Music Mart Case 2-2

Topics: Balance sheet, Generally Accepted Accounting Principles, Asset Pages: 2 (522 words) Published: January 16, 2009
AssetsLiabilities and Owners’ Equity
Current assets:Current liabilities:
Cash$25,636Notes payable$ 6,500
Accounts receivable2,620Accounts payable 5,000
Inventory4,700Total current liabilities11,500
Prepaid insurance 1,224
Total current assets34,180Other liabilities:
Mortgage payable 9,000
Total liabilities20,500
Owners’ equity
Property:Paid in capital25,000
Land 12,000Retained earnings 680
Total assets$46,180Total liabilities
and owners’ equity

Answers to Questions:
1.Increase Inventory 5,000; increase Accounts Payable 5,000 2.Decrease Inventory 1,500; increase Cash 2,300; increase Retained Earnings 800 3.Decrease Inventory 1,700; increase Accounts Receivable 2,620; increase Retained Earnings 920 (Note that Retained Earnings increases whether or not the proceeds of the sale are received in cash.) 4.Increase Prepaid Insurance 1,224; decrease Cash 1,224

(Note that current practice is to treat this as a current asset even though the policy is in effect three years; the basis is materiality.) 5.Increase Land 24,000; decrease Cash 6,000; increase Mortgage payable 18,000 (In view of what happens subsequently, it can be argued that the land is a current asset, or that $12,000 of it is. It depends on whether Smith plans to retain or to sell it. This point should be brought out, to avoid the tendency to classify land as a fixed asset without thinking.) 6.Increase Cash, $3,000; decrease Mortgage Payable, $9,000; decrease Land, $12,000

Note the decrease in the liability even though it was not “paid off” in cash.) 7.No entry. Goodwill is recognized only when it is paid for. 8.Decrease Retained Earnings 1,000; decrease Cash 1,000.

9.Decrease Retained Earnings 750; decrease Inventory 750.
(Note the basic similarity between #8 and #9; the equity of Smith in the business decreases whenever he, as an individual, takes out...
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