91Ó°ÊÓ

The Western Fittings Corporation began business on July \(1,1999 .\) The following transactions occurred during its first six months: 1\. Three individuals each invested \(\$ 30,000\) in exchange for capital stock. 2\. One year's rent was paid for \(\$ 12,000\) on July 1 3\. On August 1, several pieces of property, plant, and equipment were purchased for \(\$ 75,000\) on account. 4\. During the six months, clothing, boots, and accessories were purchased for \(\$ 60,000\) cash. 5\. The corporation had sales revenue of \(\$ 85,000\), of which \(\$ 35,000\) has not yet been collected in cash. 6\. The cost of the clothing, boots, and accessories sold in item 5 was \(\$ 55,250\). 7\. Employees were paid \(\$ 24,000\) in wages. 8\. The corporation paid utilities and telephone expenses of \(\$ 5,000\). Required a. Analyze and record these transactions using the basic accounting equation. b. Record the following adjustments for the six months ended December 31 1999: rent expense and depreciation expense. Assume a 10 -year life and zero residual value. c. What is the net income (loss) for the six months ended December \(31,1999 ?\)

Step by step solution

01

Analyze and record transactions using the basic accounting equation

1. Three individuals invest \$30,000: Assets (Cash) = Liabilities + Equity (Capital Stock) increase by \$90,000. \n 2. One year's rent is paid: Assets (Prepaid Rent) decrease and Equity (Rent Expense) increases by \$12,000. \n 3. Property, plant, and equipment are purchased: Assets (Property, plant, and equipment) increase by \$75,000 and Liabilities (Accounts Payable) increase by \$75,000. \n 4. Clothing, boots, and accessories are bought: Assets (Inventory) increase and Assets (Cash) decrease by \$60,000. \n 5. Sales revenue: Assets (Accounts Receivable and Cash) increase by \$85,000 and Equity (Sales Revenue) increases by \$85,000. \n 6. Cost of goods sold: Assets (Inventory) decrease and Equity (Cost of goods sold) increases by \$55,250. \n 7. Wages paid: Assets (Cash) decrease and Equity (Wage Expense) increases by \$24,000. \n 8. Utilities and telephone expenses: Assets (Cash) decrease and Equity (Utilities and Telephone Expenses) increase by \$5,000.

02

Record the adjustment for rent and depreciation expense

The prepaid rent of \$12,000 covered a year, which means for six months the rent expense will be \$6,000. So, Assets (Prepaid Rent) decrease by \$6,000 and Equity (Rent Expense) increases by \$6,000. \n Additionally, the equipment purchased depreciates over 10 years with zero residual value. That’s a depreciation expense of \$7,500 for the six months. So, Assets (Accumulated Depreciation) increase by \$7,500 and Equity (Depreciation Expense) increases by \$7,500.

03

Compute the Net income

Net income = Revenue - Expenses. \n Here, Revenue = Sales revenue = \$85,000. \n Expenses include Cost of goods sold, Wages, Utilities, Telephone expenses, Rent expense, Depreciation expense = \$55,250 + \$24,000 + \$5,000 + \$6,000 + \$7,500 = \$97,750. \n So, Net income = \$85,000 - \$97,750 = -\$12,750.

04

Net loss

As the result of above computation is negative, it's represented as a net loss. So, the corporation experienced a net loss of \$12,750 in its first six months of operation. This will be reflected in the equity section under retained earnings as a decrease.

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Key Concepts

These are the key concepts you need to understand to accurately answer the question.

Accounting Equation

Understanding the accounting equation is fundamental in financial accounting. It's represented as: \[ \text{Assets} = \text{Liabilities} + \text{Shareholder's Equity} \]This equation is like the backbone of accounting. It ensures that a company's balance sheet is balanced. Assets are what the company owns, such as cash and inventory. Liabilities are what the company owes, like bank loans or accounts payable. Shareholder's equity is what the owners have invested in the company, including retained earnings.

• An increase in assets, like buying equipment, will either increase liabilities or equity.
• Liabilities and equity provide the resources to acquire assets.
• Every transaction affects at least two accounts, keeping the equation in balance.

Knowing how to apply the accounting equation helps in accurately recording and analyzing transactions.

Net Income

Net income, also known as profit, is the amount of money a company keeps after deducting all its expenses from its revenue. It's calculated using this formula:\[ \text{Net Income} = \text{Total Revenue} - \text{Total Expenses} \]This amount reflects the company's profitability over a period. Positive net income indicates profit, whereas a negative result shows a loss.To calculate net income:

• Add up all revenues, such as sales revenue.
• Total the expenses, including cost of goods sold, wages, and utilities.
• Subtract expenses from revenues.

Net income is crucial as it shows the company's effectiveness in managing its operations and costs.

Depreciation Expense

Depreciation expenses account for the gradual wear and tear of long-term assets like buildings or equipment. It's a way of spreading the cost of an asset over its useful life rather than expensing it all at once.The formula for straight-line depreciation, which is straightforward and commonly used, is:\[ \text{Depreciation Expense} = \frac{\text{Cost of Asset} - \text{Residual Value}}{\text{Useful Life}} \]In the example, equipment costing \\(75,000 with a zero residual value and a 10-year life results in a yearly depreciation of \\)7,500. Over six months, it accrues to \$3,750.By accounting for depreciation:

• Assets on the balance sheet reflect current values better.
• Companies report more accurate profits over multiple periods.

Prepaid Rent

Prepaid rent is an asset because it's a payment made for rent expense in advance of the period it covers. It ensures companies recognize expenses in the period they are incurred, aligning with the matching principle in accounting.For prepaid expenses:

• The initial payment increases assets (prepaid rent).
• Over time, as the rental period progresses, the asset reduces while a rent expense is recognized.

In the exercise, the year-long prepaid rent results in \\(12,000 at first. The first six months convert half of that, or \\)6,000, to a rent expense.Regular adjustments of prepaid expenses ensure the financial records accurately reflect the current financial situation.

Sales Revenue

Sales revenue is the income from goods or services sold. It's often the primary source of revenue for businesses and a critical measure of business performance.Calculation is simple:\[ \text{Sales Revenue} = \text{Number of Units Sold} \times \text{Price per Unit} \]In the textbook example, the corporation achieved \$85,000 in sales, representing cash plus accounts receivable.Understanding sales revenue involves:

• Separating it from other revenues, like interest or investments.
• Tracking it accurately to analyze trends and make forecasts.
• Recording it as received or when the account is due.

Properly capturing sales revenue tells how successful the company's core business operations are at generating income.