To practice recording contingent liabilities and reporting them in the financial statements.
At the beginning of Year 2, Terry was informed that a new city ordinance would require them to restore the woods behind their main factory if they intend to keep using it. The estimated cost of the restoration will be approximately $790,000 and must be done within the next 5 years or the factory will be shut down. At the time, Terrys board decided to wait until the beginning of Year 6 to start the restoration. Although the notice was received and the boards decision made at the beginning of the year, no journal entries have yet been made for this obligation. The factory was built 3 years ago when Terry was still a privately held company and is being depreciated using SL depreciation using the original estimate of a 15 year useful life. The depreciation for the building has already been recorded for Year 2. The restoration will not change the factorys salvage value.
Make the appropriate journal entries, if any, to account for the new liability (including any necessary changes to income tax expense).
In making your entries, assume that Terrys Internal Rate of Return is 5%. Make any necessary changes to the financial statements.
HINT:
An obligation that will be paid more than 1 year out should be recorded at its present value, not its face value.
You will need to make two journal entries in addition to the initial recognition of the obligation. When you make the estimates for these adjusting entries, you only need to use the information from the initial recognition of this obligation. You wont need to redo any other estimates or other adjusting entries from earlier Terry problems.
When working on the Statement of Cash Flows, pay close attention to the actual cash amounts in your journal entries. The total change in cash should change by that amount. Any non-cash changes to NI will need to be removed from the CFO section to correctly make your statement to balance (just like we remove Depreciation because it doesn't have a real cash effect). When making those adjustments, the common line title when adjusting for interest on an ARO is Accretion Expense.
Use the following accounts:
Terry Co. Statement of Cash Flows For Year Ended December 31, Year 2 Cash Flow from Operations Net Income $3,556,882 Adjustments: Change in A/R ($742,500) Change in Inventory $568,400 Change in Prepaid Insurance ($47,250) Change in Prepaid Utilities ($74,250) Depreciation $1,782,000 Change in A/P ($1,283,172) Change in Income Tax Payable $264,240 Change in Unearned Revenue $297,000 Change in Wages Payable ($14,850) $749,618 Net Cash Flow from Operations $4,306,500 $0 ($1,188,000) ($5,223,000) ($6,411,000) Cash Flow from Investments Sale of A/R Purchase of Land Purchase of Equipment Net Cash Flow from Investments Cash Flow from Financing Repayment of Loans Issuance of Notes Payable Payments of Dividends Net Cash Flow from Financing ($148,500) $1,782,000 ($100,000) $1,533,500 Net Increase (Decrease) in Cash Cash, December 31, Year 2 ($571,000) $914,000 Terry Co. Balance Sheet As of 12/31/Year 2 Year 2 Year 1 Current Assets Cash AIR Allowance for Bad Debts Inventory Prepaid Insurance Prepaid Utilities Total Current Assets Long-term Investments Loans to other businesses Expansion Fund Total Long-term Investments $914,000 $1,485,000 $2,673,000 $2,524,500 ($148,500) ($742,500) $3,589,600 $4,158,000 $492,750 $445,500 $371,250 $297,000 $7,892,100 $8,167,500 $1,188,000 $1,188,000 $891,000 $891,000 $2,079,000 $2,079,000 PPE Land Building Equipment Accumulated Depreciation Total PPE Intangible Assets Patents Total Assets $3,267,000 $2,079,000 $2,376,000 $2,376,000 $8,464,300 $3,861,000 ($4,132,300) ($2,970,000). $9,975,000 $5,346,000 $445,500 $445,500 $20,391,600 $16,038,000 Liabilities and Stockholders' Equity Current Liabilities Accounts Payable $498,828 $1,782,000 Income Tax Payable $561,240 $297,000 Unearned Revenue $742,500 $445,500 Wages Payable $356,400 $371,250 Current Portion of Loan Payable $148,500 $148,500 Long-term Debt Loan Payable $742,500 $891,000 Notes Payable $4,158,000 $2,376,000 Total Long-term Debt $4,900,500 $3,267,000 Total Liabilities $7,207,968 $6,311,250 Stockholders' Equity Common Stock $3,400,000 $3,400,000 ($1 par, $6,800,000.00 authorized, $3,400,000 outstanding Additional Paid-In Capital $891,000 $891,000 Retained Earnings $8,892,632 $5,435,750 Total Stockholders' Equity $13,183,632 $9,726,750 Total Liabilities and Stockholder's Equity $20,391,600 $16,038,000 Terry Co. Multi-Step Income Statement For Year Ended December 31, Year 2 Sales Revenue Sales Revenue $29,700,000 Less: Sales Discounts $356,400 Sales Returns $1,410,750 $1,767,150 Net Sales Revenue $27,932,850 Cost of Goods Sold Cost of Goods Sold Gross Profit $16,208,255 $11,724,595 $556,875 $144,788 $408,375 $1,485,000 $243, 169 $2,838,207 Operating Activities Selling Expenses Advertising Expense Miscellaneous Selling Expenses Sales Force Salaries Expense Selling Commissions Expense Shipping Expense Total Selling Expenses Administrative Expenses Executive Salaries Expense Depreciation Expense Insurance Expense Miscellaneous Admin. Expenses Office Supplies Expense Consulting and Legal Fees Utilities Expense Total Administrative Expenses Income from Operations $1,299,375 $1,782,000 $256,163 $14,664 $115,088 $18,563 $222,750 $3,708,603 $6,546,810 $5,177,785 Rent Revenue Interest Expense Income from Continuing Operations before Taxes Income Tax Expense $92,813 ($189,338) ($96,525) $5,081,260 ($1,524,378) $3,556,882 Net Income EPS $ 1.05 Terry Co. Statement of Cash Flows For Year Ended December 31, Year 2 Cash Flow from Operations Net Income $3,556,882 Adjustments: Change in A/R ($742,500) Change in Inventory $568,400 Change in Prepaid Insurance ($47,250) Change in Prepaid Utilities ($74,250) Depreciation $1,782,000 Change in A/P ($1,283,172) Change in Income Tax Payable $264,240 Change in Unearned Revenue $297,000 Change in Wages Payable ($14,850) $749,618 Net Cash Flow from Operations $4,306,500 $0 ($1,188,000) ($5,223,000) ($6,411,000) Cash Flow from Investments Sale of A/R Purchase of Land Purchase of Equipment Net Cash Flow from Investments Cash Flow from Financing Repayment of Loans Issuance of Notes Payable Payments of Dividends Net Cash Flow from Financing ($148,500) $1,782,000 ($100,000) $1,533,500 Net Increase (Decrease) in Cash Cash, December 31, Year 2 ($571,000) $914,000 Terry Co. Balance Sheet As of 12/31/Year 2 Year 2 Year 1 Current Assets Cash AIR Allowance for Bad Debts Inventory Prepaid Insurance Prepaid Utilities Total Current Assets Long-term Investments Loans to other businesses Expansion Fund Total Long-term Investments $914,000 $1,485,000 $2,673,000 $2,524,500 ($148,500) ($742,500) $3,589,600 $4,158,000 $492,750 $445,500 $371,250 $297,000 $7,892,100 $8,167,500 $1,188,000 $1,188,000 $891,000 $891,000 $2,079,000 $2,079,000 PPE Land Building Equipment Accumulated Depreciation Total PPE Intangible Assets Patents Total Assets $3,267,000 $2,079,000 $2,376,000 $2,376,000 $8,464,300 $3,861,000 ($4,132,300) ($2,970,000). $9,975,000 $5,346,000 $445,500 $445,500 $20,391,600 $16,038,000 Liabilities and Stockholders' Equity Current Liabilities Accounts Payable $498,828 $1,782,000 Income Tax Payable $561,240 $297,000 Unearned Revenue $742,500 $445,500 Wages Payable $356,400 $371,250 Current Portion of Loan Payable $148,500 $148,500 Long-term Debt Loan Payable $742,500 $891,000 Notes Payable $4,158,000 $2,376,000 Total Long-term Debt $4,900,500 $3,267,000 Total Liabilities $7,207,968 $6,311,250 Stockholders' Equity Common Stock $3,400,000 $3,400,000 ($1 par, $6,800,000.00 authorized, $3,400,000 outstanding Additional Paid-In Capital $891,000 $891,000 Retained Earnings $8,892,632 $5,435,750 Total Stockholders' Equity $13,183,632 $9,726,750 Total Liabilities and Stockholder's Equity $20,391,600 $16,038,000 Terry Co. Multi-Step Income Statement For Year Ended December 31, Year 2 Sales Revenue Sales Revenue $29,700,000 Less: Sales Discounts $356,400 Sales Returns $1,410,750 $1,767,150 Net Sales Revenue $27,932,850 Cost of Goods Sold Cost of Goods Sold Gross Profit $16,208,255 $11,724,595 $556,875 $144,788 $408,375 $1,485,000 $243, 169 $2,838,207 Operating Activities Selling Expenses Advertising Expense Miscellaneous Selling Expenses Sales Force Salaries Expense Selling Commissions Expense Shipping Expense Total Selling Expenses Administrative Expenses Executive Salaries Expense Depreciation Expense Insurance Expense Miscellaneous Admin. Expenses Office Supplies Expense Consulting and Legal Fees Utilities Expense Total Administrative Expenses Income from Operations $1,299,375 $1,782,000 $256,163 $14,664 $115,088 $18,563 $222,750 $3,708,603 $6,546,810 $5,177,785 Rent Revenue Interest Expense Income from Continuing Operations before Taxes Income Tax Expense $92,813 ($189,338) ($96,525) $5,081,260 ($1,524,378) $3,556,882 Net Income EPS $ 1.05
