On January 1, 2021, the general ledger of Freedom Fireworks includes the following account balances: Accounts Debit Credit
Cash $ 11,200
Accounts Receivable 34,000
Allowance for Uncollectible Accounts $ 1,800
Inventory 152,000
Land 67,300
Buildings 120,000
Accumulated Depreciation 9,600
Accounts Payable 17,700
Common Stock 200,000
Retained Earnings 155,400
Totals $384,500 $384,500
During January 2021, the following transactions occur:
January 1 Borrow $100,000 from Captive Credit Corporation. The installment note bears
interest at 7% annually and matures in 5 years. Payments of $1,980 are required at
the end of each month for 60 months.
January 4 Receive $31,000 from customers on accounts receivable.
January 10 Pay cash on accounts payable, $11,000.
January 15 Pay cash for salaries, $28,900.
January 30 Firework sales for the month total $195,000. Sales include $65,000 for cash and
$130,000 on account. The cost of the units sold is $112,500.
January 31 Pay the first monthly installment of $1,980 related to the $100,000 borrowed on
January 1. Round your interest calculation to the nearest dollar.
Required:
1. Record each of the transactions listed above.
2. Record adjusting entries on January 31.
a. Depreciation on the building for the month of January is calculated using the straightline method. At the time the building was purchased, the company estimated a service life of 10 years and a residual value of $24,000.
b. At the end of January, $3,000 of accounts receivable are past due, and the company estimates that 50% of these accounts will not be collected. Of the remaining accounts receivable, the company estimates that 2% will not be collected. No accounts were written off as uncollectible in January.
c. Unpaid salaries at the end of January are $26,100.
d. Accrued income taxes at the end of January are $8,000.
3. Prepare an adjusted trial balance as of January 31, 2021, after updating beginning balances (above) for transactions during January (requirement 1) and adjusting entries at the end of January (requirement 2).
4. Prepare a multiple-step income statement for the period ended January 31, 2021.
5. Prepare a classified balance sheet as of January 31, 2021. (Hint: The carrying value of notes payable on January 31, 2021 is $98,603; $17,411 is reported as notes payable in the current liabilities section and $81,192 is reported as notes payable in the long-term liabilities section ($17, 411 + $81,192 = $98,603).
6. Record closing entries.
7. Analyze the following for Freedom Fireworks:
a. Calculate the debt to equity ratio. If the average debt to equity ratio for the industry is 1.0, is Freedom Fireworks more or less leveraged than other companies in the same industry?
b. Calculate the times interest earned ratio. If the average times interest earned ratio for the industry is 20 times, is the company more or less able to meet interest payments than other companies in the same industry?
c. Based on the ratios calculated in (a) and (b), would Freedom Fireworks be more likely to receive a higher or lower interest rate than the average borrowing rate in the industry?

Freedom Fireworks

1. Journal Entries:

January 1 Debit Cash $100,000

Credit 7% Note Payable (Captive Credit Corporation) $100,000

To record the issuance of installment note payable with monthly payments of $1,980 for 60 months.

January 4 Debit Cash $31,000

Credit Accounts receivable $31,000

To record the receipt of cash from customers.

January 10 Debit Accounts payable, $11,000

Credit Cash $11,000

To record the payment on account to suppliers.

January 15 Debit Salaries, $28,900

Credit Cash $28,900

To record cash paid for salaries.

January 30 Debit Cash $65,000

Debit Accounts receivable  $130,000

Credit Sales Revenue $195,000

To record sales for cash and on account.

Debit Cost of goods sold $112,500

Credit Inventory $112,500

To record the cost of goods sold.

January 31 Debit  Interest Expense $583

Debit 7% Note Payable $1,397

Credit Cash $1,980

To record the monthly payment for the note payable.

2. Adjusting Journal Entries:

a. Debit Depreciation expense $800

Credit Accumulated Depreciation $800

b. Debit Bad Debts Expense $2,300

Credit Allowance for Uncollectible Accounts $2,300

c. Debit Salaries Expense $26,100

Credit Salaries Payable $26,100

d. Debit Income Taxes Expense $8,000

Credit Income Taxes Payable $8,000

3. Adjusted Trial Balance

As of January 31, 2021

Accounts                                    Debit     Credit

Cash                                    $ 165,320

Accounts Receivable             133,000

Allowance for Uncollectible Accounts  $ 4,100

Inventory                                 39,500

Land                                        67,300

Buildings                               120,000

Accumulated Depreciation                     10,400

Accounts Payable                                     6,700

Salaries Payable                                      26,100

Income Taxes Payable                             8,000

7% Notes Payable                                  98,603

Common Stock                                   200,000

Retained Earnings                               155,400

Sales Revenue                                    195,000

Cost of goods sold            112,500

Salaries Expense               55,000

Interest Expense                     583

Depreciation Expense            800

Income Taxes Expense      8,000

Bad Debts Expense            2,300

Totals                            $704,303   $704,303

4. Income Statement

For the month ended January 31, 2021

Sales Revenue                                  $195,000

Cost of goods sold                              112,500

Gross profit                                        $82,500

Salaries Expense               55,000

Depreciation Expense            800

Bad Debts Expense            2,300    $58,100

Operating income                            $24,400

Interest Expense                                     583

Income before taxes                        $23,817

Income Taxes Expense                      8,000

Net income                                       $15,817

5. Classified Balance Sheet

As of January 31, 2021

Assets

Current Assets:

Cash                                    $ 165,320

Accounts Receivable             133,000

Allowance for Uncollectible     (4,100)

Inventory                                 39,500   $333,720

Land                                        67,300

Buildings                               120,000

Accumulated Depreciation   (10,400)  $176,900

Total assets                                          $510,620

Liabilities and Equity

Current Liabilities:

Accounts Payable                $6,700

Salaries Payable                   26,100

Income Taxes Payable          8,000

7% Notes Payable                  17,411       $58,211

Long-term Liabilities:

7% Notes Payable                                  $81,192

Total liabilities                                     $139,403

Equity:

Common Stock             $200,000

Retained Earnings              171,217    $371,217

Total liabilities and equity               $510,620

6. Closing Entries:

Debit Sales Revenue $195,000

Credit Income Summary $195,000

To close sales revenue to income summary.

Debit Income Summary $179,183

Credit:

Cost of goods sold $112,500

Salaries Expense 55,000

Depreciation Expense 800

Bad Debts Expense 2,300

Interest Expense  583

Income Taxes Expense 8,000

To close expenses to income summary.

Debit Net income $15,817

Credit Retained Earnings $15,817

To close net income to Retained Earnings.

7.  Analysis:

a. Debt to Equity Ratio = $139,403/$371,217 * 100 = 0.38

Freedom Fireworks is less leveraged than other companies in the same industry.

b. Times Interest Earned = EBIT/Interest Expense = $24,400/$583 = 41.85x

The company is more able to meet interest payments than other companies in the same industry.

c. Freedom Fireworks is more likely to receive a lower interest rate than the average borrowing rate in the industry.

Explanation:

a) Data and Calculations:

1. Account Balances on January 1, 2021:

Accounts                                    Debit     Credit

Cash                                       $ 11,200

Accounts Receivable              34,000

Allowance for Uncollectible Accounts $ 1,800

Inventory                               152,000

Land                                        67,300

Buildings                               120,000

Accumulated Depreciation                    9,600

Accounts Payable                                  17,700

Common Stock                                  200,000

Retained Earnings                              155,400

Totals                              $384,500 $384,500

Analysis of Transactions in January;

January 1 Cash $100,000 7% Note Payable (Captive Credit Corporation) $100,000

Monthly payments = $1,980 for 60 months.

January 4 Cash $31,000 Accounts receivable $31,000

January 10 Accounts payable, $11,000 Cash $11,000

January 15 Salaries, $28,900 Cash $28,900

January 30 Cash $65,000 Accounts receivable  $130,000 Sales Revenue $195,000

Cost of goods sold $112,500 Inventory $112,500

January 31 Interest Expense $583 7% Note Payable $1,397 Cash $1,980

Accounts Receivable   34,000

January 4 Cash           (31,000)

Sales Revenue           130,000

Jan. 31 Balance        $133,000

Allowance for Uncollectible Accounts $ 1,800

Allowance for uncollectible accounts:

50% of $3,000        $1,500

2% of $130,000        2,600

New credit balance $4,100

Bad debts expense for January          $2,300 ($4,100 - $1,800)

Analysis of Adjustments:

a. Depreciation expense $800 Accumulated Depreciation $800

b. Bad Debts Expense $2,300 Allowance for Uncollectible Accounts $2,300

c. Salaries Expense $26,100 Salaries Payable $26,100

d. Income Taxes Expense $8,000 Income Taxes Payable $8,000