COMPREHENSIVE PROBLEM 2

Guitar Universe, Inc. A mini-practice set illustrating numerous aspects of the accounting cycle for a merchandising business organized as a corporation. Students are required to: (1) perform a bank reconciliation, (2) make adjusting entriesincluding adjustments related to marketable securities, uncollectible accounts, inventory shrinkage, and depreciation, (3) prepare an income statement, statement of retained earnings, and balance sheet, and (4) assess the financial condition of the business from a short-term creditors perspective. 2 to 3 hours Strong

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2 to 3 hours, Strong a.

COMPREHENSIVE PROBLEM 2 GUITAR UNIVERSE, INC.

GUITAR UNIVERSE, INC. Bank Reconciliation December 31, 2009 Balance per bank statement, December 31, 2009 Add: Deposits in transit not recorded by bank Deduct: Outstanding checks No. 507 No. 511 No. 521 Adjusted cash balance Balance per depositor's records, December 31, 2009 Deduct: Bank service charge NSF check from Iggy Bates Adjusted cash balance (as above)

$ $ $ 4,000 9,000 8,000 $ $ $ 25 2,500 $

46,975 16,500 63,475

21,000 42,475 45,000

2,525 42,475

General Journal

a.

Bank Service Charges Accounts Receivable Cash To record bank service charges for December and the NSF check received from Iggy Bates. Marketable Securities Unrealized Holding Gain on Investments To increase reported value of marketable securities from $25,000 to $27,500. (Note: the portfolio was previously increased from $19,000 to $25,000.) Uncollectible Accounts Expense Allowance for Doubtful Accounts To record uncollectible accounts expense for December. Cost of Goods Sold Inventory To record inventory shrinkage of missing guitars. Office Supplies Expense Office Supplies To record office supplies used in December.

25 2,500 2,525

b.

2,500 2,500

c.

3,500 3,500

d.

1,350 1,350

e.

300 300

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COMPREHENSIVE PROBLEM 2 GUITAR UNIVERSE, INC. (continued)

General Journal

f.

Insurance Expense Prepaid Insurance To record insurance policies expired during December. (Note: One month of the twelve-month policy had already been accounted for in November). Depreciation Expense Accumulated Depreciation To record depreciation expense for December. Unearned Customer Deposits Sales To record revenue earned from advance special orders. Income Tax Expense Income Tax Payable To account for accrued income taxes in December.

600 600

g.

5,000 5,000

h.

3,200 3,200

i.

6,000 6,000

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COMPREHENSIVE PROBLEM 2 GUITAR UNIVERSE, INC. (continued)

j.
GUITAR UNIVERSE, INC. Adjusted Trial Balance As of December 31, 2009 Cash Marketable securities Accounts receivable Allowance for doubtful accounts Merchandise inventory Office supplies Prepaid insurance Building and fixtures Accumulated depreciation Land Accounts payable Unearned customer deposits Income taxes payable Capital stock Retained earnings Unrealized holding gain on investments Sales Cost of goods sold Bank service charges Uncollectible accounts expense Salary and wages expense Office supplies expense Insurance expense Utilities expense Depreciation expense Income tax expense $ 42,475 27,500 127,500 $ 248,650 900 6,000 1,791,000 805,000 64,800 70,000 4,800 81,000 1,000,000 240,200 8,500 1,603,200 959,350 225 12,500 395,000 700 7,000 3,600 53,000 81,000 3,821,200 $ 8,500

3,821,200

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COMPREHENSIVE PROBLEM 2 GUITAR UNIVERSE, INC. (continued)

k.
GUITAR UNIVERSE, INC. Income Statement For the Year Ended December 31, 2009 Sales Cost of goods sold Gross profit Bank service charges Uncollectible accounts expense Salary and wages expense Office supplies expense Insurance expense Utilities expense Depreciation expense Income before income tax Income taxes expense Net income $ $ $ 225 12,500 395,000 700 7,000 3,600 53,000 $ $ 1,603,200 959,350 643,850

472,025 171,825 81,000 90,825

GUITAR UNIVERSE, INC. Statement of Retained Earnings For the Year Ending December 31, 2009 Retained earnings, January 1, 2009 Add: Net income (from income statement) Ending Retained earnings, December 31, 2009 $ $ 240,200 90,825 331,025

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COMPREHENSIVE PROBLEM 2 GUITAR UNIVERSE, INC. (continued)

k. (continued)
GUITAR UNIVERSE, INC. Balance Sheet As of December 31, 2009 Current assets: Cash Marketable securities Accounts receivable Less: Allowance for doubtful accounts Merchandise inventory Office supplies Prepaid insurance Total current assets Plant and equipment: Building and fixtures Less: Accumulated depreciation Land Total plant and equipment Total assets Liabilities Current liabilities: Accounts payable Unearned customer deposits Income taxes payable Total current liabilities Long-term liabilities: Total liabilities Stockholders' Equity Capital stock Retained earnings (from statement of retained earnings) Unrealized holding gain on investments Total stockholders' equity Total Liabilities and Stockholders' Equity $ $ 127,500 (8,500) 42,475 27,500 119,000 248,650 900 6,000 444,525

1,791,000 (805,000) $ $

986,000 64,800 1,050,800 1,495,325

70,000 4,800 81,000 155,800 0 155,800

$ $

1,000,000 331,025 8,500 1,339,525 1,495,325

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COMPREHENSIVE PROBLEM 2 GUITAR UNIVERSE, INC. (concluded)

l. Step 1: Compute accounts receivable turnover (sales average accounts receivable) $1,603,200 $119,000* = 13.5 times *Ending accounts receivable is assumed to be a close approximation for average accounts receivable for this company. Step 2: Compute accounts receivable days (365 accounts receivable turnover) 365 13.5 = 27 days m. Step 1: Compute inventory turnover (cost of goods sold average merchandise inventory) $959,350 $248,650* = 3.9 times *Ending merchandise inventory is assumed to be a close approximation for average merchandise inventory for this company. Step 2: Compute inventory days (365 inventory turnover) 365 3.9 = 94 days

n.
Accounts receivable days (from part l above) Add: inventory days (from part m above) Operating cycle 27 days 94 days 121 days

o.

From a short-term creditors perspective, the company appears relatively solvent. It collects its accounts receivable in less than 30 days, and its uncollectible accounts expense represents a relatively small percentage of its total sales figures. However, it may be stocking too much inventory, as evidenced by a 94-day average inventory days figure. Students are advised to compare this figure to industry average statistics.

Note to instructor: The companys quick and current ratios also appear relatively strong, which provides additional evidence of the companys ability to meet its current obligations (quick ratio = 1.21:1; current ratio = 2.85:1).

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