ComprehensiveProblem2SolutionsManual.xls

COMPREHENSIVE PROBLEM 2Guitar Universe CompanyGuitar Universe,Inc.2 to 3 hoursA mini-practice set illustrating numerous aspects of the accounting cycle for amerchandising business organized as a company.Students are required to:(1)perform a bank reconciliation,(2)make adjusting entriesincludingadjustments related to investment in securities,uncollectible accounts,inventoryshrinkage,and depreciation,(3)prepare an income statement,statement ofretained earnings,and balance sheet,and(4)assess the financial condition ofthe business from a short-term creditors perspective.Strong The McGraw-Hill Companies,Inc.,2010CP2-Desc.2 to 3 hours,StrongCOMPREHENSIVE PROBLEM 2 GUITAR UNIVERSE COMPANYa.GUITAR UNIVERSE COMPANYBank Reconciliation31 December 2010Balance per bank statement,31 December 2010Add:Deposits in transit not recorded by bank Deduct:Outstanding checks No.507$40,000No.51190,000No.52180,000Adjusted cash balanceBalance per depositors records,31 December 2010 Deduct:Bank service charge$250NSF check from Peter Chan25,000Adjusted cash balance(as above)General Journal a.Bank Service Charges250Accounts Receivable25,000 Cash To record bank service charges for December and the NSF check received from Peter Chan.b.Investment in Securities25,000 Gain on Fair Value Change of Investments To increase reported value of investment in securities from$250,000 to$275,000.(Note:theportfolio was previously increased from$190,000to$250,000.)c.Impairment Loss of Receivable35,000 Allowance for Impairment To increase the Allowance for impairment to$85,000 d.Cost of Goods Sold13,500InventoryTo record inventory shrinkage of missing guitars.e.Office Supplies Expense3,000Office SuppliesTo record office supplies used in December.The McGraw-Hill Companies,Inc.,2010CP2$469,750165,000$634,750 210,000$424,750$450,000 25,250$424,750 25,250 25,000 35,000 13,5003,000COMPREHENSIVE PROBLEM 2GUITAR UNIVERSE COMPANY The McGraw-Hill Companies,Inc.,2010CP2 COMPREHENSIVE PROBLEM 2 GUITAR UNIVERSE,INC.(continued)General Journal f.Insurance Expense6,000 Prepaid Insurance6,000 To record insurance policies expired during December.(Note:One month of the twelve-month policy had already been accounted for in November).g.Depreciation Expense50,000 Accumulated Depreciation50,000To record depreciation expense for December.h.Unearned Customer Deposits32,000 Sales 32,000To record revenue earned from advance special orders.i.Income Tax Expense60,000 Income Tax Payable60,000To account for accrued income taxes in December.The McGraw-Hill Companies,Inc.,2010CP2(p.2)COMPREHENSIVE PROBLEM 2 GUITAR UNIVERSE COMPANY(continued)j.GUITAR UNIVERSE COMPANYAdjusted Trial BalanceAs of 31 December 2010Cash$424,750Investment in securities275,000Accounts receivable1,275,000Allowance for impairment$85,000Inventory2,486,500 Office supplies9,000Prepaid insurance60,000Building and fixtures17,910,000Accumulated depreciation8,050,000Land648,000 Accounts payable 700,000Unearned customer deposits48,000Income taxes payable810,000Share capital10,000,000Retained earnings2,462,000Gain on fair value change of investments25,000Sales16,032,000Cost of goods sold9,593,500Bank service charges2,250Impairment loss of receivable125,000Salary and wages expense3,950,000Office supplies expense7,000Insurance expense70,000Utilities expense36,000Depreciation expense530,000Income tax expense810,000$38,212,000$38,212,000 The McGraw-Hill Companies,Inc.,2010CP2(p.3)COMPREHENSIVE PROBLEM 2GUITAR UNIVERSE COMPANY(continued)k.GUITAR UNIVERSE COMPANYIncome StatementFor the Year Ended 31 December 2010Sales$16,032,000Cost of goods sold9,593,500Gross profit$6,438,500Bank service charges$2,250 Impairment loss of receivable125,000 Salary and wages expense3,950,000 Office supplies expense7,000 Insurance expense70,000 Utilities expense36,000 Depreciation expense530,0004,720,250Profit before tax$1,718,250Income taxes expense810,000Profit for the year$908,250 GUITAR UNIVERSE COMPANYStatement of Changes in EquityFor the Year Ended 31 December 2010Share capitalRetained earningsBalances,1 January 2010$10,000,000$2,462,000Add:Profit(from income statement)908,250 Gain on fair value change of investments25,000Balances,31 December 2010$10,000,000$3,395,250 The McGraw-Hill Companies,Inc.,2010CP2(p.4)COMPREHENSIVE PROBLEM 2GUITAR UNIVERSE COMPANY(continued)k.(continued)GUITAR UNIVERSE COMPNYBalance SheetAs of 31 December 2010Current assets:Cash$424,750Investment in securities 275,000Accounts receivable$1,275,000 Less:Allowance for impairment(85,000)1,190,000 Inventory 2,486,500Office supplies 9,000Prepaid insurance 60,000Total current assets$4,445,250 Property,plant and equipment:Building and fixtures$17,910,000 Less:Accumulated depreciation(8,050,000)9,860,000Land648,000Total property,plant and equipment$10,508,000Total assets$14,953,250 Liabilities Current liabilities:Accounts payable$700,000Unearned customer deposits48,000Income taxes payable810,000Total current liabilities$1,558,000 Noncurrent liabilities:0Total liabilities$1,558,000 Shareholders Equity Share capital$10,000,000Retained earnings(from statement of changes in equity)3,395,250Total shareholders equity$13,395,250 Total Liabilities and Shareholders Equity$14,953,250 The McGraw-Hill Companies,Inc.,2010CP2(p.5)COMPREHENSIVE PROBLEM 2 GUITAR UNIVERSE COMPANY(concluded)l.Step 1:Compute accounts receivable turnover(sales average accounts receivable)$16,032,000$1,190,000*=13.5 times*Ending accounts receivable is assumed to be a close approximation for averageaccounts receivable for this company.Step 2:Compute accounts receivable days(365 accounts receivable turnover)365 13.5=27 daysm.Step 1:Compute inventory turnover(cost of goods sold average inventory)$9,593,500$2,486,500*=3.9 times*Ending inventory is assumed to be a close approximation for average inventoryfor this company.Step 2:Compute inventory days(365 inventory turnover)365 3.9=94 days n.Accounts receivable days(from part l above)27 days Add:inventory days(from part m above)94 days Operating cycle 121 days o.From a short-term creditors perspective,the company appears relatively solvent.It collectsits accounts receivable in less than 30 days,and its impairment loss of receivable represents arelatively small percentage of its total sales figures.However,it may be stocking too muchinventory,as evidenced by a 94-day average inventory days figure.Students are advised tocompare this figure to industry average statistics.Note to instructor:The companys quick and current ratios also appear relatively strong,whichprovides additional evidence of the companys ability to meet its current obligations(quick ratio=1.21:1(1,889,750/1,558,000);current ratio=2.85:1(4,445,250/1,558,000).The McGraw-Hill Companies,Inc.,2010CP2(P.6)