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Chapter 11: Q24E (page 610)

The following financial information was obtained from the year ended 2018 income statements for Cash Automotive and Pennington Automotive:

Cash Pennington

Net income \( 26,070 \) 74,188

Income tax expense 9,270 27,080

Interest expense 300 2,900

Requirements

1. Compute the times-interest-earned ratio for each company. Round to two decimals.

2. Which company was better able to cover its interest expense?

Short Answer

Expert verified

Times Interest Earned Ratio

For Cash Automotive: 119 times

For Pennington Automotive: 35.92 times

Step by step solution

01

Computation of times interest earned ratio

ForcashAutomativeCo.=NetIncome+IncomeTaxExpense+InterestExpenseInterestExpense=$26,070+$9,270+$300$300=119timesForPeninngtonAutomativeCo.=NetIncome+IncomeTaxExpense+InterestExpenseInterestExpense=$74,188+$27,080+$2,900$2,900=35.92times

02

Conclusion

Based on the above-computed ratio, Cash Automotive is better enough to cover its interest expense as the income before interest and tax is 119 times more than the Pennington Automotive.

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Most popular questions from this chapter

Liam Wallace is general manager of Moonwalk Salons. During 2018, Wallace worked for the company all year at a \(13,400 monthly salary. He also earned a year-end bonus equal to 5% of his annual salary.

Wallace鈥檚 federal income tax withheld during 2018 was \)2,010 per month, plus \(1,608 on his bonus check. State income tax withheld came to \)110 per month, plus \(80 on the bonus. FICA tax was withheld on the annual earnings. Wallace authorized the following payroll deductions: Charity Fund contribution of 2% of total earnings and life insurance of \)15 per month.

Moonwalk incurred payroll tax expense on Wallace for FICA tax. The company also paid state unemployment tax and federal unemployment tax.

Requirements

1. Compute Wallace鈥檚 gross pay, payroll deductions, and net pay for the full year 2018. Round all amounts to the nearest dollar.

2. Compute Moonwalk鈥檚 total 2018 payroll tax expense for Wallace.

3. Make the journal entry to record Moonwalk鈥檚 expense for Wallace鈥檚 total earnings for the year, his payroll deductions, and net pay. Debit Salaries Expense and Bonus Expense as appropriate. Credit liability accounts for the payroll deductions and Cash for net pay. An explanation is not required.

4. Make the journal entry to record the accrual of Moonwalk鈥檚 payroll tax expense for Wallace鈥檚 total earnings.

5. Make the journal entry for the payment of the payroll withholdings and taxes.

The following transactions of Jasmine Reef occurred during 2018:

Apr. 30 Reef is party to a patent infringement lawsuit of \(190,000. Reef鈥檚attorney is certain it is remote that Reef will lose this lawsuit.

Jun. 30 Estimated warranty expense at 2% of sales of \)350,000.

Jul. 28 Warranty claims paid in the amount of \(5,500.

Sep. 30 Reef is party to a lawsuit for copyright violation of \)80,000. Reef鈥檚attorney advises that it is probable Reef will lose this lawsuit. Theattorney estimates the loss at \(80,000.

Dec. 31 Reef estimated warranty expense on sales for the second half of the yearof \)510,000 at 2%.

Requirements

1. Journalize required transactions, if any, in Reef 鈥檚 general journal. Explanations arenot required.

2. What is the balance in Estimated Warranty Payable assuming a beginning balanceof $0?

Freeman Motors, a motorcycle manufacturer, had the following contingencies.

a. Freeman estimates that it is reasonably possible but not likely that it will lose a current lawsuit. Freeman鈥檚 attorneys estimate the potential loss will be \(4,500,000.

b. Freeman received notice that it was being sued. Freeman considers this lawsuit to be frivolous.

c. Freeman is currently the defendant in a lawsuit. Freeman believes it is likely that it will lose the lawsuit and estimates the damages to be paid will be \)75,000.

Determine the appropriate accounting treatment for each of the situations Freeman is facing.

When do businesses record warranty expenses, and why?

Logan White is general manager of Valuepoint Salons. During 2018, White worked for the company all year at a \(13,600 monthly salary. He also earned a year-end bonus equal to 15% of his annual salary.

White鈥檚 federal income tax withheld during 2018 was \)1,360 per month, plus \(4,876 on his bonus check. State income tax withheld came to \)150 per month, plus \(60 on the bonus. FICA tax was withheld on the annual earnings. White authorized the following payroll deductions: Charity Fund contribution of 1% of total earnings and life insurance of \)40 per month.

Valuepoint incurred payroll tax expense on White for FICA tax. The company also paid state unemployment tax and federal unemployment tax.

Requirements

1. Compute White鈥檚 gross pay, payroll deductions, and net pay for the full year 2018. Round all amounts to the nearest dollar.

2. Compute Valuepoint鈥檚 total 2018 payroll tax expense for White.

3. Make the journal entry to record Valuepoint鈥檚 expense for White鈥檚 total earnings for the year, his payroll deductions, and net pay. Debit Salaries Expense and Bonus Expense as appropriate. Credit liability accounts for the payroll deductions and Cash for net pay. An explanation is not required.

4. Make the journal entry to record the accrual of Valuepoint鈥檚 payroll tax expense for White鈥檚 total earnings.

5. Make the journal entry for the payment of the payroll withholdings and taxes.
See all solutions

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