Question

Party Wagon, Inc., provides musical entertainment at weddings, dances, and various other functions. The company performs adjusting entries monthly, but prepares closing entries annually on December 31. The company recently hired Jack Armstrong as its new accountant. Jack’s first assignment was to prepare an income statement, a statement of retained earnings, and a balance sheet using an adjusted trial balance given to him by his predecessor, dated December 31, current year.

From the adjusted trial balance, Jack prepared the following set of financial statements.

PARTY WAGON, INC.
Income Statement
For the Year Ended December 31, Current Year
Revenue:
Party revenue earned					$	156,000
Unearned party revenue						2,160
Accounts receivable						10,800
Total revenue					$	168,960
Expenses:
Insurance expense	$	2,160
Office rent expense		14,400
Supplies expense		1,440
Dividends		1,200
Salary expense		90,000
Accumulated depreciation: van		19,200
Accumulated depreciation: equipment and music		16,800
Repair and maintenance expense		2,400
Travel expense		7,200
Miscellaneous expense		4,320
Interest expense		5,280				164,400
Income before income taxes					$	4,560
Income taxes payable						480
Net income					$	4,080

PARTY WAGON, INC.
Statement of Retained Earnings
For the Year Ended December 31, Current Year
Retained earnings (per adjusted trial balance)	$	18,000
Add: Income		4,080
Less: Income taxes expense		2,400
Retained earnings Dec. 31, current year	$	19,680

PARTY WAGON, INC.
Balance Sheet
December 31, Current Year
Assets
Cash					$	18,000
Supplies						600
Van	$	48,000
Less: Depreciation expense: van		9,600				38,400
Equipment and music	$	42,000
Less: Depreciation expense: music and equipment		8,400				33,600
Total assets					$	90,600
Liabilities & Stockholders' equity
Liabilities:
Accounts payable					$	8,400
Notes payable						46,800
Salaries payable						1,920
Prepaid rent						2,400
Unexpired insurance						5,400
Total liabilities					$	64,920
Stockholders' equity:
Capital stock						6,000
Retained earnings						19,680
Total stockholders' equity					$	25,680
Total liabilities and stockholders' equity					$	90,600

Required:

a. Prepare a corrected set of financial statements dated December 31, current year. (You may assume that all of the figures in the company’s adjusted trial balance were reported correctly except for Interest Payable of $240, which was mistakenly omitted in the financial statements prepared by Jack.)

b. Prepare the necessary year-end closing entries.

c. Using the financial statements prepared in part a, briefly evaluate the company’s profitability and liquidity. (No transactions affected the capital stock account during the year.)

Answer 1

Solution:-

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c.         For the year ended December 31, Current Year, the company generated net income of $8,400 on $156,000 sales. Thus, net income as a percentage of sales was approximately 5.4%. Moreover, the $8,400 profit represented a 30.4% return on average stockholders’ equity ($24,000 + $31,200)/2), which is a fairly strong return on investment. The company’s balance sheet at December 31, Current Year, reports cash and accounts receivable totaling $28,800. It also reports various payables (liabilities) totaling $60,000. Thus, the company may or may not currently be liquid depending on when the $46,800 note payable reported in the balance sheet is due. If this obligation is not due in the near future, then the company appears to be solvent. If, however, this note is due shortly, the company may experience some cash flow difficulty.