Accounting Homework Session, Math Problem Example

Class Discussion Questions

1. What two types of transactions cause most current liabilities?
   The two types of transactions are unearned revenue and short-term obligations.
2. To match revenue and expenses properly, should the expense for employee vacation pay be recorded in the period which the vacation privilege is earned or during the period in which the vacation is taken?

The expense should be recognized in the period which the vacation privilege is earned because this is when it becomes a liability.

1. Of two companies organized at approximately the same time and engaged in competing businesses, one issued $100 par common stock, and the other issued $5 par common stock. This Do the par designations provide any indication as to which stock is preferable as an investment?

No, because par values are assigned arbitrary by the managers and are usually independent from anything else. It is just how the company was authorized to issue it’s stock.

1. What is the primary purpose of a stock split?

The primary purpose is to reduce the price and increase the number of shares outstanding. It does nothing to the underlying value of those already holding the shares and is done when the price of stock rises too high for the average investor to purchase.

Exercises

Awesome Audio Works, Inc. warrants its products for one year. The estimated product warranty is 2% of sales. Assume that sales were $500,000 for January. In February, a customer received warranty repairs requiring $2,500 of parts.

• Determine the warranty liability at January 31, the end of the first month of the current year.

The warranty liability is 10,000.

• What accounts are decreased for the warranty work provided in February?

Parts or inventory accounts decreased 2500.

A business provides its employees with varying amounts of vacation per year, depending on the length of employment. The estimated amount of the current year’s vacation pay is $375,000. Illustrate the effects on the accounts and financial statements of the adjustment required on January 31, the end of the first month of the current year, to record the accrued vacation pay.

Computation: *$375,000 × 1/12 = $31,250

Michelangelo, Inc., a software development firm, has stock outstanding as follows: 20,000 shares of 1% preferred stock of $25 par, and 25,000 shares of $100 par common. During its first four years of operations, the following amounts were distributed as dividends: first year, $3000; second year, $4,000; third year, $30,000; fourth year, $80,000. Calculate the dividends per share on each class of stock for each of the four years.

1: P= 0.15; C=0
2: P=0.20; C=0
3. P= 0.10 from year 1 + 0.05 from year 2 + 0.25 = 0.40; C=1.28 or 32000/25000 share
4. P= 0.25; C= 75000/25000= 3.00

Indicate whether the following actions would (+) increase, (-) decrease, or (0) not affect Pillar Fall Inc.’s total assets, liabilities, and stockholders’ equity:

Problem

Three different plans for financing a $10,000,000 corporation are under consideration by its organizers. Under each of the following plans the securities will be issued at their par or face amount, and the income tax rate is estimated at 40% of income.

• Determine for each plan the earnings per share of common stock, assuming that the income before bond interest and income tax is $2,000,000.

Plan 1: $ 1.20 (1,200,000 / 1,000,000)
Plan 2: $ 1.40 (1,200,000 – 500,000 (pref div) / 500,000
Plan 3: $ 1.60 (900,000 – 500,000) / 250,000

• Determine for each plan the earnings per share of common stock, assuming the income before bond interest and income tax is $950,000.

Plan 1: $.38

Plan 2: $.76

Plan 3: $.92

• Discuss the advantages and disadvantages of each plan.

Plan 3 provides the most advantages in highest earnings per share of common stock but disadvantages in higher price could mean less sales. Plan 1 has the most disadvantages in least earnings, but could be the most advantageous in most sales because of the lowered price.