.

8. The employee is responsible for federal income taxes, state income taxes, local income taxes (if any), and the employee portion of the FICA taxes. The employer is responsible for both federal and state unemployment taxes and the employer portion of the FICA taxes.

9. An unemployment merit rating is based on an evaluation of an employer’s experience in creating or avoiding unemployment with its employees. The merit rating affects the state unemployment taxes that the employer must pay. Merit ratings cause more of the cost of unemployment benefits to be paid by those who create more unemployment.

10. The obligation to correct or replace defective products (or services) is created when the products are sold with the warranties. Even though the seller does not know with certainty when the obligation will be paid, to whom it will be paid, or the amount to be paid, past experience shows that some amount will probably be paid. If the seller can reasonably estimate that amount, the warranty liability must be reported on the balance sheet.


11-2

11. There are no conditions in which a probable loss tied to a future event can create a liability, regardless of its probability. A liability is an obligation created by a past event, not by a future event. If a disaster occurs, the company must report the loss in the period when it occurs.

12.A A wage bracket withholding table shows for a pay period of a given length (weekly, biweekly, semimonthly, monthly), the amounts of federal income taxes to be withheld from the pay of an employee, at varying amounts of gross pay and varying numbers of withholding allowances.

13.A Single employee earning $725 with two allowances has $76 taxes withheld. Single employee earning $625 with no allowances has $81 taxes withheld.

14. At February 27, 2010, Research In Motion reports ―Deferred revenue‖ in the amount of $67,573 ($ in thousands).

15. At September 26, 2009, Apple reports Accounts payable of $5,601 million.

16. At December 31, 2009, Nokia reports six current liabilities: Current portion of long-term loans; Short-term borrowings; Other financial liabilities; Accounts payable; Accrued expenses; and Provisions.

17. Palm’s current liabilities include one income-tax-related liability titled ―Income taxes payable‖. This account reflects taxes that must be paid to the government in the short term.

Instructor note: Palm also has one noncurrent income-tax-related account on its balance sheet. This account is titled ―Non-current tax liabilities.‖

QUICK STUDIES Quick Study 11-1 (5 minutes) Items 1, 3, 5, 6 are current liabilities for this company.

Quick Study 11-2 (10 minutes) Sept. 30 Cash .......................................................................... 5,200 Sales ................................................................... 5,000 Sales Taxes Payable ......................................... 200 To record cash sales and 4% sales tax.

Sept. 30 Cost of Goods Sold ................................................. 2,900 Merchandise Inventory ..................................... 2,900 To record cost of Sept. 30th sales.

Oct. 15 Sales Taxes Payable ............................................... 200 Cash .................................................................... 200 To record remittance of sales taxes to govt.


11-3

Quick Study 11-3 (10 minutes) Oct. 31 Cash .......................................................................... 5,500,000 Unearned Ticket Revenue ................................. 5,500,000 To record sales in advance of concerts.

Nov. 8 Unearned Ticket Revenue ....................................... 1,375,000 Earned Ticket Revenue ..................................... 1,375,000 To record concert revenues earned.

($5,500,000 / 4 dates = $1,375,000)

Quick Study 11-4 (10 minutes)

1. (b); reason—is reasonably estimated but not a probable loss.

2. (b); reason—probable loss but cannot be reasonably estimated.

3. (a); reason—can be reasonably estimated and loss is probable. Quick Study 11-5 (15 minutes) 1. Computation of interest payable at December 31, 2011:

Days from November 7 to December 31 .................... 54 days Accrued interest (8% x $150,000 x 54/360) ................ $1,800

2. 2011

Dec.31 Interest Expense ...................................................... 1,800 Interest Payable ................................................ 1,800 To record payment of note plus interest

(8% x $150,000 x 54/360).

3. 2012

Feb. 5 Interest Expense* .................................................... 1,200 Interest Payable ....................................................... 1,800 Notes Payable .......................................................... 150,000 Cash .................................................................... 153,000 To record payment of note plus interest

*(8% x $150,000 x 36/360).


11-4


Jan. 14 Sales Salaries Expense ........................................... 14,000

FICA—Social Sec. Taxes Payable* .................. 868

FICA—Medicare Taxes Payable** .................... 203

Employee Fed. Inc. Taxes Payable .................. 2,600

Employee Medical Insurance Payable ............. 309

Employee Union Dues Payable ........................ 120

Salaries Payable ................................................ 9,900

To record payroll for period.

* $14,000 x 6.2% ** $14,000 x 1.45%


[Note: Two months (January and February) of earnings have already been recorded for each of the 10 employees.]

Mar. 31 Payroll Taxes Expense ............................................ 2,770.00 FICA—Social Security Taxes Payable1 ............ 1,240.00 FICA—Medicare Taxes Payable2 ....................... 290.00 State Unemployment Taxes Payable3 .............. 1,080.00 Federal Unemployment Taxes Payable4 .......... 160.00

To record employer payroll taxes. 1(10 x $2,000) x 6.2% = $1,240.00 2(10 x $2,000) x 1.45% = $290.00 3(10 x $2,000 [check $2,000 under max: $7,000 – {$2,000 x 2}]) x 5.4% = $1,080.00 4(10 x $2,000 [check $2,000 under max: $7,000 – {$2,000 x 2}]) x 0.8% = $160.00


2011

July 24 Estimated Warranty Liability .................................. 35 Repair Parts Inventory ....................................... 35 To record cost of warranty repairs.

Quick Study 11-9 (5 minutes) Dec. 31 Employee Bonus Expense ...................................... 10,000 Bonus Payable ................................................. 10,000 To record expected bonus costs.



11-5

Vacation Benefits Expense* ................................... 307.69 Vacation Benefits Payable .............................. 307.69 To record vacation benefits accrued.

* ($4,000-3,692.31)

Quick Study 11-11 (10 minutes) Times interest earned = = 5.8 times Interpretation: This company’s times interest earned ratio of 5.8 exceeds (is superior to) its competitors’ average ratio of 4.0. A times interest earned of 5.8 suggests sufficient income to cover interest obligations. Quick Study 11-12A (15 minutes) Gross Pay ............................................................................ $735.00 Social Security tax deduction (6.2%) .............................. $45.57 Medicare tax deduction (1.45%) ...................................... 10.66 Federal income tax deduction (from Exhibit 11A.6) ...... 93.00 State income tax deduction (1.0%) ................................. 7.35 Total deductions ............................................................... 156.58

Net Pay ................................................................................. $578.42

Quick Study 11-13B (10 minutes)

Dec. 31 Income Taxes Expense ........................................... 30,000 Income Taxes Payable ...................................... 22,000 Deferred Income Tax Liability .......................... 8,000 To record tax expense and deferred tax liability.


a. The definitions and characteristics of current liabilities are broadly similar for both U.S. GAAP and IFRS. Although differences exist, the similarities vastly outweigh any differences.

b. Examples of financial liabilities under IFRS include interest-bearing loans and borrowings, and trade (account) and other payables.

$2,044,000

$350,000


11-6

EXERCISES Exercise 11-1 (10 minutes) 1. C 3. N 5. C 7. C 9. L

2. C 4. C 6. C 8. C 10. L

Exercise 11-2 (10 minutes)

[Note: All entries dated December 31, 2011] 1. Cash .......................................................................... 2,100,000 Sales .................................................................... 2,000,000 Sales Taxes Payable .......................................... 100,000 To record sales and sales taxes.

Cost of Goods Sold .................................................. 1,000,000 Merchandise Inventory ...................................... 1,000,000 To record cost of sales.

2. Unearned Services Revenue ................................... 40,000 Earned Services Revenue ................................. 40,000 To record product revenue earned.


[Note: All entries dated December 31, 2011.] 1. No adjusting entry can be made since the loss cannot be reasonably

estimated. Disclosure of the suit as a contingent liability should be made in the notes to the financial statements.

2. No adjusting entry is required since it is not probable that the supplier will

default on the debt. The guarantor, Moor Company, should describe the guarantee in its financial statement notes as a contingent liability.

Exercise 11-4 (30 minutes) 1. Maturity date = May 15 + 60 days = July 14, 2011 2a. May 15 Cash .......................................................................... 94,000 Notes Payable .................................................... 94,000 Borrowed cash by issuing an interest-bearing note.


11-7

Exercise 11-4 (Concluded)

2b. July 14 Interest Expense* .................................................... 1,880 Notes Payable .......................................................... 94,000 Cash .................................................................... 95,880 Repaid note plus interest.

* Principal ................................. $94,000 x Interest rate ......................... 12% x Fraction of year .................. 60/360 Total interest .......................... $ 1,880

Exercise 11-5 (30 minutes) 1. Maturity date = November 1 + 90 days = January 30, 2012. 2. Principal ..................................................... $150,000 x Interest rate ............................................. 9% x Fraction of year (Nov. 1 – Dec. 31)........ 60/360 Total interest in 2011 ................................. $ 2,250

3. Principal ..................................................... $150,000 x Interest rate ............................................. 9% x Fraction of year (Jan. 1 – Jan. 30)......... 30/360 Total interest in 2012 ................................. $ 1,125 4a. 2011 Nov. 1 Cash .......................................................................... 150,000 Notes Payable .................................................... 150,000 Borrowed cash by issuing an interest-bearing note.

4b. 2011 Dec. 31 Interest Expense ...................................................... 2,250 Interest Payable ................................................. 2,250 Accrued interest on note payable.

4c.

2012 Jan. 30 Interest Expense ...................................................... 1,125 Interest Payable ....................................................... 2,250 Notes Payable .......................................................... 150,000 Cash .................................................................... 153,375 Repaid note plus interest.


11-8


Subject to Tax

Rate

Tax

Explanation

a. FICA--Social Security ........... $ 800 6.20% $ 49.60 Full amount is subject to tax.

FICA—Medicare ..................... 800 1.45 11.60 Full amount is subject to tax.

FUTA .......................................... 600 0.80 4.80 $200 is over the maximum.

SUTA .......................................... 600 2.90 17.40 $200 is over the maximum. b. FICA--Social Security ........... $2,100 6.20% $130.20 Full amount is subject to tax.

FICA—Medicare ..................... 2,100 1.45 30.45 Full amount is subject to tax.

FUTA .......................................... 0 0.80 0.00 Full amount is over maximum.

SUTA .......................................... 0 2.90 0.00 Full amount is over maximum. c. FICA--Social Security ........... $6,300 6.20% $390.60 $1,700 is over the maximum.

FICA—Medicare ..................... 8,000 1.45 116.00 Full amount is subject to tax.

FUTA .......................................... 0 0.80 0.00 Full amount is over maximum.

SUTA .......................................... 0 2.90 0.00 Full amount is over maximum.

Exercise 11-7 (10 minutes) Sept. 30 Salaries Expense ..................................................... 800.00 FICA—Social Security Taxes Payable ............. 49.60 FICA—Medicare Taxes Payable ....................... 11.60 Employee Federal Income Taxes Payable ......... 135.00 Accrued Payroll Payable ................................... 603.80 To record payroll for pay period ended September 30.


11-9

Exercise 11- 8 (10 minutes) Sept. 30 Payroll Taxes Expense ............................................ 83.40 FICA—Social Security Taxes Payable ............. 49.60 FICA—Medicare Taxes Payable ....................... 11.60 Federal Unemployment Taxes Payable ........... 4.80 State Unemployment Taxes Payable ............... 17.40 To record employer payroll taxes.

Exercise 11-9 (15 minutes) 1. B = 0.03 ($1,000,000 – B)

B = $30,000 – 0.03B 1.03B = $30,000 B = $29,126 (rounded to nearest dollar)

2. 2011 Dec. 31 Employee Bonus Expense ................................ 29,126

Bonus Payable .......................................... 29,126 To record expected bonus costs.

3. 2012 Jan. 19 Bonus Payable .................................................... 29,126 Cash ........................................................... 29,126

To record payment of bonus.


[Note: All entries dated December 31, 2011.] 1. Warranty Expense.......................................................... 3,600 Estimated Warranty Liability .................................. 3,600 To record warranty expense [3,000 units x 8% x $15].

2. Vacation Benefits Expense ........................................... 2,400 Vacation Benefits Payable ...................................... 2,400 To record vacation benefits expense

[20 employees x 1 day x $120].


11-10

Exercise 11-11 (25 minutes) 1. Warranty Expense = 4% of dollar sales = 4% x $5,500 = $220 2. The December 31, 2011, balance of the liability equals the expense

because no repairs are provided in 2011. Therefore, the ending balance of the Estimated Warranty Liability account is $220.

3. The company should report no additional warranty expense in 2012 for

this copier. 4. The December 31, 2012, balance of the Estimated Warranty Liability

account equals the 2012 beginning balance minus the costs incurred in 2012 to repair the copier:

Beginning 2011 balance .................. $220 Less parts cost ................................ (199) Ending 2012 balance ....................... $ 21

5. Journal entries: 2011 (a) Aug. 16 Cash .......................................................................... 5,500 Sales ................................................................... 5,500 To record cash sale of copier.

Aug. 16 Cost of Goods Sold ................................................. 3,800 Merchandise Inventory ..................................... 3,800 To record cost of August 16 sale.

(b)

Dec. 31 Warranty Expense ................................................... 220 Estimated Warranty Liability ............................ 220 To record warranty expense for copier sold in 2011.

2012 (c) Nov. 22 Estimated Warranty Liability .................................. 199

Repair Parts Inventory ...................................... 199 To record cost of warranty repairs.


11-11


(a) (b) (c) (d) (e) (f) Numerator Income before interest & taxes ....

$223,000

$205,000

$218,000

$407,000

$121,000

$ 8,000

Denominator Interest expense ...... $ 48,000 $ 15,000 $ 8,000 $ 12,000 $ 12,000 $12,000 Ratio ...................... 4.65 13.67 27.25 33.92 10.08 0.67

Analysis: Company (d) has the strongest ability to pay interest expense as it comes due as evidenced by the company’s times interest earned (coverage) ratio of 33.92 times. Exercise 11-13A (15 minutes) Regular pay (40 hours @ $12) ........................................... $480.00

Overtime premium pay (8 hours @ [$12 x 150%]) ........... 144.00

Gross pay .......................................................................... 624.00

FICA—Social Security tax deduction (6.2%) .................... $ 38.69

FICA—Medicare tax deduction (1.45%) ............................ 9.05

Income tax deduction (from Exhibit 11A.6) ...................... 61.00

Total deductions ............................................................... 108.74

Net pay ................................................................................. $515.26


11-12

Exercise 11-14B (25 minutes)

1. Income Taxes Payable (target balance) ............................................... $29,100 Total accrued [($27,900 + $18,200 + $32,700) x .30] ............................ 23,640 Adjustment (additional expense) .......................................................... $ 5,460 2. 2011 (a) Dec. 31 Income Tax Expense ................................................ 5,460 Income Taxes Payable ....................................... 5,460 To adjust tax expense and liability.

2012 (b) Jan. 20 Income Taxes Payable ............................................. 29,100 Cash ..................................................................... 29,100 To make the final quarterly payment

of income taxes for 2011.

Exercise 11-15 (25 minutes) 1. Warranty Expense ................................................... 6,201 Estimated Warranty Liability ............................ 6,201 To record warranty expense and liability.

2. Estimated Warranty Liability .................................. 5,220 Inventory............................................................. 5,220 To record cost of warranty replacements.

3. Volvo would report warranty expense of $6,201 for 2008.


11-13

Exercise 11-16 (30 minutes) (1)

July 31 Sales Salaries Expense ........................................... 120,000

Office Salaries Expense .......................................... 60,000

FICA—Social Sec. Taxes Payable .................... 11,160

FICA—Medicare Taxes Payable ........................ 2,610

Employee Fed. Inc. Taxes Payable ................... 45,000

Employee State Inc. Taxes Payable ................. 10,000

Employee Medical Insurance Payable* ............ 2,800

Employee Life Insurance Payable** ................. 1,600

Employee Union Dues Payable ......................... 1,000

Salaries Payable ................................................. 105,830 To record payroll for period.

* $7,000 x 40% ** $4,000 x 40%

(2)

July 31 Salaries Payable ....................................................... 105,830

Cash .................................................................... 105,830 To record payment of payroll.*

*Check numbers may be entered in the Payroll Register.

(3)

July 31 Payroll Taxes Expense ............................................ 23,470

FICASocial Sec. Taxes Payable .................... 11,160 FICAMedicare Taxes Payable ........................ 2,610 State Unemployment Taxes Payable................ 2,700 Federal Unemployment Taxes Payable ........... 400

Employee Medical Insurance Payable* ............ 4,200

Employee Life Insurance Payable** ................. 2,400 To record employer payroll taxes and expenses. SUTA = $50,000 x 5.4% = $2,700 FUTA = $50,000 x 0.8% = $400 FICA—Social Sec. & Medicare = Same as employees * $7,000 x 60% ** $4,000 x 60%

(4)

July 31 FICASocial Security Taxes Payable.................... 22,320 FICAMedicare Taxes Payable .............................. 5,220 Employee Fed. Income Taxes Payable. ................. 45,000 Employee State Income Taxes Payable. ................ 10,000 Employee Medical Insurance Payable ................... 7,000

Employee Life Insurance Payable .......................... 4,000

Employee Union Dues Payable ............................... 1,000

State Unemployment Taxes Payable ...................... 2,700

Federal Unemployment Taxes Payable.................. 400 Cash .................................................................... 97,640

To record payment of FICA, income taxes, SUTA, FUTA, union dues, and insurance premiums.


11-14

PROBLEM SET A Problem 11-1A (45 minutes)

Frier Com. Bank UMB

1. Maturity dates Date of the note .............................. May 19 July 8 Nov. 28 Term of the note (in days) ............. 90 120 60 Maturity date ................................... Aug. 17 Nov. 5 Jan. 27

2. Interest due at maturity Principal of the note ...................... $30,000 $60,000 $21,000 Annual interest rate ....................... 9% 10% 8% Fraction of year .............................. 90/360 120/360 60/360 Interest expense............................. $ 675 $ 2,000 $ 280

3. Accrued interest on UMB note at the end of 2010 Total interest for note .................................................... $ 280 Fraction of term in 2010 ................................................ 33/60 Accrued interest expense ............................................. $ 154

4. Interest on UMB note in 2011 Total interest for note .................................................... $ 280 Fraction of term in 2011 ................................................ 27/60 Interest expense in 2011 ............................................... $ 126


11-15

Problem 11-1A (Concluded) 5.

2010 Apr. 20 Merchandise Inventory ........................................... 38,500 Accounts Payable—Frier .................................. 38,500 Purchased merchandise on credit.

May 19 Accounts Payable—Frier ........................................ 38,500

Cash .................................................................... 8,500 Notes Payable—Frier ........................................ 30,000 Paid $8,500 cash and gave a 90-day,

9% note to extend due date on account.

July 8 Cash .......................................................................... 60,000 Notes Payable—Community ............................. 60,000 Borrowed cash with a 120-day, 10% note.

Aug. 17 Interest Expense ...................................................... 675 Notes Payable—Frier .............................................. 30,000 Cash .................................................................... 30,675 Paid note with interest.

Nov. 5 Interest Expense ...................................................... 2,000

Notes Payable—Community ................................... 60,000 Cash .................................................................... 62,000 Paid note with interest.

28 Cash .......................................................................... 21,000

Notes Payable—UMB Bank .............................. 21,000 Borrowed cash with 60-day, 8% note.

Dec. 31 Interest Expense ...................................................... 154 Interest Payable ................................................. 154 Accrued interest on note payable.

2011 Jan. 27 Interest Expense ...................................................... 126 Notes Payable—UMB Bank .................................... 21,000 Interest Payable ...................................................... 154 Cash .................................................................... 21,280 Paid note with interest.


11-16

Problem 11-2A (40 minutes) 1. 2010 Nov. 11 Cash .......................................................................... 6,000 Sales ................................................................... 6,000 Sold razors to customers.

11 Cost of Goods Sold ................................................. 1,350

Merchandise Inventory ..................................... 1,350 To record cost of November 11 sale (75 x $18).

30 Warranty Expense ................................................... 420

Estimated Warranty Liability ............................ 420 To record razor warranty expense

and liability at 7% of selling price.

Dec. 9 Estimated Warranty Liability .................................. 270 Merchandise Inventory ..................................... 270 To record cost of razor warranty

replacements (15 x $18).

16 Cash .......................................................................... 16,800

Sales ................................................................... 16,800 Sold razors to customers.


Merchandise Inventory ..................................... 3,780 To record cost of December 16 sale (210 x $18).

29 Estimated Warranty Liability .................................. 540 Merchandise Inventory ..................................... 540 To record cost of razor warranty


31 Warranty Expense ................................................... 1,176

Estimated Warranty Liability ............................ 1,176 To record razor warranty expense



11-17

Problem 11-2A (Concluded) 2011 Jan. 5 Cash .......................................................................... 10,400 Sales ................................................................... 10,400 Sold razors to customers.


Merchandise Inventory ..................................... 2,340 To record cost of January 5 sale (130 x $18).

17 Estimated Warranty Liability .................................. 900

Merchandise Inventory ..................................... 900 To record cost of razor warranty



Estimated Warranty Liability ............................ 728 To record razor warranty expense


2. Warranty expense for November 2010 and December 2010

Sales Percent Warranty Expense

November ................. $ 6,000 7% $ 420 December .................. 16,800 7 1,176 Total .......................... $22,800 $1,596

3. Warranty expense for January 2011

Sales in January .............................. $10,400 Warranty percent ............................. 7% Warranty expense ........................... $ 728

4. Balance of the estimated liability as of December 31, 2010

Warranty expense for November .................................... $ 420 credit Warranty expense for December .................................... 1,176 credit Cost of replacing items in December (45 x $18)* .......... (810) debit Estimated Warranty Liability balance ............................ $ 786

1,050 credit

*Can be viewed as $270 + $540

5. Balance of the estimated liability as of January 31, 2011 Beginning balance .......................................................... $ 786 credit Warranty expense for January ...................................... 728 credit Cost of replacing items in January (50 x $18) .............. ( 900) debit Estimated Warranty Liability balance ........................... $ 614 credit


11-18

Problem 11-3A (60 minutes) 1. Ace Co. = = 3.33 2. Deuce Co. = = 1.54 3. Sales increase by 30% (multiply prior sales by 1.3)

Ace Co. Deuce Co.

Sales ............................................. $650,000 $650,000 Variable expenses ...................... 520,000 390,000 Income before interest ............... 130,000 260,000 Interest expense (fixed) .............. 30,000 130,000

Net income ................................... $100,000 $130,000

Net income increases by* .......... 43% 86%

* Computed as the increase in net income divided by prior net income. 4. Sales increase by 50% (multiply prior sales by 1.5)

Ace Co. Deuce Co.

Sales ............................................. $750,000 $750,000 Variable expenses ...................... 600,000 450,000 Income before interest ............... 150,000 300,000 Interest expense (fixed) .............. 30,000 130,000 Net income ................................... $120,000 $170,000

Net income increases by ............ 71% 143%

5. Sales increase by 80% (multiply prior sales by 1.8)

Ace Co. Deuce Co.

Sales ............................................. $900,000 $900,000 Variable expenses ...................... 720,000 540,000 Income before interest ............... 180,000 360,000 Interest expense (fixed) .............. 30,000 130,000 Net income ................................... $150,000 $230,000

Net income increases by ............ 114% 229%

Income before interest & taxes

Interest expense


Interest expense

$100,000

$30,000

$200,000

$130,000


11-19

Problem 11-3A (Concluded) 6. Sales decrease by 10% (multiply prior sales by 0.9)

Ace Co. Deuce Co.

Sales ........................................ $450,000 $450,000 Variable expenses ................. 360,000 270,000 Income before interest .......... 90,000 180,000 Interest expense (fixed) ......... 30,000 130,000 Net income .............................. $ 60,000 $ 50,000

Net income decreases by ...... -14% -29%

7. Sales decrease by 20% (multiply prior sales by 0.8)

Ace Co. Deuce Co.



8. Sales decrease by 40% (multiply prior sales by 0.6)

Ace Co. Deuce Co.

Sales ........................................ $300,000 $300,000 Variable expenses ................. 240,000 180,000 Income before interest .......... 60,000 120,000 Interest expense (fixed) ......... 30,000 130,000 Net income .............................. $ 30,000 $ (10,000)


9. The higher fixed cost strategy (having more fixed interest expense) of

Deuce Co. accentuates the effects of increases and decreases in sales. That is, increases in sales produce greater increases in net income and decreases in sales produce greater decreases in net income. The higher fixed cost strategy of Deuce Co. is indicated by a lower value of the times interest earned ratio.

The higher fixed cost strategy works fine if the sales level increases. Deuce Co. enjoys greater percent increases in its net income because it has made this choice (see parts 3, 4, and 5).

The lower fixed cost strategy protects the company if the sales level decreases. Ace Co. experiences smaller percent decreases in its net income because it has made this choice (see parts 6, 7, and 8).


11-20

Problem 11-4A (60 minutes) 1. Each employee’s FICA withholdings for Social Security

Dale Ted Kate Chas Total

Maximum base ............ $106,800 $106,800 $106,800 $106,800 Earned through 8/18 ... 105,300 36,650 6,750 1,050 Amount subject to tax $ 1,500 $ 70,150 $100,050 $105,750 Earned this week ......... $ 2,000 $ 900 $ 450 $ 400

Subject to tax ............... 1,500 900 450 400 Tax rate ........................ 6.20% 6.20% 6.20% 6.20%

Social Security tax ...... $ 93.00 $ 55.80 $ 27.90 $ 24.80 $201.50 2. Each employee’s FICA withholdings for Medicare (no limits)


Earned this week ......... $ 2,000 $ 900 $ 450 $ 400 Tax rate ........................ 1.45% 1.45% 1.45% 1.45%

Medicare tax ................ $ 29.00 $ 13.05 $ 6.53 $ 5.80 $ 54.38 3. Employer’s FICA taxes for Social Security


Amount from part 1 ..... $ 93.00 $ 55.80 $ 27.90 $ 24.80 $201.50 4. Employer’s FICA taxes for Medicare


Amount from part 2 ..... $ 29.00 $ 13.05 $ 6.53 $ 5.80 $ 54.38


11-21

Problem 11-4A (Concluded) 5. Employer’s FUTA taxes Dale Ted Kate Chas Total

Maximum base .............. $ 7,000 $ 7,000 $ 7,000 $ 7,000 Earned through 8/18 ..... 105,300 36,650 6,750 1,050 Amount subject to tax .. 0 0 250 5,950 Earned this week ......... $ 2,000 $ 900 $ 450 $ 400 Subject to tax ............... 0 0 250 400 Tax rate ........................ 0.8% 0.8% 0.8% 0.8% FUTA tax ...................... $ 0.00 $ 0.00 $ 2.00 $ 3.20 $ 5.20

6. Employer’s SUTA taxes


Subject to tax (from 5) $ 0 $ 0 $ 250 $ 400 Tax rate ........................ 2.15% 2.15% 2.15% 2.15% SUTA tax ...................... $ 0.00 $ 0.00 $ 5.38 $ 8.60

10.60 $ 13.98

7. Each employee’s net (take-home) pay


Gross earnings ............. $2,000.00 $900.00 $450.00 $400.00 $3,750.00 Less FICA Social Sec. tax .... (93.00) (55.80) (27.90) (24.80) (201.50) FICA Medicare taxes .... (29.00) (13.05) (6.53) (5.80) (54.38) Withholding taxes ........ (252.00) (99.00) (54.00) (36.00) (441.00) Health insurance .......... (16.00) (16.00) (16.00) (16.00) (64.00) Take-home pay ............. $1,610.00 $716.15 $345.57 $317.40 $2,989.12

8. Employer’s total payroll-related expense for each employee


Gross earnings .............. $2,000.00 $ 900.00 $450.00 $400.00 $3,750.00 Plus FICA Social Sec. tax ...... 93.00 55.80 27.90 24.80 201.50 FICA Medicare taxes ..... 29.00 13.05 6.53 5.80 54.38 FUTA tax ......................... 0.00 0.00 2.00 3.20 5.20 SUTA tax ......................... 0.00 0.00 5.38 8.60 13.98 Health insurance ............ 16.00 16.00 16.00 16.00 64.00 Pension contrib. (8%) .... 160.00 72.00 36.00 32.00 300.00 Total payroll expense .... $2,298.00 $1,056.85 $543.81 $490.40 $4,389.06


11-22

Problem 11-5A (25 minutes) Part 1

Jan. 8 Office Salaries Expense .......................................... 11,380.00

Sales Salaries Expense ........................................... 32,920.00

FICA—Social Sec. Taxes Payable* .................. 2,746.60

FICA—Medicare Taxes Payable** .................... 642.35

Employee Fed. Inc. Taxes Payable .................. 6,340.00

Employee Medical Insurance Payable ............. 670.00

Employee Union Dues Payable ........................ 420.00

Salaries Payable ................................................ 33,481.05


* $44,300 x 6.2% ** $44,300 x 1.45%

Part 2

Jan. 8 Payroll Taxes Expense ............................................ 5,515.35

FICA—Social Sec. Taxes Payable .................... 2,746.60

FICA—Medicare Taxes Payable ....................... 642.35

State Unemployment Taxes Payable* .............. 1,772.00

Federal Unemployment Taxes Payable** ........... 354.40

To record employer payroll taxes.

* $44,300 x .04 = $1,772.00

**$44,300 x .008 = $354.40


11-23

Problem 11-6AA (50 minutes)

Mar. 15 FICASocial Security Taxes Payable ................... 3,224

FICAMedicare Taxes Payable ............................. 754

Employee Fed. Income Taxes Payable. ................. 3,900 Cash .................................................................... 7,878 To record payment of FICA and federal

income taxes.

31 Office Salaries Expense .......................................... 10,400 Shop Wages Expense ............................................. 15,600 FICASocial Sec. Taxes Payable .................... 1,612

FICAMedicare Taxes Payable ....................... 377

Employee Fed. Income Taxes Payable ............ 3,900 Salaries Payable ................................................ 20,111 To record payroll for period.

31 Salaries Payable ...................................................... 20,111 Cash .................................................................... 20,111 To record payment of payroll.*

*The check numbers may be entered in the Payroll Register.

31 Payroll Taxes Expense* ........................................... 2,853 FICASocial Sec. Taxes Payable .................... 1,612


State Unemployment Taxes Payable ............... 720 Federal Unemployment Taxes Payable ........... 144 To record employer payroll taxes. *Amount earned through 2/28 = 2 x $2,600 = $5,200 Subject to SUTA/FUTA in March = $7,000 - $5,200 = $1,800 SUTA = $1,800 x 10 employees x 4.0% = $720 FUTA = $1,800 x 10 employees x 0.8% = $144 FICASocial Security Taxes = $1,612 (same as employees)

FICAMedicare Taxes = $377 (same as employees)


11-24

Problem 11-6AA (Concluded) Apr. 15 FICASocial Security Taxes Payable ................... 3,224


Employee Fed. Income Taxes Payable .................. 3,900 Cash .................................................................... 7,878 To record payment of FICA and

federal income taxes.

15 State Unemployment Taxes Payable ..................... 2,800 Cash .................................................................... 2,800 To record payment of SUTA taxes [$2,080 + $720].

30 Federal Unemployment Taxes Payable ................. 560 Cash .................................................................... 560 To record payment of FUTA taxes [$416 + $144].

30 No entry required upon mailing Form 941.


11-25

PROBLEM SET B Problem 11-1B (45 minutes)

Quinn Products

Blackhawk Bank

City Bank

1. Maturity dates

Date of the note ................................ May 23 July 15 Dec. 6 Term of the note (in days) ............... 60 120 45 Maturity date ..................................... July 22 Nov. 12 Jan. 20 2. Interest due at maturity

Principal of the note ......................... $3,600 $ 9,000 $16,000 Annual interest rate ......................... 15% 10% 9% Fraction of year ................................ 60/360 120/360 45/360 Interest expense ............................... $ 90 $ 300 $ 180

3. Accrued interest on City Bank note at the end of 2010

Total interest for note ................................................................ $ 180 Fraction of term in 2010 ............................................................. 25/45 Accrued interest expense ......................................................... $ 100

4. Interest on City Bank note in 2011

Total interest for note ................................................................ $ 180 Fraction of term in 2011 ............................................................. 20/45 Interest expense in 2011............................................................ $ 80


11-26

Problem 11-1B (Concluded) 5. 2010 Apr. 22 Merchandise Inventory ........................................... 4,000 Accounts PayableQuinn Products ............... 4,000 Purchased merchandise on credit.

May 23 Accounts PayableQuinn Products ..................... 4,000

Cash .................................................................... 400 Notes PayableQuinn Products ..................... 3,600 Paid $400 cash and gave a 60-day,

15% note to extend due date on account.

July 15 Cash .......................................................................... 9,000 Notes PayableBlackhawk Bank .................... 9,000 Borrowed cash with a 120-day, 10% note.

22 Interest Expense ...................................................... 90

Notes PayableQuinn Products ........................... 3,600

Cash .................................................................... 3,690 Paid note with interest.

Nov. 12 Interest Expense ...................................................... 300 Notes PayableBlackhawk Bank .......................... 9,000


Dec. 6 Cash .......................................................................... 16,000 Notes PayableCity Bank ................................ 16,000 Borrowed cash with a 45-day, 9% note.

31 Interest Expense ...................................................... 100 Interest Payable ................................................. 100 Accrued interest on note payable.

2011 Jan. 20 Interest Expense ...................................................... 80 Interest Payable ....................................................... 100 Notes PayableCity Bank ...................................... 16,000



11-27

Problem 11-2B (40 minutes) 1. 2011 Nov. 16 Cash .......................................................................... 1,750 Sales ................................................................... 1,750 Sold coffee grinders to customers.

16 Cost of Goods Sold ................................................. 700

Merchandise Inventory ..................................... 700 To record cost of November 16 sale (50 x $14).


Estimated Warranty Liability ............................ 175 To record coffee grinder warranty expense


Dec. 12 Estimated Warranty Liability .................................. 84 Merchandise Inventory ..................................... 84 To record cost of coffee grinder

warranty replacements (6 x $14).

18 Cash .......................................................................... 5,250

Sales ................................................................... 5,250 Sold coffee grinders to customers.


Merchandise Inventory ..................................... 2,100 To record cost of December 18 sale (150 x $14).


Merchandise Inventory ..................................... 238 To record cost of coffee grinder






11-28

Problem 11-2B (Concluded)

2012 Jan. 7 Cash .......................................................................... 2,100 Sales ................................................................... 2,100 Sold coffee grinders to customers.

7 Cost of Goods Sold ................................................. 840

Merchandise Inventory ..................................... 840 To record cost of January 7 sale (60 x $14).


Merchandise Inventory ..................................... 532 To record cost of coffee grinder





2. Warranty expense for November 2011 and December 2011

Sales Percent Warranty Expense

November ........................ $1,750 10% $ 175 December ......................... 5,250 10 525 Total .................................. $7,000 $ 700

3. Warranty expense for January 2012

Sales in January............................................................... $2,100 Warranty percent ............................................................. 10% Warranty expense ............................................................ $ 210

4. Balance of the estimated liability as of December 31, 2011

Warranty expense for November ................................... $ 175 credit Warranty expense for December .................................... 525 credit Cost of replacing items in December (23 x $14) ........... (322) debit Estimated Warranty Liability balance ............................ $ 378 credit

5. Balance of the estimated liability as of January 31, 2012

Beginning balance ........................................................... $ 378 credit Warranty expense for January ....................................... 210 credit Cost of replacing items in January (38 x $14) ............... (532) debit Estimated Warranty Liability balance ............................ $ 56 credit


11-29

Problem 11-3B (60 minutes) 1. Virgo Co. = = 1.33 2. Zodiac Co. = = 2.00 3. Sales increase by 10% (multiply prior sales by 1.10)

Virgo Co. Zodiac Co.


Net income increases by ....... 40% 20% 4. Sales increase by 40% (multiply prior sales by 1.40)



Net income increases by ....... 160% 80% 5. Sales increase by 90% (multiply prior sales by 1.90)



Net income increases by ....... 360% 180%


Interest expense


Interest expense

$60,000

$45,000

$30,000

$15,000


11-30

Problem 11-3B (Concluded) 6. Sales decrease by 20% (multiply prior sales by 0.80)


Sales ........................................ $ 96,000 $ 96,000 Variable expenses ................. 48,000 72,000 Income before interest .......... 48,000 24,000 Interest expense (fixed) ......... 45,000 15,000 Net income .............................. $ 3,000 $ 9,000

Net income decreases by ...... -80% -40% 7. Sales decrease by 50% (multiply prior sales by 0.50)


Sales ........................................ $ 60,000 $ 60,000 Variable expenses ................. 30,000 45,000 Income before interest .......... 30,000 15,000 Interest expense (fixed) ......... 45,000 15,000 Net income .............................. $(15,000) $ 0

Net income decreases by ...... -200% -100% 8. Sales decrease by 80% (multiply prior sales by 0.20)


Sales ........................................ $ 24,000 $24,000 Variable expenses ................. 12,000 18,000 Income before interest .......... 12,000 6,000 Interest expense (fixed) ......... 45,000 15,000 Net income .............................. $(33,000) $(9,000)

Net income decreases by ...... -320% -160% 9. The higher fixed cost strategy (having more fixed interest expense) of

Virgo Co. accentuates the effects of increases and decreases in sales. That is, increases in sales produce greater increases in net income and decreases in sales produce greater decreases in net income. The higher fixed cost strategy of Virgo Co. is indicated by a lower value of the times interest earned ratio.

The higher fixed cost strategy works fine if the sales level increases. Virgo Co. enjoys substantially greater increases in its net income because it has made this choice (see parts 3, 4, and 5).

The lower fixed cost strategy protects the company if the sales level decreases. Zodiac Co. experiences much smaller decreases in its net income because it has made this choice (see parts 6, 7, and 8).


11-31

Problem 11-4B (60 minutes) 1. Each employee’s FICA withholdings for Social Security

Alli Eve Hong Juan Total

Maximum base ............ $106,800 $106,800 $106,800 $106,800

Earned through 9/23 ... 104,300 36,650 6,650 22,200

Amount subject to tax $ 2,500 $ 70,150 $100,150 $ 84,600

Earned this week ......... $ 2,500 $ 1,515 $ 475 $ 600

Subject to tax ............... $ 2,500 $ 1,515 $ 475 $ 600

Tax rate ........................ 6.20% 6.20% 6.20% 6.20%

Social Security tax ...... $ 155.00 $ 93.93 $ 29.45 $ 37.20 $315.58

2. Each employee’s FICA withholdings for Medicare (no limits)


Earned this week ......... $ 2,500 $ 1,515 $ 475 $ 600

Tax rate ........................ 1.45% 1.45% 1.45% 1.45%

Medicare tax ................ $ 36.25 $ 21.97 $ 6.89 $ 8.70 $ 73.81

3. Employer’s FICA taxes for Social Security


Amount from part 1 ..... $ 155.00 $ 93.93 $ 29.45 $ 37.20 $315.58

4. Employer’s FICA taxes for Medicare


Amount from part 2 ..... $ 36.25 $ 21.97 $ 6.89 $ 8.70 $ 73.81


11-32

Problem 11-4B(Concluded)

5. Employer’s FUTA taxes Alli Eve Hong Juan Total

Maximum base ............ $ 7,000 $ 7,000 $ 7,000 $ 7,000 Earned through 9/23 ... 104,300 36,650 6,650 22,200 Amount subject to tax . $ 0 $ 0 $ 350 $ 0

Earned this week ........ $ 2,500 $ 1,515 $ 475 $ 600 Subject to tax .............. $ 0 $ 0 $ 350 $ 0 Tax rate ........................ 0.8% 0.8% 0.8% 0.8% FUTA tax ...................... $ 0.00 $ 0.00 $ 2.80 $ 0.00 $ 2.80

6. Employer’s SUTA taxes Alli Eve Hong Juan Total

Subject to tax (from 5) . $ 0 $ 0 $ 350 $ 0 Tax rate ........................ 1.75% 1.75% 1.75% 1.75% SUTA tax ..................... $ 0.00 $ 0.00 $ 6.13 $ 0.00 $ 6.13

7. Each employee’s net (take-home pay) Alli Eve Hong Juan Total

Gross earnings............. $2,500.00 $1,515.00 $475.00 $600.00 $5,090.00 Less FICA Social Sec. tax .... (155.00) (93.93) (29.45) (37.20) (315.58) FICA Medicare taxes ... (36.25) (21.97) (6.89) (8.70) (73.81) Withholding taxes ........ (198.00) (182.00) (52.00) (48.00) (480.00) Health insurance .......... (22.00) (22.00) (22.00) (22.00) (88.00) Take-home pay ............. $2,088.75 $1,195.10 $364.66 $484.10 $4,132.61

8. Employer’s total payroll-related expense for each employee Alli Eve Hong Juan Total

Gross earnings............. $2,500.00 $1,515.00 $475.00 $600.00 $5,090.00 Plus FICA Social Sec. tax .... 155.00 93.93 29.45 37.20 315.58 FICA Medicare taxes ... 36.25 21.97 6.89 8.70 73.81 FUTA tax ....................... 0.00 0.00 2.80 0.00 2.80 SUTA tax ....................... 0.00 0.00 6.13 0.00 6.13 Health insurance .......... 22.00 22.00 22.00 22.00 88.00 Pension contrib. (5%) .. 125.00 75.75 23.75 30.00 254.50 Total payroll .................. $2,838.25 $1,728.65

2.49

$566.02 $697.90 $5,830.82


11-33

Problem 11-5B (25 minutes) Part 1

Jan. 8 Sales Salaries Expense ........................................... 69,490

Office Salaries Expense .......................................... 42,450

Delivery Wages Expense ......................................... 2,060

FICA—Social Security Taxes Payable* ............ 7,068

FICA—Medicare Taxes Payable** ..................... 1,653

Employee Fed. Income Taxes Payable ............ 17,250

Employee Med. Insurance Payable .................. 2,320

Employee Union Dues Payable ........................ 275

Salaries Payable ................................................. 85,434


* $114,000 x 6.2% = $7,068 ** $114,000 x 1.45% = $1,653

Part 2

Jan. 8 Payroll Taxes Expense ............................................ 13,509

FICA—Social Security Taxes Payable ............. 7,068

FICA—Medicare Taxes Payable ........................ 1,653

State Unemployment Taxes Payable* .............. 3,876

Federal Unemployment Taxes Payable** ........... 912

To record employer payroll taxes.

* $114,000 x .034 = $3,876

**$114,000 x .008 = $912


11-34

Problem 11-6BA (50 minutes) June 15 FICA—Social Security Taxes Payable ................... 744 FICA—Medicare Taxes Payable ............................. 174 Employee Fed. Income Taxes Payable .................. 900 Cash .................................................................... 1,818 To record payment of FICA and


30 Office Salaries Expense .......................................... 2,000 Shop Wages Expense ............................................. 4,000 FICA—Social Security Taxes Payable ............. 372 FICA—Medicare Taxes Payable ....................... 87 Employee Fed. Income Taxes Payable ............ 900 Salaries Payable ................................................ 4,641 To record payroll period.

30 Salaries Payable ...................................................... 4,641 Cash .................................................................... 4,641 To record payment of payroll.*

*The check numbers may be entered in the Payroll Register.

30 Payroll Taxes Expense* ........................................... 699 FICASocial Security Taxes Payable ............. 372


State Unemployment Taxes Payable ............... 200 Federal Unemployment Taxes Payable ........... 40 To record employer payroll taxes. *Amount earned through 5/31 = 5 x $1,200 = $6,000 Subject to SUTA/FUTA in June = $7,000 - $6,000 = $1,000 SUTA = $1,000 x 5 employees x 4.0% = $200 FUTA = $1,000 x 5 employees x 0.8% = $40 FICASocial Security Taxes = $372 (same as employees)

FICAMedicare Taxes = $87 (same as employees)


11-35

Problem 11-6BA (Concluded) July 15 FICASocial Security Taxes Payable ................... 744


Employee Fed. Income Taxes Payable .................. 900 Cash .................................................................... 1,818 To record payment of FICA and


15 State Unemployment Taxes Payable ..................... 680 Cash .................................................................... 680 To record payment of SUTA taxes

[$480 + $200].

31 Federal Unemployment Taxes Payable ................. 136 Cash .................................................................... 136 To record payment of FUTA taxes

[$96 + $40].

31 No entry required upon mailing Form 941.


11-36

Serial Problem — SP 11

Serial Problem — SP 11, Business Solutions (30 minutes)

1. Gross pay (8 days x $125 per day) ................................... $1,000.00 FICA Social Security tax deduction (6.2%)* ..................... $ 62.00 FICA Medicare tax deduction (1.45%) .............................. 14.50 Income tax deduction ........................................................ 159.00 Total deductions ................................................................. 235.50

Net Pay ................................................................................ $ 764.50

*Employee has not reached the maximum limit.

2. 2012

Feb. 26 Wages Expense ....................................................... 1,000.00 FICA—Social Security Taxes Payable ............. 62.00 FICA—Medicare Taxes Payable ....................... 14.50 Employee Federal Income Taxes Payable ...... 159.00 Cash .................................................................... 764.50 To record payroll period.

3. 2012

Feb. 26 Payroll Taxes Expense ............................................ 124.50 FICA—Social Sec. Taxes Payable .................... 62.00 FICA—Medicare Taxes Payable ....................... 14.50 State Unemployment Taxes Payable* .............. 40.00 Federal Unemployment Taxes Payable** ........... 8.00 To record employer payroll taxes.

* $1,000 x .04 = $40.00

**$1,000 x .008 = $8.00

4. 2012

Mar. 25 Accounts Receivable – Wildcat Services .............. 2,912 Sales ................................................................... 2,800 Sales Taxes Payable ......................................... 112 Sold merchandise on credit and collected

sales tax of 4%.

Mar. 25 Cost of Goods Sold ................................................. 2,002 Merchandise Inventory ..................................... 2,002 To record cost of March 25 sale.


11-37

Comprehensive Problem

Bug-Off Exterminators (100 minutes)

Part 1

a. Correct ending balance of cash and the amount of the omitted check Balance per bank .................................. $15,100 Plus deposit in transit .......................... 2,450 Less outstanding checks ..................... (1,800) Reconciled balance .............................. $15,750 Balance per books ................................ $17,000 Plus interest earned.............................. 52 Less service charges ........................... (15) Balance before omitted check ............. 17,037 Reconciled balance (from above) ............ (15,750)

Omitted check ....................................... $ 1,287 b. Allowance for doubtful accounts

Unadjusted balance .............................. $ 828 credit Anticipated write-off ............................. (679) debit Revised unadjusted balance ............... 149 credit Desired ending balance ....................... 700 credit Necessary adjustment .......................... $ 551 credit

c. Depreciation expense on the truck

Cost ..................................................................... $32,000 Less salvage value ............................................ (8,000) Depreciable cost ................................................ $24,000 Useful life (years) ............................................... 4 Annual depreciation for 2011 ........................... $ 6,000

d. Depreciation expense on the equipment

Sprayer Injector

Cost ........................................................ $27,000 $18,000 Less salvage value ............................... (3,000) (2,500) Depreciable cost ................................... $24,000 $15,500

Useful life (years) .................................. 8 5 Depreciation for 2011 ........................... $ 3,000 $ 3,100


11-38

Comprehensive Problem (Continued) e. Adjusted revenue and unearned revenue balances

Total advance received ........................................ $ 3,840 Months in contract ................................................ 12 Revenue per month .............................................. $ 320 Months of services provided ............................... 5 Total earned ($320 x 5 months) ........................... (1,600) Overstatement of revenue ($3,840 – $1,600) ...... $ 2,240 Extermination Services Revenue account Unadjusted balance .............................................. $60,000 Overstatement ....................................................... (2,240) Adjusted balance .................................................. $57,760 Unearned Services Revenue account Unadjusted balance .............................................. $ 0 Adjustment ............................................................ 2,240 Adjusted balance .................................................. $ 2,240

f. Warranty expense

Adjusted services revenue for the year (from e) .... $57,760 Warranty percent ................................................. 2.5% Warranty expense (estimated) ............................ $ 1,444

Estimated warranty liability Unadjusted balance ............................................. $ 1,400 credit Warranty expense ................................................ 1,444 credit

Ending adjusted balance .................................... $ 2,844 credit

g. Note payable and interest accrual

The note originated on December 31, 2011. The first time interest will be payable is December 31, 2012. The annual interest expense on the note is $1,200 ($15,000 x .08). Thus, the adjusted balance for both Interest Payable and Interest Expense at December 31, 2011, is zero.


11-39

Comprehensive Problem (Continued)

Part 2

BUG-OFF EXTERMINATORS December 31, 2011

Unadjusted Trial Balance

Adjustments .

Adjusted Trial Balance

Cash ........................................... $ 17,000 (a) $1,250 $ 15,750

Accounts receivable ................. 4,000 (b1) 679 3,321

Allowance for doubtful accounts ..................

$ 828

(b1)

$ 679

(b2)

551

$ 700

Merchandise inventory ............ 11,700 11,700

Trucks ......................................... 32,000 32,000

Accum. deprec.–Trucks ........... 0 (c) 6,000 6,000

Equipment .................................. 45,000 45,000

Accum. deprec.–Equip ............ 12,200 (d) 6,100 18,300

Accounts payable ..................... 5,000 (a) 1,287 3,713

Estim. warranty liability ............ 1,400 (f) 1,444 2,844

Unearned services rev ............. 0 (e) 2,240 2,240

Interest payable ........................ 0 0

Long-term notes payable ........ 15,000 15,000

D. Buggs, Capital ...................... 59,700 59,700

D. Buggs, Withdrawals ............ 10,000 10,000

Extermination services revenue ....................

60,000

(e)

2,240

57,760

Interest revenue ........................ 872 (a) 52 924

Sales ............................................ 71,026 71,026

Cost of goods sold ................... 46,300 46,300

Deprec. expense–Trucks ......... 0 (c) 6,000 6,000

Deprec. expense–Equip ........... 0 (d) 6,100 6,100

Wages expense ......................... 35,000 35,000

Interest expense ........................ 0 0

Rent expense ............................. 9,000 9,000

Bad debts expense ................... 0 (b2) 551 551

Miscellaneous expense ........... 1,226 (a) 15 1,241

Repairs expense ....................... 8,000 8,000

Utilities expense ........................ 6,800 6,800

Warranty expense ..................... 0 _______ (f) 1,444 ______ 1,444 _______

Totals .......................................... $226,026 $226,026 $18,316 $18,316 $238,207 $238,207


11-40

Comprehensive Problem (Continued) Part 3 2011

(a) Miscellaneous Expenses ............................................ 15

Accounts Payable ........................................................ 1,287

Interest Revenue .................................................... 52

Cash ........................................................................ 1,250

Adjust cash account. (Separate entries are acceptable.)

(b1) Allowance for Doubtful Accounts ............................... 679

Accounts Receivable ............................................. 679

Wrote off uncollectible accounts.

(b2) Bad Debts Expense ...................................................... 551

Allowance for Doubtful Accounts ......................... 551

Recognize bad debts expense.

(c) Depreciation Expense—Trucks ................................... 6,000

Accumulated Depreciation—Trucks ..................... 6,000

Depreciation on truck.

(d) Depreciation Expense—Equipment ............................ 6,100

Accumulated Depreciation—Equipment .............. 6,100

Depreciation on equipment.

(e) Extermination Services Revenue ................................ 2,240

Unearned Services Revenue ................................. 2,240

Adjust for unearned revenues.

(f) Warranty Expense ........................................................ 1,444

Estimated Warranty Liability ................................. 1,444

Estimate warranty expense.

(g) No interest accrual required for 2011


11-41

Comprehensive Problem (Continued)

Part 4

BUG-OFF EXTERMINATORS Income Statement

For Year Ended December 31, 2011

Revenues

Extermination services revenue ............... $57,760

Sales ............................................................ 71,026

Interest revenue ......................................... 924

Total revenues............................................ $129,710

Expenses

Cost of goods sold .................................... 46,300

Depreciation expense—Trucks ................ 6,000

Depreciation expense—Equipment ......... 6,100

Wages expense .......................................... 35,000

Interest expense......................................... 0

Rent expense.............................................. 9,000

Bad debts expense .................................... 551

Miscellaneous expenses ........................... 1,241

Repairs expense ........................................ 8,000

Utilities expense......................................... 6,800

Warranty expense ...................................... 1,444

Total expenses ........................................... 120,436

Net income ................................................... $ 9,274

BUG-OFF EXTERMINATORS Statement of Owner’s Equity

For Year Ended December 31, 2011

D. Buggs, Capital, December 31, 2010 ......................... $ 59,700

Add: Investments by owner ........................................ 0

Net income ........................................................... 9,274

68,974

Less: Withdrawals by owner ........................................ (10,000)

D. Buggs, Capital, December 31, 2011 ........................ $ 58,974


11-42

Comprehensive Problem

Part 4 (concluded)

BUG-OFF EXTERMINATORS Balance Sheet

December 31, 2011

Assets Current assets

Cash ................................................................ $15,750

Accounts receivable ...................................... $ 3,321

Allowance for doubtful accounts ................. (700) 2,621

Merchandise inventory ................................. 11,700

Total current assets ...................................... 30,071

Plant assets

Trucks ............................................................. 32,000

Accumulated depreciation—Trucks ............ (6,000) 26,000

Equipment ...................................................... 45,000

Accumulated depreciation—Equipment ..... (18,300) 26,700

Total plant assets .......................................... 52,700

Total assets ...................................................... $82,771

Liabilities

Current liabilities

Accounts payable .......................................... $ 3,713

Estimated warranty liability .......................... 2,844

Unearned services revenue .......................... 2,240

Total current liabilities .................................. $ 8,797

Long-term liabilities

Long-term notes payable .............................. 15,000

Total liabilities .................................................. 23,797

Equity

D. Buggs, Capital ............................................. 58,974

Total liabilities and equity ............................... $82,771


11-43

Reporting in Action — BTN 11-1 1. Times interest earned

($ thousands)

2010 Fiscal Year

2009 Fiscal Year

2008 Fiscal Year

Net income ................................................. $2,457,144 $1,892,616 $1,293,867

Add income taxes ...................................... 809,366 907,747 516,653

Income before taxes .................................. 3,266,510 2,800,363 1,810,520

Add interest expense ................................ 1 502 31

Income before interest and taxes ............ $3,266,511 $2,800,865 $1,810,551

Times interest earned ratio .................. 3,266,511. 5,579.4 58,403.9

Analysis comment: For each of these fiscal years, it is obvious that Research In Motion’s risk of not being able to cover its interest expense is low. In addition, Research In Motion’s times interest earned ratio is markedly higher than the industry average of 18.1 for all three years.

2. Gift card liabilities arise when a customer purchases a gift card. It is deferred (unearned) revenue until the gift card recipient buys merchandise using (redeeming) the card.

3. Yes. Research In Motion has both commitments and contingencies (see its Note No.12). Its contingencies arise from (a) a credit facility, (b) lease commitments, and (c) litigation.

4. The solution depends on the financial statement information accessed.


11-44

Comparative Analysis — BTN 11-2

1. Research In Motion—Times interest earned

($ millions)

Current Year

One Year Prior

Two Years Prior

Net income .................................................. $2,457.144 $1,892.616 $1,293.867

Add income taxes ...................................... 809.366 907.747 516.653 Add interest expense ................................ .001 .502 .031 Income before taxes and interest ............. $3,266.511 $2,800.865 $1,810.551 Times interest earned ratio ................... 3,266,511.0a 5,579.4b 58,404.9c

a$3,266.511/$0.001

b$2,800.865/$0.502

c$1,810.551/$0.031

Apple—Times interest earned

($ millions)

Current Year

One Year Prior

Two Years Prior

Net income .................................................. $ 8,235 $6,119 $3,495

Add income taxes ...................................... 3,831 2,828 1,511

Add interest expense ................................ 3 2 1

Income before taxes and interest ............. $12,069 $8,949 $5,007

Times interest earned ratio ................... 4,023a 4,475b 5,007c

a$12,069/$3

b$ 8,949/$2

c$ 5,007/$1

2. Research In Motion and Apple both are in very strong positions in their

ability to make any interest payments should their income decline. For

all three years, Research In Motion’s times interest earned markedly

exceeded the industry average of 18.1. For each of the three years,

Apple too had times interest earned metrics that substantially exceeded

the industry average of 18.1. The difference between Research In

Motion and Apple is not worth mentioning as both are strong.


11-45

Ethics Challenge — BTN 11-3 1. It is in Bly’s self-interest to maximize the amount of revenues less

warranty expenses so as to maximize his personal bonus. Since Bly

has some input into setting the warranty expense accrual percent, he

potentially faces an ethical dilemma. Specifically, the lower the

expense accrual, the lower the warranty expense, and the higher his

bonus. (The evidence indicates that Bly has tended to overestimate

warranty expense in prior years.)

2. Although Bly might be able to affect the amount of revenues less

warranty expenses via the warranty expense accrual in the short run,

over several years the amounts should even out. The dealership

should probably adjust the warranty expense accrual to match the

usual (average) experience over time. Given the variable nature of

warranty expenses, at times it might warrant being adjusted upward

(lowering Bly’s bonus) or downward (increasing Bly’s bonus). The

accountant and others should offer input into this decision. Since the

experience with warranties has varied, a percent should perhaps be

based on a long-run average, with some additional weight given to

recent experience.


11-46

Communicating in Practice — BTN 11-4

MEMORANDUM To: Madeline Pretti, General Manager From: Dustin Clemens, ManagerAccounting and Finance Date: Subject: Reporting warranties in financial statements This memorandum is in response to your comment on my proposal for the

treatment of a contingency in our financial statements. You specifically

object to the proposed recognition of an expense and liability for

warranties. The purpose of this memorandum is to respond to your

objection.

Both the conservatism and matching principles apply to accounting for

warranties. Conservatism requires us to include an expense in this year’s

financial statements for costs that we may or may not pay in the future.

Another point in favor of reporting the expense and liability now is that we

offered the warranty in order to achieve the reported sales. Therefore, our

income measure would be incomplete if it did not match the cost of

fulfilling the warranty against revenues generated by offering the warranty.

This treatment would be in compliance with the matching principle.

Your comment also raised the objection that we don’t know what costs

will be. If they are not reasonably estimable, generally accepted

accounting principles will allow us to leave them out of the financial

statements. But we must describe the contingency in the notes. I will be

checking with the product design engineers to get their opinion on the

reasonableness of repair costs. If the product is different from others, we

may have a basis for going with only a note disclosure. However, financial

statement recognition is a more effective way to get the information into

users’ hands. As a result, it is usually preferred, even if we are uncertain

about the amount.


11-47

Taking It to the Net — BTN 11-5 1. McDonald’s 2009 current liabilities include the following

Accounts payable

Income taxes

Other taxes

Accrued interest

Accrued payroll and other liabilities

Current maturities of long-term debt 2. The portion of long-term debt maturing in the next 12 months ($

millions) is

$18.1 / ($18.1 + $10,560.3) = 0.17% 3. Times interest earned for McDonald’s as of 12/31/2009

($ millions) 12/31/2009

Net Income ............................................................... $ 4,551.0

Plus income taxes ................................................... 1,936.0

Plus interest expense .............................................. 473.2

Income before interest and taxes .......................... $ 6,960.2

Times interest earned ............................................. 14.7 times

Comment: The 14.7 times interest earned ratio seems more than sufficient for McDonald’s to cover its interest obligations, and it is higher than the industry average of 12.0.


11-48

Teamwork in Action — BTN 11-6 1. Option A: Interest Expense = $6,000 x 10% x 90/360 = $150 Option B: Interest Expense = $6,000 x 8% x 120/360 = $160

The interest expense in option B does exceed option A. If interest cost is the only consideration, then Option A is the preferred loan. However, if a mere $10 more is paid in interest expense the business can use the loan money for an additional 30 days. The decision on which loan is preferred will ultimately depend on whether interest cost savings is valued more than the additional time to use the loaned money.

2. Entries: 2a. Issue date, Option A

June 1 Cash .......................................................................... 6,000 Notes Payable .................................................... 6,000 Borrowed cash by issuing an

interest-bearing note.

2b. Issue date, Option B

June 1 Cash .......................................................................... 6,000 Notes Payable .................................................... 6,000 Borrowed cash by issuing an

interest-bearing note.

2c. Maturity date, Option A Aug. 30 Notes Payable .......................................................... 6,000 Interest Expense ...................................................... 150 Cash .................................................................... 6,150 Repaid note plus interest.

2d. Maturity date, Option B

Sep. 29 Notes Payable .......................................................... 6,000 Interest Expense ...................................................... 160 Cash .................................................................... 6,160 Repaid note plus interest.


11-49

Teamwork in Action (Concluded) 4. Entries: 4a. Adjusting entry, Option A (Dec. 31)

Dec. 31 Interest Expense ...................................................... 50 Interest Payable ................................................. 50 Accrue interest on note

payable [$6,000 x 10% x 30/360].

4b. Adjusting entry, Option B (Dec. 31)

Dec. 31 Interest Expense ...................................................... 40 Interest Payable ................................................. 40 Accrue interest on note payable

[$6,000 x 8% x 30/360].

4c. Maturity date entry, Option A March 1 Interest Expense ...................................................... 100 Interest Payable ....................................................... 50 Notes Payable .......................................................... 6,000 Cash .................................................................... 6,150 Repaid note plus interest.

4d. Maturity date entry, Option B March 31 Interest Expense ...................................................... 120 Interest Payable ....................................................... 40 Notes Payable .......................................................... 6,000 Cash .................................................................... 6,160 Repaid note plus interest.


11-50

Entrepreneurial Decision — BTN 11-7 1.

SnorgTees Income Statement (Prospective)

Current Operations

European Total

Sales ............................................. $1,000,000 $ 250,000 $1,250,000

Cost of goods sold (30%) ........... 300,000 75,000 375,000

Gross profit ................................. 700,000 175,000 875,000

Operating expenses (25%) ......... 250,000 62,500 312,500

Income before interest ............... 450,000 112,500 562,500

Interest expense.......................... 0 21,000 21,000

Net income ................................... $ 450,000 $ 91,500 $ 541,500

2. Times interest earned = $562,500 / $21,000 = 26.8 times

3.


Current Operations

European Total

Sales ............................................. $1,000,000 $ 400,000 $1,400,000


Gross profit ................................. 700,000 280,000 980,000




Net income ................................... $ 450,000 $ 159,000 $ 609,000

Times interest earned = $630,000 / $21,000 = 30.0 times


11-51

Entrepreneurial Decision (concluded)

4.


Current Operations

European Total

Sales ............................................. $1,000,000 $ 100,000 $1,100,000


Gross profit ................................. 700,000 70,000 770,000




Net income ................................... $ 450,000 $ 24,000 $ 474,000

Times interest earned = $495,000 / $21,000 = 23.6 times

5. In each of these cases, SnorgTees’ times interest earned is at least 23.6, so it appears that if it takes out the loan and can generate at least $100,000 in sales in Europe, then the company will have little trouble paying its interest expense.

Hitting the Road — BTN 11-8 There is no formal solution to this problem. A discussion of the importance of safeguarding social security information would be appropriate especially with respect to the Administration’s decision to no longer transfer benefit information online.


11-52

Global Decision — BTN 11-9 1. Nokia — Times interest earned

(Euro millions) Current Year One Year Prior

Net income ................................................. € 260 €3,889

Add income taxes ...................................... 702 1,081

Income before income taxes .................... 962 4,970

Add interest expense ................................ 243 185

Income before taxes and interest ............ €1,205 €5,155

Times interest earned ratio ....................... 5.0a 27.9b

a1,205/ 243

b5,155/ 185

2. Of these three companies, Research In Motion and Apple both have

superior coverage of interest expense for the current year and prior

year. Specifically, Research In Motion’s times interest earned of 3,267

for the current year is on par with that of Apple’s value of 4,023, and

both markedly exceed Nokia’s value of 5.0. The prior year shows

similar results with the exception of Nokia’s substantially higher times

interest earned of 27.9.

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