Four Star Video has been in the video rental business for five years. The following is a list of accounts for Four Star Video at May 31, 2017. It reflects the recurring transactions for the month of May but does not reflect any month-end adjustments.
1. For each of the items below, identify and analyze the necessary adjustment on May 31, 2017.
a. Four Star rents a store in a shopping mall and prepays the annual rent of $7,200 on April 1 of each year.
b. The asset account Video Inventory represents the cost of videos purchased from suppliers. When a new title is purchased from a supplier, its cost is added to this account. When a title has served its useful life and can no longer be rented (even at a reduced price), it is removed from the inventory in the store. Based on the monthly count, the cost of titles on hand at the end of May is $23,140.
c. The display stands have an estimated useful life of five years and an estimated salvage value of $500. Assume Four Star Video uses the straight-line method of depreciation.
d. Wages and salaries owed but unpaid to employees at the end of May amount to $1,450.
e. In addition to individual rentals, Four Star operates a popular discount subscription program. Customers pay an annual fee of $120 for an unlimited number of rentals. Based on the $10 per month earned on each of these subscriptions, the amount earned for the month of May is $2,440.
f. Four Star accrues income taxes using an estimated tax rate equal to 30% of the income for the month.
2. On the basis of the information you have, does Four Star appear to be a profitable business?
Homework Answers
Section 1
Part A
|
Activity |
Operating |
|
Account(s) |
Prepaid Rent Decrease Rent Expense Increase |
|
Statement(s) |
Balance Sheet and Income Statement |
|
Balance Sheet |
Income statement |
||||||||||||
|
Assets |
= |
Liabilities |
+ |
Stockholders’ Equity |
revenue |
- |
expenses |
= |
Net income |
||||
|
Prepaid rent |
(600) |
(600) |
Rent expense |
600 |
(600) |
||||||||
7200/12 = 600
Part B
|
Activity |
Operating |
|
Account(s) |
Video Inventory Decrease Video Expense Increase |
|
Statement(s) |
Balance Sheet and Income Statement |
|
Balance Sheet |
Income statement |
||||||||||||
|
Assets |
= |
Liabilities |
+ |
Stockholders’ Equity |
revenue |
- |
expenses |
= |
Net income |
||||
|
Video inventory |
(2460) |
(2460) |
Video expense |
2460 |
(2460) |
||||||||
25600-23140 = 2460
Part C
|
Activity |
Operating |
|
Account(s) |
Accumulated Depreciation—Display Stands Increase Depreciation Expense Increase |
|
Statement(s) |
Balance Sheet and Income Statement |
|
Balance Sheet |
Income statement |
||||||||||||
|
Assets |
= |
Liabilities |
+ |
Stockholders’ Equity |
revenue |
- |
expenses |
= |
Net income |
||||
|
Accumulated Depreciation—Display Stands |
(140) |
(140) |
Depreciation expense |
140 |
(140) |
||||||||
(8900-500)/60 = 140
Accumulated Depreciation—Display Stands is a contra account
Part D
|
Activity |
Operating |
|
Account(s) |
Wages and Salaries Payable Increase Wages and Salaries Expense Increase |
|
Statement(s) |
Balance Sheet and Income Statement |
|
Balance Sheet |
Income statement |
||||||||||||
|
Assets |
= |
Liabilities |
+ |
Stockholders’ Equity |
revenue |
- |
expenses |
= |
Net income |
||||
|
Wages and Salaries Payable |
1450 |
(1450) |
Wages and Salaries expense |
1450 |
(1450) |
||||||||
Part E
|
Activity |
Operating |
|
Account(s) |
Customer Subscriptions Decrease Subscription Revenue Increase |
|
Statement(s) |
Balance Sheet and Income Statement |
|
Balance Sheet |
Income statement |
||||||||||||
|
Assets |
= |
Liabilities |
+ |
Stockholders’ Equity |
revenue |
- |
expenses |
= |
Net income |
||||
|
Customer Subscriptions |
(2440) |
2440 |
Subscription Revenue |
2440 |
2440 |
||||||||
Part F
|
Activity |
Operating |
|
Account(s) |
Income Taxes Payable Increase Income Taxes Expense Increase |
|
Statement(s) |
Balance Sheet and Income Statement |
|
Balance Sheet |
Income statement |
||||||||||||
|
Assets |
= |
Liabilities |
+ |
Stockholders’ Equity |
revenue |
- |
expenses |
= |
Net income |
||||
|
Income Taxes Payable |
849 |
(849) |
Income Taxes expense |
849 |
(849) |
||||||||
Income tax expense = (total revenue – total expenses)*tax rate
= ((2440+9200)-(3770+1240+600+600+2460+140))*30%
Section 2
Yes, it seems to be profitable business. Its net income = ((2440+9200)-(3770+1240+600+600+2460+140)) * (1-30%) = $1981 and therefore its profit margin = 1981/(2440+9200) = 17.02%
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