Accounting theory and practice, Volume 2 (of 3)

In this appendix enough material is furnished for approximately 30 hours of classroom work. If more time is devoted to the work, this material may well be supplemented by drawing on Appendix C.

The student will find it convenient to have a supply of standard-ruled journal paper and of analysis paper—10-or 12-column—to be used for working sheets.

For all formal statement work prepared for presentation to the instructor, it is suggested that plain, unruled paper of uniform size (8½ × 11 inches, letter size) be used. The chief purpose of this second semester’s work is to give training in analysis—the ability to grasp the essentials of a given set of conditions and to see the significance and interrelations of the various parts. Next in importance to this is the ability to draw up a statement or statements which shall present clearly and in proper order the results of your analysis. The student should develop the habit of thinking clearly and setting forth conclusions in intelligent, clean-cut form. In ninety-nine cases out of every hundred, slovenly, sloppy work evidences a like characteristic of reasoning ability. If the course develops clear thinking and clean-cut presentation, it will have accomplished its two main purposes.

The problems have a more or less direct relation to Chapters XXVIII to XXXV of this volume, but of course they are not limited to the principles developed there. Many of the problems are somewhat closely connected and relate to each other while some are entirely disconnected. They are graded, proceeding from the simpler to the more difficult by easy stages. Where necessary, instructions are given, although the student is thrown more on his own resources than previously. In the solution of problems involving trial balance, adjustments, and financial statements, the method of the accountant’s working sheet will be found to offer the best procedure. See Volume I, Chapter XLIII, pages 386-391, for explanation and illustration.

As to the method of attacking problems, the student is perhaps already aware that before attempting solution it is best to read and study the problem carefully to determine exactly what is called for and then to decide as to the treatment of all doubtful points and items—what they mean and how they must be handled to arrive at what is called for. With these preliminary points cleared up, the solution itself is mostly a matter of accuracy and form. In all problems calling for financial statements, the trial balance should first be tested as to the equality of debits and credits. As stated above, the method of the work sheet is usually the best method for summarizing results, although sometimes skeleton ledger accounts will be found helpful in order to visualize the effect of entries and to trace their course through the accounts. Only painstaking work and the solution of many problems will produce facility and confidence in work of this kind.

The instructor should direct the student to take Problem XXVIII under consideration throughout the whole semester, in order adequately to get his material together and into shape. It may well be treated as a thesis for the semester.

I

At the close of the fiscal year ended June 30, 1913, Thomas J. Howe called you in to determine his financial condition. From the books, which were kept on the single-entry plan, and from other sources, you gathered the following information:

The ledger contained the following accounts: Thomas J. Howe, Capital, $4,000; Thomas J. Howe, Drawing (debit) $472; Expense (debit) $184; Sales $18,945; Purchases $17,450; customers’ accounts considered good: H. E. Brewer $110; D. Cohen $85; Will Benton $190; Linn Bros. $77; customers’ accounts which have proved uncollectible and are considered bad: Peter Metz $43; L. C. Fish $101; creditors’ accounts: Stone Bros. $942; Little & Co. $1,082; H. Hudson $1,220; also accounts with Salaries $375; Advertising $112.

Other sources yielded this information: stock of goods on hand inventoried at $5,641; horses and wagons estimated as worth $730; store fixtures $1,114; rent of store building unpaid $300; clerks’ salaries unpaid $84; notes receivable $2,300; notes payable outstanding (non-interest bearing) $2,400. Bill of goods received from Stone Bros., which has been included in the inventory but which has not been entered in Stone Bros.’ account, $193; interest accrued on notes receivable $16; cash in the bank and safe $1,724.

It was found that the following information was available for determining his financial condition as at the close of the preceding fiscal year, June 30, 1912: cash $1,478; notes receivable $500; notes payable $800; Howe’s capital $4,000; store fixtures $900; inventory of goods in stock $2,800; horses and wagons at an estimated value of $800; customers’ accounts total $2,314; creditors’ accounts total $3,609.

From the foregoing prepare:

Instructions

See Volume I, Chapters LV and LVI.

II

The following trial balance was taken from the books of Thomas J. Howe at the close of the next fiscal year.

Thomas J. Howe
Trial Balance, June 30, 1914

At this date, you will find that the following items must be considered to determine the financial condition of Mr. Howe: Merchandise inventory $2,470; insurance unexpired $100; interest accrued on notes receivable $66; interest accrued on notes payable $30; he owes for two months’ rent $300.

1% of net sales is to be set aside as a reserve for uncollectible accounts. Furniture and fixtures are to be written off in the amount of 10%. Provide for a reserve of 10% for depreciation of horses, wagons, and harness.

Advertising carried forward to the next period $75; unused stationery and other expense items $42; commissions on sales due but unpaid $90.

III

Joseph Mason was Howe’s greatest competitor. After getting better acquainted with each other, Howe conceived the plan of uniting their capital and services in the form of a partnership. After some discussion it was decided to operate as Howe & Mason, the capital to consist of $12,000, of which Howe is to contribute $8,000 in the form of his existing business. The excess of Howe’s net worth, as shown by the balance sheet of June 30, 1914, over $8,000, his investment in the partnership, is to be considered as a loan to the firm. Mason is to transfer his entire business—assets and liabilities—and sufficient cash to make his net investment $4,000, or one-third of the total capitalization.

As of July 1, 1914, the date of the formation of the partnership, Mason’s assets and liabilities were as follows: cash $1,340; accounts receivable $2,460; notes receivable $1,120; stock of goods inventoried at $4,590; furniture and fixtures appraised at $1,316; accounts payable $5,280; notes payable $1,770; rent unpaid $320.

Prepare journal entries to give effect to the foregoing on Howe’s books, which are to be continued for the partnership.

During the year Charles Palmer purchased one-third interest in the capital and profits of the firm by contributing $9,000 in cash. The total capital of the new firm is set at $18,000. Business is to be conducted under the old firm name, the old partners retaining their respective capital investments. Howe’s loan account is to be continued at its original amount.

Write the necessary journal entries to record on the books of the firm the admission of the new partner and the adjustments between Howe and Mason.

Before determining the profits for the year Palmer assigns his interest in the capital and profits of the firm to John H. Bartlett, who settles directly with Palmer for $10,000. Howe and Mason agree to admit Bartlett as a partner in place of Palmer and new articles of partnership are signed by the members.

Give journal entries to show the effect on the partnership books.

Instructions

Note carefully the terms under which Palmer is admitted. His capital will appear on the books as $6,000. Make the adjustment through a good-will account. Howe and Mason withdraw cash to effect their respective adjustments.

IV

The business has been in operation as a partnership one year. At the conclusion of this period the trial balance given below shows the condition of the accounts on the books of the firm.

Howe & Mason
Trial Balance, June 30, 1915

Additional information is as follows:

Merchandise inventory, June 30, 1915, $13,260; stationery and printed matter on hand $35; unused postage stamps $17.00. One-fourth of advertising is to be applied to the next year. Warehouse labor of $130, due but unpaid, has not been recorded on the books. Interest accrued but not recorded: on notes receivable $71, on notes payable $47, on bank balances $8. Rent prepaid $200.

You find that no record has been made on the books for $750 worth of merchandise received from Marsh & Co., but that these goods have been included in the current inventory. Four-fifths of the insurance has expired. Interest is to be accrued on Howe’s Loan account at 6%. Through error $100 of commissions on sales has been charged to Salesmen’s Salaries account.

It has been decided to provide for depreciation and reserves as follows: 10% reserve on reducing balances for horses, wagons, and harness; a reserve of ½% on sales for uncollectible accounts; by writing off 10% of the book value of furniture and fixtures.

Profits and losses are to be shared according to the original investments of the partners.

Give due consideration to the foregoing and construct:

Instructions

Note the bases for the various depreciation reserves and that depreciation on furniture and fixtures is to be written off the books, i.e., no reserve is to be set up.

V

July 1, 1915, the capital of the firm of Howe & Mason is increased to $30,000 and Wm. R. Gray is admitted as a partner.

Among other things, the articles of copartnership provide that:

Business is to be conducted under the firm name of Howe, Mason & Co.

The representation of the partners in the capital of the firm shall be Howe, 8/20; Mason, 5/20; Bartlett, 3/20; Gray, 4/20.

Profits and losses shall be shared according to the capital representation of the partners as at the time of formation of this partnership. In the event of the death of a partner an accounting shall be made at the close of the fiscal year in which the death occurs and the value of the deceased partner’s estate determined as of the date of his death by prorating profits on a monthly basis.

Gray is to pay for one-fifth interest in the capital of the firm by giving the firm his note for $2,000 and $4,000 in cash. The difference in capital is to be supplied by good-will, which is to be distributed among the three partners constituting the firm of Howe & Mason on the basis of their original capital representations in that firm, i.e., in the ratio of $8,000, $4,000, $6,000 respectively.

After adjustments have been made, the respective partners’ drawing accounts shall be settled in cash.

Instructions

The partnership agreement is to be interpreted to mean that, after distribution of the good-will, Howe, Mason, and Bartlett are to contribute or withdraw cash necessary to give them the respective capital shares agreed upon for the new firm.

VI

Wm. R. Gray died November 30, 1917, two years and five months after he became a partner in the firm of Howe, Mason & Co. As provided in the articles of partnership, the business continued until the end of the fiscal year, June 30, 1918, at which date an accounting was made on the basis of the following trial balance and subjoined data.

Howe, Mason & Co.
Trial Balance, June 30, 1918

The books have been closed at the end of each fiscal year.

Merchandise inventories, June 30, 1918, bags $2,431, trunks $4,380. A reserve of ½% of the sales is to be provided for bad debts. The furniture and fixtures are to be written down 10% of their book value.

The old account of Horses, Wagons, and Harness was closed and Delivery Equipment opened when the horses were sold and an automobile service installed. It is deemed advisable to increase the reserve by 10% of the declining value.

An additional 5% of the original cost of the buildings will be set aside as a reserve for depreciation.

Accruals are as follows: taxes $370; interest on mortgage 9 months at 5%; interest on notes receivable $80; interest on notes payable $520; interest on bank balances $61.20; office salaries $150; interest on Howe loan 6% for one year.

Advances made to salesmen on salaries $400; tenants paid $300 in advance rent; unused postage $32; miscellaneous office supplies on hand $30; one-fourth of the insurance remains in force; advertising deferred $600. Distribute in-freight and warehouse labor on the basis of gross purchases.

Profits and losses are to be shared according to the original investments, as stated in the articles of partnership.

One clause in the partnership agreement entered into July 1, 1915, read as follows:

“In the event of dissolution, good-will is to be increased at the rate of 24% per year of the original value.” Take this into account now as effective for 2 years and 5 months.

As of June 30, 1918:

VII

The Ironclad Trunk Corporation was organized and incorporated November 1, 1912, for the purpose of manufacturing trunks, bags, and brushes of all kinds and dealing in traveling requisites of every description.

The authorized capital of $100,000 consists of 750 shares of common stock having a par value of $100 per share, and 250 shares of preferred stock of the same par value.

The incorporators subscribed for at par and paid for the common stock as indicated below:

Arthur Butler, 250 shares in cash.

A. J. Lindsey, 150 shares by transferring the following assets and liabilities: cash $3,000; accounts receivable $7,000; notes payable $3,000; notes receivable $2,000; stock of raw material $9,000; accounts payable $5,000; furniture and fixtures $2,000.

Edward Harrison, 100 shares by giving bill of sale of machinery appraised at $6,000; the balance to be paid in one year.

Charles E. Wells, 50 shares by his personal note for $5,000 with interest at 6%, due in one year.

In connection with the organization of the corporation the following items were paid in cash: corporation tax $50; filing fees $20; recording fees $12; legal expenses $500.

Instructions

Refer to trial balance of VIII to see the method pursued in making the opening entries for the corporation.

VIII

The following trial balance was taken from the books of the Ironclad Trunk Corporation at the close of its first year. From it and the additional notations appended thereto you are asked to furnish:

• (a) Working sheet.
• (b) Balance sheet.
• (c) Income statement.
• (d) Closing journal entries.

Ironclad Trunk Corporation
Trial Balance, October 31, 1913

You are presented with properly certified statements showing the present inventory of materials and supplies to be $16,300; goods in process $1,400; finished goods $9,800, and factory supplies in storeroom $700. It has been estimated that $200 of the freight inward is applicable to the present inventory of materials and supplies. Salesmen have been overpaid $600 on their salary accounts. Items aggregating $400 which have been charged to Expense are found to be on hand. In the customers ledger you find accounts having credit balances amounting to $1,500, and uncollectible accounts to the amount of $710. You decide to write down furniture and fixtures 10%.

Instructions

It will be noted that the trial balance presented indicates that the books have been partially adjusted. The uncollectible accounts of $710 were taken into consideration when the estimate for reserve for doubtful accounts was made. Charge them against the reserve.

IX

After Edward S. White, the inventor of a process for constructing a superior fiber for trunk-making, demonstrated the practicability of his process, the Ironclad Trunk Corporation purchased all his rights in patents granted by United States, Canada, Mexico, and Great Britain. The sale went into effect January 1, 1914. The consideration of $100,000 was made payable $60,000 in cash, $20,000 in bonds at par, and $20,000 in two-year interest bearing notes of the company.

To provide for payment of the patent, the corporation, after duly complying with all legal requirements, issued $100,000 in 20-year 6% sinking fund bonds, under date of December 1, 1913, interest payable June 1 and December 1. During the month $70,000 of the bonds were sold for cash on a 7% basis, and the remainder at the same price during the following month.

The trust agreement provided that a sinking fund should be established by a charge against profits every interest period, of an amount sufficient on a 4% compound interest basis—interest compounded semiannually—to retire the bonds at maturity. The fund was placed in a trust company for accumulation.

Instructions

It will be noted that the problem requires the calculation of the selling price of the bonds, i.e., their valuation on the given basis. This may be found from bond tables but preferably by the formula of Chapter XV. The sinking fund may also be found from tables or the formula of Chapter XXV.

(1.035⁴⁰ = 3.95925972; 1.02³¹ = 1.84758882; and 1.02⁴⁰ =2.20803966)

X

• 1. The first sinking fund instalment.
• 2. The first bond interest payment.
• 3. The liberation of the sinking fund at maturity.
• 4. The retirement of the bonds at maturity.

Instructions

Averaging the bonds sold at par with those sold on a 7% basis places the whole issue approximately on a 6.787% basis. Use that as the effective rate for the amortization schedule.

XI

Several customers of the Ironclad Trunk Corporation protested vigorously against paying their accounts when we sent them statements requesting payment. They denied that they owed the amounts shown on our books and produced receipts and canceled checks to prove their contentions. In many cases we found that the receipts and checks were dated several weeks before the credits appeared on the books and in some cases no credits had been entered.

The manager immediately requested Leroy Swift, a certified public accountant, to make a thorough audit. Among other things, the accountant’s report disclosed the following:

The petty cash sales had been entered in the cash book at smaller amounts than the records showed. The discrepancy between cash book and sales records was: trunks $1,040, bags $360.

Freight bills had been raised $300. The Railroad Company had been overpaid this amount but refunded it on the request of our bookkeeper, S. O. Bright, who cashed the checks and retained the money.

The Customers column and Net Cash column in the cash book were short-footed $8,430. To make the balance in the Customers’ controlling account agree with the total of the individual accounts, the sales book was short-footed the same amount—bags $2,790, and trunks $5,640.

Credits to customers’ accounts in the amount of $4,740 were missing. Not a trace of a record for this amount or any part thereof could be found in any book.

Leather novelties amounting to $1,560 had been sold from the National Novelty Co.’s consignment but no remittance had been made. The only record of the transactions were duplicate bills of the sales made. The money received for these sales had not been deposited and was appropriated by the embezzler.

Nine productive labor pay-rolls had been over-footed $100 each.

A $1,000 note receivable had been transferred by forged indorsement as $950 part payment on a $1,300 automobile bought by the embezzler for his personal use. The Self-Starter Auto Co. were the holders of the note.

Checks for $1,800 were drawn to the order of fictitious creditors. The indorsements were forged by Bright and the checks duly passed through the bank.

The relatives and friends of Bright agreed to repay the company the greater part or all of the losses due to his embezzlement. In order to provide funds for immediate needs the present stockholders donate 20% of their present holdings of stock, both common and preferred.

Prepare journal entries to give effect to the foregoing as of December 13, 1913.

XII

The City of Oswego donated to the Ironclad Trunk Corporation a building site having a market value of $40,000, on condition that the company build a factory worth at least $100,000 and operate at least five years, employing not less than 100 factory operators.

To take advantage of this offer the corporation obtained permission to issue $100,000 of 7% cumulative preferred stock having a par value of $100 per share, dividends payable semiannually. A condition of the issue made the stock redeemable by lot at the call of the company, the shareholder having the option of receiving 110 in cash or 120 in common stock. A redemption fund is to be created out of profits at the yearly rate of 10% of the issue.

The entire issue was sold for cash May 1, 1914 at 100½. On the same day 101 Blue Valley R. R. 4% bonds, par $1,000, were purchased at 98 with accumulated interest. The bonds are payable July 1, 1924; interest payable January 1 and July 1. The entire bond investment was set aside as a building fund.

Record as of July 31, 1914, the transactions that took place in connection with the erection of the building and the removal from the old to the new plant.

The corporation paid taxes of $400 on the building site and partially completed building. Of this amount $100 applied to the uncompleted building. During the period the manager devoted two-thirds of his time to superintending building operations and one-third to supervising installation of machinery and equipment. His salary amounted to $3,000.

The old land and building and part of the machinery were sold to the American Harness Company for $49,000, payable $11,000 in cash and the balance covered by mortgage for five years at 6%. The amount of the sale was distributed—land $12,000, building $29,000, machinery and tools $8,000. At the date of the sale the accounts appeared on the books as follows: land $10,000; buildings $31,000, with a reserve of $3,000 and nine months’ depreciation on a 5% basis still to be provided for; machinery and tools $25,000 with a reserve for depreciation of $2,500. The machinery and tools sold cost $12,000, on which depreciation has been booked for one year at 10% on original cost. Take into consideration an additional period of nine months.

The remaining machinery, having been designed especially for our use, could not be sold for more than one-half its cost; accordingly, the directors had the machines moved to the new plant. The old machines appear on the books at a cost of $13,000, with reserve recorded for one year at 10% and nine months’ depreciation still to be booked. Additional expenses of removing were as follows: dismantling $40; crating, drayage and freight $170; labor for setting up machines $60; superintendent’s time for moving and installation $150.

The manager, not being sure as to the amount at which to book the machinery, obtained an estimate to duplicate this particular machinery and put it in running order for $9,000.