COMPREHENSIVE PROBLEM 2

Guitar Universe, Inc. 2 to 3 hours

A mini-practice set illustrating numerous aspects of the accounting cycle for a Strong
merchandising business organized as a corporation. Students are required to: (1)
perform a bank reconciliation, (2) make adjusting entries—including
adjustments related to marketable securities, uncollectible accounts, inventory
shrinkage, and depreciation, (3) prepare an income statement, statement of
retained earnings, and balance sheet, and (4) assess the financial condition of
the business from a short-term creditor’s perspective.

© The McGraw-Hill Companies, Inc., 2010

CP2-Desc.
2 to 3 hours, Strong COMPREHENSIVE PROBLEM 2
GUITAR UNIVERSE, INC.
a.
GUITAR UNIVERSE, INC.
Bank Reconciliation
December 31, 2009
Balance per bank statement, December 31, 2009 $ 46,975
Add: Deposits in transit not recorded by bank 16,500
$ 63,475
Deduct: Outstanding checks
No. 507 $ 4,000
No. 511 9,000
No. 521 8,000 21,000
Adjusted cash balance $ 42,475

Balance per depositor's records, December 31, 2009 $ 45,000

Deduct:
Bank service charge $ 25
NSF check from Iggy Bates 2,500 2,525
Adjusted cash balance (as above) $ 42,475

General Journal

a. Bank Service Charges 25

Accounts Receivable 2,500
Cash 2,525
To record bank service charges for December and
the NSF check received from Iggy Bates.

b. Marketable Securities 2,500

Unrealized Holding Gain on Investments 2,500
To increase reported value of marketable
securities from $25,000 to $27,500. (Note: the
portfolio was previously increased from $19,000
to $25,000.)

c. Uncollectible Accounts Expense 3,500

Allowance for Doubtful Accounts 3,500
To record uncollectible accounts expense for
December.

d. Cost of Goods Sold 1,350

Inventory 1,350
To record inventory shrinkage of missing guitars.

e. Office Supplies Expense 300

Office Supplies 300
To record office supplies used in December.

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CP2
 COMPREHENSIVE PROBLEM 2
GUITAR UNIVERSE, INC. (continued)
General Journal

f. Insurance Expense 600

Prepaid Insurance 600
To record insurance policies expired during
December. (Note: One month of the twelve-month
policy had already been accounted for in
November).

g. Depreciation Expense 5,000

Accumulated Depreciation 5,000
To record depreciation expense for December.

h. Unearned Customer Deposits 3,200

Sales 3,200
To record revenue earned from advance special
orders.

i. Income Tax Expense 6,000

Income Tax Payable 6,000
To account for accrued income taxes in
December.

© The McGraw-Hill Companies, Inc., 2010

CP2(p.2)
 COMPREHENSIVE PROBLEM 2
GUITAR UNIVERSE, INC. (continued)
j.
GUITAR UNIVERSE, INC.
Adjusted Trial Balance
As of December 31, 2009
Cash $ 42,475
Marketable securities 27,500
Accounts receivable 127,500
Allowance for doubtful accounts $ 8,500
Merchandise inventory 248,650
Office supplies 900
Prepaid insurance 6,000
Building and fixtures 1,791,000
Accumulated depreciation 805,000
Land 64,800
Accounts payable 70,000
Unearned customer deposits 4,800
Income taxes payable 81,000
Capital stock 1,000,000
Retained earnings 240,200
Unrealized holding gain on investments 8,500
Sales 1,603,200
Cost of goods sold 959,350
Bank service charges 225
Uncollectible accounts expense 12,500
Salary and wages expense 395,000
Office supplies expense 700
Insurance expense 7,000
Utilities expense 3,600
Depreciation expense 53,000
Income tax expense 81,000
$ 3,821,200 $ 3,821,200

© The McGraw-Hill Companies, Inc., 2010

CP2(p.3)
 COMPREHENSIVE PROBLEM 2
GUITAR UNIVERSE, INC. (continued)
k.
GUITAR UNIVERSE, INC.
Income Statement
For the Year Ended December 31, 2009
Sales $ 1,603,200
Cost of goods sold 959,350
Gross profit $ 643,850
Bank service charges $ 225
Uncollectible accounts expense 12,500
Salary and wages expense 395,000
Office supplies expense 700
Insurance expense 7,000
Utilities expense 3,600
Depreciation expense 53,000 472,025
Income before income tax $ 171,825
Income taxes expense 81,000
Net income $ 90,825

GUITAR UNIVERSE, INC.

Statement of Retained Earnings
For the Year Ending December 31, 2009
Retained earnings, January 1, 2009 $ 240,200
Add: Net income (from income statement) 90,825
Ending Retained earnings, December 31, 2009 $ 331,025

© The McGraw-Hill Companies, Inc., 2010

CP2(p.4)
 COMPREHENSIVE PROBLEM 2
GUITAR UNIVERSE, INC. (continued)
k. (continued)
GUITAR UNIVERSE, INC.
Balance Sheet
As of December 31, 2009
Current assets:
Cash $ 42,475
Marketable securities 27,500
Accounts receivable $ 127,500
Less: Allowance for doubtful accounts (8,500) 119,000

Merchandise inventory 248,650

Office supplies 900
Prepaid insurance 6,000
Total current assets $ 444,525

Plant and equipment:

Building and fixtures $ 1,791,000
Less: Accumulated depreciation (805,000) 986,000
Land 64,800
Total plant and equipment $ 1,050,800
Total assets $ 1,495,325

Liabilities
Current liabilities:
Accounts payable $ 70,000
Unearned customer deposits 4,800
Income taxes payable 81,000
Total current liabilities $ 155,800

Long-term liabilities: 0
Total liabilities $ 155,800

Stockholders' Equity
Capital stock $ 1,000,000
Retained earnings (from statement of retained earnings) 331,025
Unrealized holding gain on investments 8,500
Total stockholders' equity $ 1,339,525

Total Liabilities and Stockholders' Equity $ 1,495,325

© The McGraw-Hill Companies, Inc., 2010

CP2(p.5)
 COMPREHENSIVE PROBLEM 2
GUITAR UNIVERSE, INC. (concluded)
l. Step 1: Compute accounts receivable turnover (sales  average accounts receivable)
$1,603,200  $119,000* = 13.5 times
*Ending accounts receivable is assumed to be a close approximation for average
accounts receivable for this company.

Step 2: Compute accounts receivable days (365  accounts receivable turnover)

365  13.5 = 27 days

m. Step 1: Compute inventory turnover (cost of goods sold  average merchandise inventory)
$959,350  $248,650* = 3.9 times
*Ending merchandise inventory is assumed to be a close approximation for
average merchandise inventory for this company.

Step 2: Compute inventory days (365  inventory turnover)

365  3.9 = 94 days

n.
Accounts receivable days (from part l above) 27 days
Add: inventory days (from part m above) 94 days
Operating cycle 121 days

o. From a short-term creditor’s perspective, the company appears relatively solvent. It collects
its accounts receivable in less than 30 days, and its uncollectible accounts expense represents
a relatively small percentage of its total sales figures. However, it may be stocking too much
inventory, as evidenced by a 94-day average inventory days figure. Students are advised to
compare this figure to industry average statistics.

Note to instructor: The company’s quick and current ratios also appear relatively strong, which
provides additional evidence of the company’s ability to meet its current obligations (quick ratio
= 1.21:1; current ratio = 2.85:1).

© The McGraw-Hill Companies, Inc., 2010

CP2(P.6)