Question

Abbey Park was organized on April 1, 2016, by Trudy Crawford. Trudy is a good manager but a poor accountant. From the trial balance prepared by a part-time bookkeeper, Trudy prepared the following income statement for the quarter that ended March 31, 2017.

Abbay Park
Income statement
For the quarter ended March 31,2017
Revenues 83000
Rent Revenue
Operating expenses
Advertising expense 4200
Salaries and wages expense 27600
Utilities expense 1500
Depreciation expense 800
Maintenance expense 2800
Total operating expense 36900
Net income 46100
Trudy knew that something was wrong with the statement because net income had never exceeded $20,000 in any one quarter. Knowing that you are an experienced accountant, she asks you to review the income statement and other data. You first look at the trial balance. In addition to the account balances reported in the income statement, the ledger contains these selected balances at March 31, 2017.
Supplies 4500
Prepaid insurance 7200
Notes payable 20000
You then make inquiries and discover the following.
1. Rent revenue includes advanced rentals for summer-month occupancy, $21,000.
2. There were $600 of supplies on hand at March 31.
3. Prepaid insurance resulted from the payment of a 1-year policy on January 1, 2017.
4. The mail on April 1, 2017, brought the following bills: advertising for week of March 24, $110; repairs made March 10, $1,040; and utilities $240.
5. Wage expense totals $290 per day. At March 31, 3 days’ wages have been incurred but not paid.
6. The note payable is a 3-month, 7% note dated January 1, 2017. Instructions With the class divided into groups, answer the following.
(a) Prepare a correct income statement for the quarter ended March 31, 2017.
(b) Explain to Trudy the generally accepted accounting principles that she did not follow in preparing her income statement and their effect on her results.

Answer 1

Abbey Park

a) Correct Income Statement for the quarter ended March 31, 2017:

Abbey Park

Income statement

For the quarter ended March 31,2017

Revenue

Rent Revenue $62,000

Operating expenses

Advertising expense 4,310

Salaries and wages expense 28,470

Utilities expense 1,740

Depreciation expense 800

Maintenance expense 3,840

Supplies Expense 3,900

Insurance expense 1,800

Interest expense 350

Total operating expense 45,210

Net income $16,790

b) The generally accepted accounting principles that Trudy did not follow in the preparation of her income statement are the accrual concept and the matching principle. Failure to follow these principles means that the net income will be misstated. The accounts were based on the cash basis instead of the accrual basis of generally accepted accounting principles. This means that records for non-cash transactions were not recognized while some others were recognized based on their cash effects.

Step-by-step explanation:

a) Income Statement for the quarter ended March 31, 2017:

Abbey Park

Income statement

For the quarter ended March 31,2017

Revenue

Rent Revenue $83,000

Operating expenses

Advertising expense 4,200

Salaries and wages expense 27,600

Utilities expense 1,500

Depreciation expense 800

Maintenance expense 2,800

Total operating expense 36,900

Net income $46,100

Adjustments:

1. Rent Revenue = $62,000 ($83,000 - 21,000)

2. Supplies Expenses $3,900 ($4,500 - 600)

Supplies balance = 600

3. Prepaid Insurance = $5,400 ($7,200 - 1,800)

Insurance expense = $1,800 ($7,200/4)

4. Advertising Expense = $4,310 ($4,200 + 110)

Maintenance Expense = $3,840 ($2,800 + 1,040)

Utilities Expense = $1,740 ($1,500 + 240)

Expenses Payable = $1,390

5. Wages Expenses = $28,470 (27,600 + ($290 * 3))

Wages payable $870

6. Interest Expense = $350 ($20,000 * 7% * 3/12)