REVIEW PROBLEMS FOR CHAPTERS 2-3 OF INTRODUCTORY ACCOUNTING FOR LAWYERS (2D EDITION)

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1 Legal Accounting Fall 2001 Prof. David W. Clark REVIEW PROBLEMS FOR CHAPTERS 2-3 OF INTRODUCTORY ACCOUNTING FOR LAWYERS (2D EDITION) Giga and Mega Byte are twin 18 year olds who are very entreprenurial. Despite the crash of technology stocks, they decide to use their computer skills to open a business selling computer maintenance and repair services. Their company is named Computer Repair Associates of South Hampton, L.L.C, ( CRASH ). Using the information set out below, prepare a balance sheet for CRASH as of 8/31/01 and an income statement for the month of August. Complete, in detail, each step of the process required to generate these financial statements. 1. On 8/1, Giga contributes to CRASH a computer, tools and miscellaneous other equipment worth $5, Mega contributes $5,000 in cash to CRASH on 8/1. 3. On 8/2 CRASH borrows $10,000 from Kilo Byte, Mega s and Giga s father. CRASH needs the money to help cover expenses during the first year, while the company is building up business.. CRASH gives Kilo Byte a one-year promissory note providing for 6% interest, with interest and principal to be paid at maturity. 4. On 8/3, CRASH signs a one year lease with SLUMLORD, L.L.P ( SLUMLORD ) for a building that CRASH will temporarily use as an office. The lease requires a $500 up-front payment which will be returned at the end of the lease if the building is left in good shape. The rent is $600 per month, but the rent for the first 3 months is not due until October 31, 2001 because the owner of SLUMLORD is a friend of Kilo Byte. However, SLUMLORD requires the last month s rent to be paid at the beginning of the lease to insure SLUMLORD receives its last payment. 5. On 8/5, CRASH purchases miscellaneous tables, chairs, pictures, etc. for $2,500 in cash. These items will be used to decorate CRASH s offices. 6. On 8/7, CRASH purchases $450 worth of computer repair manuals and $1,100 worth of additional computer repair tools from Computers R Us, Inc. ( CRU ). CRASH pays cash for the books, and CRU allows CRASH to charge the tools on store credit. 7. On 8/15, CRASH pays $ cash for three months of advertising on cable television during re-runs of Star Trek. Thus, unless CRASH buys additional advertising, it will end on 11/15/ On 8/16, a customer brings a computer in for repair. On 8/17, the customer picks up the computer and pays CRASH $150 cash.

2 9. On 8/17, another customer hires CRASH to come to the customer s office and upgrade several of the customer s computers. The work is completed on 8/19, and the amount due to CRASH is $1,250. CRASH does not require cash payment because CRASH expects additional business from this customer. Instead, CRASH mails an invoice to the customer. 10. On 8/20, a law firm hires CRASH to install and troubleshoot a computer network system for the law firm s office. The work will be performed in September, and CRASH will charge the law firm $75 per hour. However, CRASH requires that $2,500 be paid immediately, in advance. CRASH is sure its total hourly fee will exceed this advance payment. 11. On 8/29, Mega and Giga agree that Giga can withdraw $501 from the company s noninterest bearing checking account. Giga withdraws the money that day to buy himself a new suit. 12. On 8/31, CRASH pays $550 of the amount it owes CRU.

3 Legal Accounting Fall 2001 Prof. David W. Clark ANSWERS TO THE REVIEW PROBLEMS FOR CHAPTERS 2-3 OF INTRODUCTORY ACCOUNTING AND FINANCE FOR LAWYERS (2 ND EDITION) I. JOURNAL ENTRIES 8/1 EQUIPMENT $5,000 OWNER S EQUITY $5,000 CASH $5,000 OWNER S EQUITY $5,000 8/2 CASH $10,000 NOTES PAYABLE $10,000 8/3 LEASE DEPOSIT $500 CASH $500 PREPAID LEASE $600 CASH $600 8/5 OFFICE FURNITURE $2,500 CASH $2,500 8/7 EQUIPMENT $450 CASH $450 EQUIPMENT $1,100 A/P 1 $1,100 1 A/R, N/R, A/P, and N/P are occasionally used as short-hand for accounts receivable, notes receivable, accounts payable and notes payable.

4 8/15 PREPAID ADVERTISING $750 CASH $750 8/17 CASH $150 FEE INCOME $150 8/19 A/R $1,250 FEE INCOME $1,250 8/20 CASH $2,500 DEFERRED FEE $2,500 8/29 OWNER S EQUITY $501 CASH $501 8/31 A/P $550 CASH $550 2 LEASE EXPENSE $600 LEASE PAYABLE $600 ADVERTISING EXP. $125 3 PREPAID ADVERTISING $125 INTEREST PAYABLE $50 INTEREST EXPENSE $50 2 This entry is made on 8/31 because this entry represents the August portion of the prepaid lease. As of 8/31, 1 month of the prepaid lease asset has been used up and is now entered as a lease expense for 1 month. 3 This entry is made on 8/31 because this entry represents the proportion of the prepaid advertising asset used up in August (½ of 1 month).

5 II. LEDGERS CASH PREPAID ADVERTISING 5, , ,500 ==== OFFICE FURNITURE ,500 2, ,500 11,799 ==== ===== A/R LEASE DEPOSIT 1, , ==== === 600 PREPAID LEASE 600 ==== 5, ,100 6,550 ===== EQUIPMENT

6 A/P OWNER S EQUITY 1,100 5, , ==== 9,499 ==== DEFERRED FEE FEE INCOME 2, ,250 2,500 ==== 1,400 ==== LEASE PAYABLE INTEREST EXPENSE ==== ==== NOTES PAYABLE LEASE EXPENSE 10, , ====== === INTEREST PAYABLE ADVERTISING EXPENSE ==== ===

7 III. TRIAL BALANCE DEBITS CREDITS 11, ,250 2, ,550 10, ,499 2,500 1, ,549 25,549 ====== =====

8 IV. CLOSE OUT TEMPORARY ACCOUNTS (REVENUE AND EXPENSE) TO P&L ACCOUNT AND CLOSE OUT P&L TO OWNER S EQUITY A. CLOSING JOURNAL ENTRIES FOR REVENUES AND EXPENSES 8/31 FEE INCOME 1,400 P&L 1,400 P&L 50 INTEREST EXPENSE 50 P&L 600 LEASE EXPENSE 600 P&L 125 ADVERTISING EXPENSE 125 B. LEDGERS FOR CLOSING OF REVENUE AND EXPENSE ACCOUNTS AND P&L FEE INCOME ADVERTISING EXPENSE 1, , INTEREST EXPENSE P& L ACCOUNT , LEASE EXPENSE The red entries in the revenue and expense accounts are the entries closing out those accounts (offsetting entries are made in the P&L account). The red entry in the P&L account is the entry closing out this account (an offsetting entry is made in the Owner s Equity account).

9 C. CLOSING JOURNAL ENTRY FOR P&L AND FINAL LEDGER FOR OWNER S EQUITY 8/31 P&L 625 RETAINED EARNINGS OWNER S EQUITY 5,000 5, ,124 =====

10 V. INCOME STATEMENT COMPUTER REPAIR ASSOCIATES OF SOUTH HAMPTON, L.L.C. INCOME STATEMENT FOR AUGUST 2001 FEE INCOME 1,400 INTEREST EXPENSE 50 ADVERTISING EXPENSE 125 LEASE EXPENSE 600 (775) NET PROFIT 625 ====

11 VI. BALANCE SHEET COMPUTER REPAIR ASSOCIATES OF SOUTH HAMPTON, L.L.C. BALANCE SHEET FOR AUGUST 31, 2001 ASSETS LIABILITIES Cash 11,799 A/P 550 A/R 1,250 N/P 10,000 Prepaid Lease 600 Deferred Fee 2,500 Prepaid Advertising 625 Lease Payable 600 Lease Deposit 500 Interest Payable 50 Office Furniture 2,500 Equipment 6,550 Total Liabilities 13,700 OWNER S EQUITY Capital Stock 9,499 Retained Earnings Total Owner s Equity 10,124 TOTAL LIABILITIES TOTAL & OWNER S ASSETS 23,824 EQUITY 23,824 ======= ======= POINTS TO PONDER 1. Would you invest in this company? 2. If Mega and Giga decided to split up and dissolve CRASH, what would be the value of the company? 3. Based solely on the information presented in this problem, what future journal entries would be required and how would they affect the balance sheet and income statement? 5 Closing out the P&L account requires a left side entry in the P&L Account and an offsetting right side entry in the Owner s Equity account (increasing Owner s Equity by $625).