Continuing Cookie Chronicle 1 CONTINUING COOKIE CHRONICLE CCC1 Natalie Koebel spent much of her childhood learning the art of cookie-making from The Continuing Cookie her grandmother. They passed many happy hours mastering every type of cookie imaginable Chronicle starts in this chapter and later creating new recipes that were both healthy and delicious. Now at the start of her sec- and continues in every chapter. ond year in college, Natalie is investigating various possibilities for starting her own business as part of the requirements of the entrepreneurship program in which she is enrolled. A long-time friend insists that Natalie has to somehow include cookies in her business plan. After a series of brainstorming sessions, Natalie settles on the idea of operating a cookie- making school. She will start on a part-time basis and offer her services in people’s homes. Now that she has started thinking about it, the possibilities seem endless. During the fall, she will concentrate on holiday cookies. She will offer individual lessons and group sessions (which will probably be more entertainment than education for the participants). Natalie also decides to include children in her target market. Natalie hopes that during her remaining 3 years at college she is able to become a compe- tent businessperson. Upon graduation, her plan is either to expand the business into a full-time career or to transfer ownership to another student. The first difficult decision is coming up with the perfect name for her business. In the end, she settles on “Cookie Creations” and then moves on to more important issues. Instructions (a) What form of business organization—proprietorship, partnership, or corporation—do you recommend that Natalie use for her business? Discuss the benefits and weaknesses of each form and give the reasons for your choice. (b) Will Natalie need accounting information? If yes, what information will she need and why? How often will she need this information? (c) If Natalie chooses the corporate form of organization, identify specific asset, liability, and equity accounts that Cookie Creations will likely use to record its business transactions. (d) Should Natalie open a separate bank account for the business? Why or why not? 2 Continuing Cookie Chronicle CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapter 1.) CCC2 After researching the different forms of business organization, Natalie Koebel decides to operate “Cookie Creations” as a corporation. She then starts the process of getting the busi- ness running. In November 2007, the following activities take place. Nov. 8 Natalie invests $500 in exchange for common stock. 11 Natalie pays $165 to have advertising brochures and posters printed. She plans to dis- tribute these as opportunities arise. (Hint: Use Advertising Supplies.) 13 She buys baking supplies, such as flour, sugar, butter, and chocolate chips, for $125 cash. 14 Natalie starts to gather some baking equipment to take with her when teaching the cookie classes. She has an excellent top-of-the-line food processor and mixer that orig- inally cost her $750. Natalie decides to start using it only in her new business. She esti- mates that the equipment is currently worth $400. She exchanges the equipment for common stock. 16 Natalie realizes that her initial cash investment is not enough. Her grandmother lends her $2,000 cash, for which Natalie signs a note payable in the name of the business. (Hint: The note does not have to be repaid for 24 months. As a result, the notes payable should be reported in the accounts as the last liability and also on the balance sheet as the last liability.) 17 She buys more baking equipment for $900 cash. 20 She teaches her first class and collects $125 cash. 25 Natalie books a second class for December 4 for $125. She receives $25 cash in advance as a down payment. 30 Natalie pays $1,320 for a one-year insurance policy that will expire on December 1, 2008. Instructions (a) Prepare journal entries to record the November transactions. (b) Post the journal entries to general ledger accounts. (c) Prepare a trial balance at November 30. Continuing Cookie Chronicle 3 CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 and 2. Use the informa- tion from the previous chapters and follow the instructions below using the general ledger accounts you have already prepared.) CCC3 It is the end of November and Natalie has been in touch with her grandmother. Her grandmother asked Natalie how well things went in her first month of business. Natalie, too, would like to know if she has been profitable or not during November. Natalie realizes that in order to determine Cookie Creations’ income, she must first make adjustments. Natalie puts together the following additional information. 1. A count reveals that $75 of brochures and posters remain at the end of November. 2. A count reveals that $35 of baking supplies were used during November. 3. Natalie estimates that all of her baking equipment will have a useful life of 5 years or 60 months and zero salvage value. (Assume Natalie decides to record a full month’s worth of deprecia- tion, regardless of when the equipment was obtained by the business. Round to the nearest dollar.) 4. Natalie’s grandmother has decided to charge interest of 6% on the note payable extended on November 16. The loan plus interest is to be repaid in 24 months. (Assume that half a month of interest accrued during November.) 5. On November 30, a friend of Natalie’s asks her to teach a class at the neighborhood school. Natalie agrees and teaches a group of 35 first-grade students how to make Santa Claus cookies. The next day, Natalie prepares an invoice for $250 and leaves it with the school prin- cipal. The principal says that he will pass the invoice along to the head office, and it will be paid sometime in December. 6. Natalie receives a cellphone bill for $45. She uses her cellphone only for business. The bill is for services provided during November and is due December 15. Instructions Using the information that you have gathered through Chapter 2, and based on the new infor- mation above, do the following. (a) Prepare and post the adjusting journal entries. (b) Prepare an adjusted trial balance. (c) Using the adjusted trial balance, prepare Cookie Creations’ income statement for the month of November. 4 Continuing Cookie Chronicle CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapter 1 through 3.) CCC4 Natalie had a very busy December.At the end of the month, after journalizing and post- ing the December transactions and adjusting entries. Natalie prepared the following adjusted trial balance. COOKIE CREATIONS Adjusted Trial Balance December 31, 2007 Debit Credit Cash $1,130 Accounts Receivable 875 Baking Supplies 350 Prepaid Insurance 1,210 Baking Equipment 1,300 Accumulated Depreciation—Baking Equipment $ 43 Accounts Payable 75 Wages Payable 56 Interest Payable 15 Unearned Revenue 300 Notes Payable 2,000 Common Stock 900 Dividends 500 Teaching Revenue 4,315 Wages Expense 856 Telephone Expense 125 Advertising Supplies Expense 165 Baking Supplies Expense 1,025 Depreciation Expense 43 Insurance Expense 110 Interest Expense 15 $7,704 $7,704 Instructions Using the information in the adjusted trial balance, do the following. (a) Prepare an income statement and a retained earnings statement for the 2 months ended December 31, 2007, and a classified balance sheet as of December 31, 2007. The note payable has a stated interest rate of 6%, and the principal and interest are due on November 16, 2009. (b) Natalie has decided that her year-end will be December 31, 2007. Prepare and post closing entries as of December 31, 2007. (c) Prepare a post-closing trial balance. Continuing Cookie Chronicle 5 CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 4. From the in- formation gathered in the previous chapters, follow the instructions below using the general ledger accounts you have already prepared.) CCC5 Because Natalie has had such a successful first few months, she is considering other opportunities to develop her business. One opportunity is the sale of fine European mixers. The owner of Kzinski Supply Co. has approached Natalie to become the exclusive distributor of these fine mixers in her state. The current cost of a mixer is approximately $525, and Natalie would sell each one for $1,050. Natalie comes to you for advice on how to account for these mixers. Each appliance has a serial number and can be easily identified. Natalie asks you the following questions. 1. “Would you consider these mixers to be inventory? Or should they be classified as supplies or equipment?” 2. “I’ve learned a little about keeping track of inventory using both the perpetual and the periodic systems of accounting for inventory. Which system do you think is better? Which one would you recommend for the type of inventory that I want to sell?” 3. “How often do I need to count inventory if I maintain it using the perpetual system? Do I need to count inventory at all?” In the end, Natalie decides to use the perpetual inventory system. The following transac- tions happen during the month of January. Jan. 4 Bought five mixers on account from Kzinski Supply Co. for $2,625, FOB shipping point, terms n/30. 6 Paid $100 freight on the January 4 purchase. 7 Returned one of the mixers to Kzinski because it was damaged during shipping. Kzinski issues Cookie Creations credit for the cost of mixer plus $20 for the cost of freight that was paid on January 6 for one mixer. 8 Collected $375 of the accounts receivable from December 2007. 12 Three mixers are sold on account for $3,150, FOB destination, terns n/30. (Cost of goods sold is $545 per mixer.) 14 Paid the $75 of delivery charges for the three mixers that were sold on January 12. 14 Bought four mixers on account from Kzinski Supply Co. for $2,100, FOB shipping point, terms n/30. 17 Natalie is concerned that there is not enough cash available to pay for all of the mixers purchased. She invests an additional $1,000 cash in Cookie Creations. 18 Paid $80 freight on the January 14 purchase. 20 Sold two mixers for $2,100 cash. (Cost of goods sold is $545 per mixer.) 28 Natalie issued a check to her assistant for all the help the assistant has given her during the month. Her assistant worked 20 hours in January and is also paid the $56 owed at December 31, 2007. Natalie’s assistant earns $8 an hour. 28 Collected the amounts due from customers for the January 12 transaction. 30 Paid a $145 cellphone bill ($75 for the December 2007 account payable and $70 for the month of January). (Recall that the cellphone is used only for business purposes.) 31 Paid Kzinski all amounts due. 31 Cash dividends of $750 are paid. As of January 31, the following adjusting entry data is available. 1. A count of baking supplies reveals that none were used in January. 2. Another month’s worth of depreciation needs to be recorded on the baking equipment bought in November. (Recall that the baking equipment has a useful life of 5 years or 60 months and no salvage value. Round to the nearest dollar.) 3. An additional month’s worth of interest on her grandmother’s loan needs to be accrued. (The interest rate is 6%.) 4. During the month, $110 of insurance has expired. 5. An analysis of the unearned revenue account reveals that Natalie has not had time to teach any of these lessons this month because she has been so busy selling mixers. As a result, there is no change to the unearned revenue account. Natalie hopes to complete the remaining lessons in February. 6 Continuing Cookie Chronicle Instructions Using the information from previous chapters and the new information above, do the following. (a) Answer Natalie’s questions. (b) Prepare and post the January 2008 transactions. (c) Prepare a trial balance. (d) Prepare and post the adjusting journal entries required. (e) Prepare an adjusted trial balance. (f) Prepare a multiple-step income statement for the month ended January 31, 2008. Continuing Cookie Chronicle 7 CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 5.) CCC6 Natalie is busy establishing both divisions of her business (cookie classes and mixer sales) and completing her business degree. Her goals for the next 11 months are to sell one mixer per month and to give two to three classes per week. The cost of the fine European mixers is expected to increase. Natalie has just negotiated new terms with Kzinski that include shipping costs in the negotiated purchase price (mixers will be shipped FOB destination). Assume that Natalie has decided to use a periodic inventory system and now must choose a cost flow assumption for her mixer inventory. The following transactions occur in February to May 2008. Feb. 2 Natalie buys two deluxe mixers on account from Kzinski Supply Co. for $1,100 ($550 each), FOB destination, terms n/30. 16 She sells one deluxe mixer for $1,050 cash. 25 She pays the amount owed to Kzinski. Mar. 2 She buys one deluxe mixer on account from Kzinski Supply Co. for $567, FOB destination, terms n/30. 30 Natalie sells two deluxe mixers for a total of $2,100 cash. 31 She pays the amount owed to Kzinski. Apr. 1 She buys two deluxe mixers on account from Kzinski Supply Co. for $1,122 ($561 each), FOB destination, terms n/30. 13 She sells three deluxe mixers for a total of $3,150 cash. 30 Natalie pays the amounts owed to Kzinski. May 4 She buys three deluxe mixers on account from Kzinski Supply Co. for $1,720 ($573.33 each), FOB destination, terms n/30. 27 She sells one deluxe mixer for $1,050 cash. Instructions (a) Determine the cost of goods available for sale. Recall from Chapter 5 that at the end of January, Cookie Creations had three mixers on hand at a cost of $545 each. (b) Calculate (i) ending inventory, (ii) cost of goods sold, (iii) gross profit, and (iv) gross profit rate under each of the following methods: LIFO, FIFO, and average cost. 8 Continuing Cookie Chronicle CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 6.) CCC7 Natalie’s biggest competitor is Trial Appliances. Trial Appliances sells a fine European mixer similar to the one that customers are able to buy from Cookie Creations. Natalie estimates that Trial Appliances sells twice as many mixers as she does. Trial Appliances also sells other appliances. Natalie believes that one of the major reasons Trial Appliances sells the number of mixers that it does is because it sells all of its appliances on an extended payment plan. Natalie knows that Trial Appliances sells its mixers for $1,100. She also knows that under the extended payment plan approximately $275 (25%) is collected in the year the mixer is sold, $550 (50%) is collected the year after the appliance is sold, and the remaining $275 (25%) is collected in the third year. Trial Appliances sells approximately 65 mixers a year and tries to keep a gross profit margin of approximately 50%. Natalie comes to you to ask about the accounting for revenues when mixers are sold on an ex- tended payment plan. She would really like to generate more sales revenues and cash flow. Based on her discussions with the sales manager at Trial Appliances, she believes that she could sell more mix- ers if she offered her customers the option of paying over an extended period of time. Natalie asks you the following questions. 1. “I currently sell 32 mixers a year at $1,025 apiece. My cost of goods sold averages $566 per mixer. What is my gross profit rate?” 2. “I’ve heard that sometimes revenue cannot be recorded until the cash is collected. What are the guidelines that determine when revenue should be recorded? How will these guidelines affect me if I start selling mixers on an extended payment plan?” 3. “What are some of the advantages and disadvantages of giving my customers the option of paying through an extended payment plan?” Instructions (a) Answer Natalie’s questions. (b) Do you think Natalie should offer her customers the option of paying through an extended payment plan? Why or why not? Continuing Cookie Chronicle 9 CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 7.) CCC8 Part 1 Natalie is struggling to keep up with the recording of her accounting transac- tions. She is spending a lot of time marketing and selling mixers and giving her cookie classes. Her friend John is an accounting student who runs his own accounting service. He has asked Natalie if she would like to have him do her accounting. John and Natalie meet and discuss her business. John suggests that he do the following for Natalie. 1. Hold cash until there is enough to be deposited. (He would keep the cash locked up in his vehicle). He would also take all of the deposits to the bank at least twice a month. 2. Write and sign all of the checks. 3. Record all of the deposits in the accounting records. 4. Record all of the checks in the accounting records. 5. Prepare the monthly bank reconciliation. 6. Transfer all of Natalie’s manual accounting records to his computer accounting program. John maintains all of the accounting information that he keeps for his clients on his laptop computer. 7. Prepare monthly financial statements for Natalie to review. 8. Write himself a check every month for the work he has done for Natalie. Instructions Identify the weaknesses in internal control that you see in the system John is recommending. Can you suggest any improvements if Natalie hires John to do the accounting? Part 2 Natalie decides that she cannot afford to hire John to do her accounting. One way that she can ensure that her cash account does not have any errors and is accurate and up-to-date is to prepare a bank reconciliation at the end of each month. Natalie would like you to help her. She asks you to prepare a bank reconciliation for June 2008 using the following information. GENERAL LEDGER—COOKIE CREATIONS Cash Date Explanation Ref. Debit Credit Balance 2008 June 1 Balance 2,657 1 750 3,407 3 Check #600 625 2,782 3 Check #601 95 2,687 8 Check #602 56 2,631 9 1,050 3,681 13 Check #603 425 3,256 20 155 3,411 28 Check #604 247 3,164 28 110 3,274 10 Continuing Cookie Chronicle PREMIER BANK Statement of Account—Cookie Creations June 30, 2008 Checks and Date Explanation Other Debits Deposits Balance May 31 Balance 3,256 June 1 Deposit 750 4,066 6 Check #600 625 3,381 6 Check #601 95 3,286 8 Check #602 56 3,230 9 Deposit 1,050 4,280 10 NSF check 100 10 NSF—fee 35 4,145 14 Check #603 452 3,693 20 Deposit 125 3,818 23 EFT—Telus 85 3,733 28 Check #599 361 3,372 30 Bank charges 13 3,359 Additional information: 1. On May 31, there were two outstanding checks: #595 for $238 and #604 for $247. 2. Premier Bank made a posting error to the bank statement: check #603 was issued for $425, not $452. 3. The deposit made on June 20 was for $125 that Natalie received for teaching a class. Natalie made an error in recording this transaction. 4. The electronic funds transfer (EFT) was for Natalie’s cellphone use. Remember that she uses this phone only for business. 5. The NSF check was from Ron Black. Natalie received this check for teaching a class to Ron’s children. Natalie contacted Ron, and he assured her that she will receive a check in the mail for the outstanding amount of the invoice and the NSF bank charge. Instructions (a) Prepare Cookie Creations’ bank reconciliation for June 30. (b) Prepare any necessary adjusting entries at June 30. (c) If a balance sheet is prepared for Cookie Creations at June 30, what balance will be reported as cash in the current assets section? Continuing Cookie Chronicle 11 CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 8.) CCC9 One of Natalie’s friends, Curtis Lesperance, runs a coffee shop where he sells specialty coffees and prepares and sells muffins and cookies. He is eager to buy one of Natalie’s fine European mixers, which would enable him to make larger batches of muffins and cookies. However, Curtis cannot afford to pay for the mixer for at least 30 days. He asks Natalie if she would be willing to sell him the mixer on credit. Natalie comes to you for advice. She asks the following questions. 1. “Curtis has given me a set of his most recent financial statements. What calculations should I do with the data from these statements, and what questions should I ask him after I have an- alyzed the statements? How will this information help me decide if I should extend credit to Curtis?” 2. “Is there an alternative other than extending credit to Curtis for 30 days?” 3. “I am thinking seriously about being able to have my customers use credit cards. What are some of the advantages and disadvantages of letting my customers pay by credit card?” The following transactions occurred in June through August 2008. June 1 After much thought, Natalie sells a mixer to Curtis on credit, terms n/30, for $1,050 (cost of mixer $566). 30 Curtis calls Natalie. He is unable to pay the amount outstanding for another month, so he signs a one-month, 8.25% note receivable. July 31 Curtis calls Natalie. He indicates that he is unable to pay today but hopes to have a check for her at the end of the week. Natalie prepares the journal entry to record the dishonoring of the note. She assumes she will be paid within a week. Aug. 7 Natalie receives a check from Curtis in payment of his balance owed. Instructions (a) Answer Natalie’s questions. (b) Prepare journal entries for the transactions that occurred in June, July, and August. (The company uses a perpetual inventory system) 12 Continuing Cookie Chronicle CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 9.) CCC10 Natalie is thinking of buying a van that will be used only for business. The cost of the van is estimated at $34,500. Natalie would spend an additional $2,500 to have the van painted. In addition, she wants the back seat of the van removed so that she will have lots of room to trans- port her mixer inventory as well as her baking supplies. The cost of taking out the back seat and installing shelving units is estimated at $1,500. She expects the van to last about 5 years, and she expects to drive it for 200,000 miles. The annual cost of vehicle insurance will be $2,400. Natalie estimates that at the end of the 5-year useful life the van will sell for $6,500. Assume that she will buy the van on August 15, 2008, and it will be ready for use on September 1, 2008. Natalie is concerned about the impact of the van’s cost on her income statement and balance sheet. She has come to you for advice on calculating the van’s depreciation. Instructions (a) Determine the cost of the van. (b) Prepare three depreciation tables for 2008, 2009 and 2010: one for straight-line depreciation (similar to the one in Illustration 10-10), one for double-declining balance depreciation (Illustration 10-14), and one for units-of-activity depreciation (Illustration 10-12). For units- of-activity, Natalie estimates she will drive the van as follows: 15,000 miles in 2008; 45,000 miles in 2009; 50,000 miles in 2010; 45,000 miles in 2011; 35,000 miles in 2012; and 10,000 miles in 2013. Recall that Cookie Creations has a December 31 fiscal year-end. (c) What impact will the three methods of depreciation have on Natalie’s balance sheet at December 31, 2008? What impact will the three methods have on Natalie’s income statement in 2008? (d) What impact will the three methods of depreciation have on Natalie’s income statement over the van’s total 5-year useful life? (e) What method of depreciation would you recommend Natalie use? Continuing Cookie Chronicle 13 CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 10.) CCC11 Natalie is thinking of repaying all amounts outstanding to her grandmother. Recall that Cookie Creations borrowed $2,000 on November 16, 2007, from Natalie’s grandmother. Interest on the note is 6% per year, and the note plus interest was to be repaid in 24 months. Recall that a monthly adjusting journal entry was prepared for the months of November 2007 (1/2 month), December 2007, and January 2008. Instructions (a) Calculate the interest payable that was accrued and recorded to July 31, 2008, assuming monthly adjusting entries were made. (b) Prepare the journal entry at August 31, 2008, to record one month's accrued interest. (c) Natalie repays her grandmother on September 15, 2008—10 months after her grandmother extended the loan to Cookie Creations. Prepare the journal entry for the loan repayment. 14 Continuing Cookie Chronicle CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 11.) CCC12 Natalie and her friend Curtis Lesperance decide they can benefit from joining Cookie Creations and Curtis’s coffee shop. They come to you with questions. Part 1 Curtis has operated his coffee shop for 2 years. He buys coffee, muffins, and cookies from a local supplier. Natalie’s business consists of giving cookie-making classes and selling fine European mixers. The plan is for Natalie to use the premises Curtis currently rents to give her cooking-making classes and demonstrations of the mixers that she sells. Natalie will also hire, train, and supervise staff to bake the cookies and muffins sold in the coffee shop. By offering her classes on the premises, Natalie will save on travel time going from one place to another.Another advantage is that the coffee shop will have one central location for selling the mixers. The current market values of the assets of both businesses are as follows. Curtis’s Coffee Cookie Creations Cash $7,500 $10,000 Accounts receivable 100 500 Merchandise inventory 450 1,130 Equipment 2,500 1,000* *Cookie Creations decided not to buy the delivery van considered in Chapter 10. Combining forces will also allow Natalie and Curtis to pool their resources and buy a few more assets to run their new business venture. Curtis and Natalie then meet with a lawyer and form a corporation on November 1, 2008, called Cookie & Coffee Creations Inc. The articles of incorporation state that there will be two classes of shares that the corporation is authorized to issue: common shares and preferred shares. They authorize 100,000 no-par shares of common stock, and 10,000 no-par shares of preferred stock with a $0.50 noncumulative dividend. The assets held by each business will be transferred into the new corporation at current mar- ket value. Curtis will receive 10,550 common shares, and Natalie will receive 12,630 common shares in the corporation. Therefore, the shares have a fair value of $1 per share. Natalie and Curtis are very excited about this new business venture. They come to you with the following questions: 1. “Curtis’s dad and Natalie’s grandmother are interested in investing $5,000 each in the busi- ness venture. We are thinking of issuing them preferred shares. What would be the advantage of issuing them preferred shares instead of common shares?” 2. “Our lawyer has sent us a bill for $750. When we discussed the bill with her, she indicated that she would be willing to receive common shares in our new corporation instead of cash for her services. We would be happy to issue her shares, but we’re a bit worried about accounting for this transaction. Can we do this? If so, how do we determine how many shares to give her?” Instructions (a) Answer their questions. (b) Prepare the journal entries required on November 1, 2008, the date when Natalie and Curtis transfer the assets of their respective businesses into Cookie & Coffee Creations Inc. (c) Assume that Cookie & Coffee Creations Inc. issues 1,000 $0.50 noncumulative preferred shares to Curtis’s dad and the same number to Natalie’s grandmother, in both cases for $5,000. Also assume that Cookie & Coffee Creations Inc. issues 750 common shares to its lawyer. Prepare the journal entries for each of these transactions. They all occurred on November 1. (d) Prepare the opening balance sheet for Cookie & Coffee Creations Inc. as of November 1, 2008, including the journal entries in (b) and (c) above. Part 2 After establishing their company’s fiscal year-end to be October 31, Natalie and Curtis begin operating Cookie & Coffee Creations Inc. on November 1, 2008. On that date, after the issue of shares, the paid-in capital section of the company’s balance sheet is as follows. Paid-in capital Preferred stock, $0.50 noncumulative, no par value, 10,000 shares authorized, 2,000 issued $10,000 Common stock, no par value, 100,000 shares authorized, 23,930 issued 23,930 Continuing Cookie Chronicle 15 Cookie & Coffee Creations then has the following selected transactions during its first year of operations. Dec. 1 Issues an additional 500 preferred shares to Natalie’s brother for $2,500. Apr. 30 Declares a semiannual dividend to the preferred stockholders of record on May 15, payable on June 1. June 1 Pays the preferred dividend. June 30 Repurchases 750 shares of common stock issued to the lawyer, for $500. Recall that these were originally issued for $750. The lawyer had decided to retire and wanted to liquidate all of her assets. Oct. 31 The company has had a very successful first year of operations. It earned revenues of $462,500 and incurred expenses of $370,000 (including $750 legal fee, but excluding income tax). Records income tax expense. (The company has a 20% income tax rate.) 31 Declares a semiannual dividend to the preferred stockholders of record on November 15, payable on December 1. Instructions (a) Prepare the journal entries to record the above transactions. (b) Prepare the statement of retained earnings for the year. (c) Prepare the stockholders’ equity section of the balance sheet as of October 31. (d) Prepare closing entries. (e) Calculate the earnings per share. Assume weighted-average shares of 23,680. 16 Continuing Cookie Chronicle CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 12.) CCC 13 Natalie has been approached by Ken Thornton, a shareholder in The Beanery Coffee Inc. Ken wants to retire and would like to sell his 1,000 shares in The Beanery Coffee, which rep- resent 20% of all shares issued. The Beanery is currently operated by Ken’s twin daughters, each of whom owns 40% of the common shares. The Beanery not only operates a coffee shop but also roasts and sells beans ro retailers, under the name “Rocky Mountain Beanery.” The business has been operating for approximately 5 years. In the last 2 years Ken has lost interest and left the day-to-day operations to his daughters. Both daughters at times find the work at the coffee shop overwhelming. They would like to have a third shareholder involved to take over some of the responsibilities of running a small business. Both feel that Natalie and Curtis are entrepreneurial in spirit and that their expertise would be a welcome addition to the business operation. The twins have also said that they plan to operate this business for another 10 years and then retire. Ken has met with Curtis and Natalie to discuss the business operation. They have concluded that there would be many advantages for Cookie & Coffee Creations Inc. to acquire an interest in The Beanery Coffee. One of the major advantages would be volume discounts for purchases of the coffee bean inventory. Despite the apparent advantages, Natalie and Curtis are still not convinced that they should participate in this business venture. They come to you with the following questions. 1. “We are a little concerned about how much influence we would have in the decision-making process for The Beanery Coffee. Would the amount of influence we have affect how we would account for this investment?” 2. “Can you think of other advantages of going ahead with this investment?” 3. “Can you think of any disadvantages of going ahead with this investment?” Instructions (a) Answer Natalie and Curtis’s questions. (b) Assume that Ken wants to sell his 1,000 shares of The Beanery Coffee for $15,000. Prepare the journal entry required if Cookie & Coffee Creations Inc. buys Ken’s shares. (c) Assume that Cookie & Coffee Creations Inc. buys the shares and in the following year The Beanery Coffee earns $50,000 net income and pays $25,000 in dividends. Prepare the journal entries required under both the cost method and the equity method of accounting for this investment. (d) Identify where this investment would be classified on the balance sheet of Cookie & Coffee Creations Inc. and explain why. What amount would appear on the balance sheet under each of the methods of accounting for the investment? Continuing Cookie Chronicle 17 CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 13.) CCC14 Natalie has prepared the balance sheet and income statement of Cookie & Coffee Creations Inc. for the first year of operations, but does not understand how to prepare the cash flow statement. The income statement and balance sheet appear on the next page. Recall that the company started operations on November 1, 2008, so all of the opening balances are zero. Additional information: 1. The company bought kitchen equipment (a commercial oven) for $14,000 on November 1, 2008, and signed a $9,000 note payable to help pay for it. The terms provide for semiannual fixed principal payments of $1,500 on May 1 and November 1 of each year, plus interest of 5%. All other furniture, fixture, and equipment were purchased during the year for cash. 2. Recall from Chapter 12 that the company originally issued 23,930 common shares for $23,930, of which 750 shares were repurchased from the lawyer for $500. COOKIE & COFFEE CREATIONS INC. Income Statement Year Ended October 31, 2009 Sales $462,500 Cost of goods sold 231,250 Gross profit 231,250 Operating expenses Depreciation expense $ 9,850 Salaries and wages expense 92,500 Other operating expenses 35,987 138,337 Income from operations 92,913 Other expenses Interest expense 413 Income before income tax 92,500 Income tax expense 18,500 Net income $ 74,000 COOKIE & COFFEE CREATIONS INC. Balance Sheet October 31, 2009 Assets Current assets Cash $29,294 Accounts receivable 3,250 Inventory 17,897 Prepaid expenses 6,300 $ 56,741 Property, plant, and equipment Furniture and fixtures $12,500 Accumulated depreciation—furniture and fixtures (1,250) 11,250 Computer equipment 4,200 Accumulated depreciation—computer equipment (600) 3,600 Kitchen equipment 80,000 Accumulated depreciation—kitchen equipment (8,000) 72,000 86,850 Total assets $143,591 18 Continuing Cookie Chronicle Liabilities and Stockholders’ Equity Current liabilities Accounts payable $ 5,848 Income tax payable 18,500 Dividends payable 625 Salaries payable 2,250 Interest payable 188 Note payable—current portion 3,000 $ 30,411 Long-term liabilities Note payable—long-term portion 4,500 Total liabilities 34,911 Stockholders’ equity Paid-in capital Preferred stock, 2,500 shares issued and outstanding $ 12,500 Common stock, 23,930 shares issued, 23,180 outstanding 23,930 36,430 Retained earnings 72,750 Total paid-in capital and retained earnings 109,180 Less: Treasury stock—common (750 shares), at cost (500) Total stockholders’ equity 108,680 Total liabilities and stockholders’ equity $143,591 3. Recall from Chapter 12 that the company declared a semiannual dividend to the preferred stockholders on April 30, and the dividend was paid on June 1. The second semiannual divi- dend was declared to the preferred stockholders on October 31, to be paid on December 1. 4. Prepaid expenses relate only to operating expenses. Instructions Prepare a cash flow statement, using (a) the indirect method OR (b) the direct method, as as- signed by your instructor. Continuing Cookie Chronicle 19 CONTINUING COOKIE CHRONICLE (Note: This is a continuation of the Cookie Chronicle from Chapters 1 through 14.) CCC15 The balance sheet and income statement of Cookie & Coffee Creations Inc. for its first year of operations, the year ended October 31, 2009, follows. COOKIE & COFFEE CREATIONS INC. Balance Sheet October 31, 2009 Assets Current assets Cash $29,294 Accounts receivable 3,250 Merchandise inventory 17,897 Prepaid expenses 6,300 $ 56,741 Property, plant, and equipment Furniture and fixtures $ 12,500 Accumulated depreciation—furniture and fixtures (1,250) 11,250 Computer equipment 4,200 Accumulated depreciation—computer equipment (600) 3,600 Kitchen equipment 80,000 Accumulated depreciation—kitchen equipment (8,000) 72,000 86,850 Total assets $143,591 Liabilities and Stockholders’ Equity Current liabilities Accounts payable $ 5,848 Income tax payable 18,500 Dividends payable 625 Salaries payable 2,250 Interest payable 188 Note payable—current portion 3,000 $ 30,411 Long-term liabilities Note payable—long-term portion 4,500 Total liabilities 34,911 Stockholders’ equity Paid-in capital Preferred stock, 2,500 shares issued $12,500 Common stock, 23,930 shares issued, 23,180 outstanding 23,930 36,430 Retained earnings 72,750 Total paid-in capital and retained earnings 109,180 Less: Treasury stock—common (750 shares), at cost (500) Total stockholders’ equity 108,680 Total liabilities and stockholders’ equity $143,591 20 Continuing Cookie Chronicle COOKIE & COFFEE CREATIONS INC. Income Statement Year Ended October 31, 2009 Sales $462,500 Cost of goods sold 231,250 Gross profit 231,250 Operating expenses Depreciation expense $ 9,850 Salaries and wages expense 92,500 Other operating expenses 35,987 138,337 Income from operations 92,913 Other expenses Interest expense 413 Income before income tax 92,500 Income tax expense 18,500 Net income $ 74,000 Additional information: Natalie and Curtis are thinking about borrowing an additional $20,000 to buy more kitchen equipment. The loan would be repaid over a 4-year period. The terms of the loan provide for equal semiannual installment payments of $2,500 on May 1 and November 1 of each year, plus interest of 5% on the outstanding balance. Dividends on preferred stock were $1,250. Since this is the first year of operations and the begining balances are zero, use the ending balance as the average balance where appropriate. Instructions (a) Calculate the following ratios. 1. Current ratio 6. Gross profit margin 2. Receivables turnover 7. Profit margin 3. Inventory turnover 8. Asset turnover 4. Debt to total assets 9. Return on assets 5. Times interest earned 10. Return on common stockholders’ equity (b) Comment on your findings from part (a). (c) Based on your analysis in parts (a) and (b), do you think a bank would lend Cookie & Coffee Creations Inc. $20,000 to buy the additional equipment? Explain your reasoning. (d) What alternatives could Cookie & Coffee Creations consider instead of bank financing?
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