91Ó°ÊÓ

Set up column headings as necessary (including a Warranty Payable column) and use the accounting equation to record the effects of each of the following transactions on the firm's balance sheet: 1\. Accrued warranties estimated at \(\$ 1,200,000\) on December 31,2000 . (Set up a Warranty Payable column.) 2\. Paid warranty claims costing \(\$ 1,300,000\) in cash during 2001 3\. Borrowed \(\$ 10,000,000\) at \(9 \%\) annual interest for 240 days on September 30 \(2001 .\) Assume 360 days in a year. 4\. Sold goods costing \(\$ 12,000,000\) for \(\$ 25,000,000\) cash during 2001. 5\. Accrued interest on the loan on December 31,2001 . (Set up an interest payable column in your worksheet.) 6\. Management estimated that the warranties obligation at December 31,2001 (based on past sales and warranty claims) should be \(\$ 1,500,000\). Why was there a negative balance in the Warranty Payable column before your adjustment? 7\. Repaid the loan, plus interest at the maturity date.

Step by step solution

01

Analyze first transaction

Accrued warranties estimated at $1,200,000 at year-end 2000. This represent as a liability in the balance sheet. Hence, with this transactionthe liability under 'Warranty Payable' increases by $1,200,000.

02

Analyze second transaction

Claims costing $1,300,000 is paid in cash during 2001. This decreases the 'Cash' account by $1,300,000 and the 'Warranty payable' by the same amount. However, since the company only accrued $1,200,000 in step 1, this creates a deficit of $100,000 in the 'Warranty payable'.

03

Analyze third transaction

Borrowed $10,000,000 at an annual interest rate of 9% for 240 days. This boosts the cash account by $10,000,000 and raises the 'Loan Payable' account by the same amount. The interest is not accounted for until it is accrued.

04

Analyze fourth transaction

Goods costing $12,000,000 are sold for $25,000,000 cash. This will increase the cash account by $25,000,000 and decrease the inventory by $12,000,000. The remainder $13,000,000 is profit and will go into 'retained earnings'.

05

Analyze fifth transaction

Accrue interest on the loan at year-end 2001. Interest payable can be calculated as \(10,000,000 * 9\% * (240/360)\). Hence the interest payable is $600,000, which increases the 'Interest Payable' account and decrease the 'Retained Earnings' by the same amount.

06

Analyze sixth transaction

Estimate the warranty obligation to be $1,500,000 at year-end 2001. The 'Warranty payable' account would then be adjusted to $1,500,000 from a deficit of $100,000, and the 'Retained Earnings' account would decrease to account for the additional $1,600,000 warranty payable.

07

Analyze seventh transaction

Repay the loan plus accrued interest. This reduces the 'Cash' account by $10,600,000 (loan amount plus accrued interest), and the 'Loan Payable' and 'Interest Payable' accounts return to zero.

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Key Concepts

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

Balance Sheet

The balance sheet is a fundamental financial statement in accounting. It provides a snapshot of a company's financial position at a specific point in time.
It is structured around the accounting equation: \[ \text{Assets} = \text{Liabilities} + \text{Equity} \]This equation must always balance, meaning that the resources controlled by the company (assets) must equal the liabilities owed to outsiders and the equity owned by shareholders.
This important document includes different sections:

• Assets: 91Ó°ÊÓ owned by the company, such as cash, inventory, and property.
• Liabilities: Obligations the company must pay, like loans and warranties.
• Equity: The residual interest in the assets after liabilities are settled.

In the exercise, each transaction affects components of the balance sheet. For example, selling goods increases cash (asset) and retained earnings (equity), while accruing interest increases both interest payable (liability) and decreases retained earnings.

Liabilities

Liabilities refer to the amounts a company owes to lenders, suppliers, and other parties. They are crucial for understanding the financial health of a business and are reported on the balance sheet.
Liabilities can be current (short-term) or non-current (long-term):

• Current Liabilities: Debts or obligations the company expects to settle within a year, such as warranty payables and interest payables.
• Non-current Liabilities: Obligations due after more than a year, like long-term loans.

In the exercise, liabilities include loans borrowed by the company and the warranty and interest obligations. For instance, when the company accrued $1,200,000 in warranties, it increased its liabilities, representing promises to repair or replace products if they fail.

Retained Earnings

Retained earnings are the cumulative amount of net income kept by the company rather than distributed as dividends. It represents the portion of profits reinvested in the business or used to pay down debt.
Retained earnings are not cash, but rather a representation of how much profit is retained in the business over time.

• An increase in retained earnings indicates profitability as profits are retained.
• Conversely, if the company incurs a loss, retained earnings decrease.

In the exercise scenario, when goods were sold for $25,000,000, a portion of the resulting profit was added to the retained earnings. However, adjusting warranty payables impacted retained earnings negatively, as more funds were needed to cover these anticipated costs.

Warranty Payable

Warranty payable is a specific type of liability that accounts for the estimated future costs linked to warranty obligations. This liability ensures that the company can meet the commitment to repair or replace defective products.
Warranties create an obligation based on past transactions, usually calculated using historical data and estimates.

• An estimate increases warranty payables, as seen when the company estimated $1,200,000 for warranties at year-end 2000.
• When claims are paid, like the $1,300,000 cash outflow during 2001, the warranty payable reduces.

In the exercise, there was a negative balance before adjustment because the claims paid exceeded the accrued warrants, highlighting the importance of accurate predictions and adjustments to warrant payables.