Question

Lily May Electronics recognizes expenses for wages, interest, and rent when cash payments are made. The following related cash payments were made during December 2011.

1. December 1                                   Paid $1,100 for rent to cover the subsequent twelve months.

2. December 5 and 20                    Paid wages in the amount of $7,500. Wages in the amount of $7,500 are paid on the fifth and the twentieth of each month for the fifteen days just ended. The next payment will be on January 5, 2012.

3. December 15                                Paid $600 interest on an outstanding note payable. The note has

face value of $10,000 and a 12 percent annual interest rate. Interest

payments in the amount of $600 are made every six months.

As of December 31, the current assets and current liabilities reported on Lily May’s balance sheet were $24,000 and $15,000, respectively. Lily May’s income statement reported net income of $7,500. Compute Lily May’s current ratio and net income if the company were to account for wages, interest, and rent on an accrual basis.

Answer 1

Solution:

Current Assets = Reported Current Assets + Adjustments on rent

Current Assets = $24,000 + $1,100

Current Assets = $25,100

Current Liabilities = Reported current liabilities + Adjustment on wages + Adjustment on interest

Current liabilities = $15,000 + ($7,500 ÷ 15 days per pay period) *10 days left in December + $10,000 ´ 12%*15/360

Current liabilities = $15,000 + $5,000 + $50

Current liabilities = $20,050

Current ratio = Current Assets/Current liabilities

Current ratio = $25,100/$20,050

Current ratio = $1.25

Net Income = Reported net income + Adjustment on rent - Adjustment on wages - Adjustment on rent

Net Income = $7,500 + $1,100 - $5,000 - $50

Net Income = $3,550