First consider the upper zone, where prices are above the level where

marginal cost (MC) crosses average cost (AC) at the zero profit point. At
any price above that level, the firm will earn profits in the short run. If the
price falls exactly on the zero profit point where the MC and AC curves
cross, then the firm earns zero profits. If a price falls into the zone
between the zero profit point, where MC crosses AC, and the shutdown
point, where MC crosses AVC, the firm will be making losses in the short
run—but since the firm is more than covering its variable costs, the losses
are smaller than if the firm shut down immediately. Finally, consider a
price at or below the shutdown point where MC crosses AVC. At any price
like this one, the firm will shut down immediately, because it cannot even
cover its variable costs.
CHAPTER 4

Problem 4.1
Correcting Classification Errors

Weaklink, Inc., a service company, performs adjusting entries monthly, but prepares closing entries
annually on December 31. The company recently hired John Notsogood as its new accountant. John’s
first assignment was to prepare an income statement, a statement of retained earnings, and a balance
sheet using an adjusted trial balance given to him by his predecessor, dated December 31, 2002.

WEAKLINK, INC.
Income Statement
for the Year Ended December 31, 2002
Revenue:
Service revenue earned.......................................................... $150,000
Unearned revenue.................................................................. 2,000
Accounts receivable............................................................... 10,000
Total revenue......................................................................... $162,000
Expenses:
Insurance expense.................................................................. $ 2,100
Office rent expense................................................................ 16,000
Supplies and expense............................................................. 1,000
Dividends............................................................................... 2,000
Salary expense....................................................................... 80,000
Accumulated depreciation; auto............................................ 15,000
Accumulated depreciation; equipment.................................. 12,000
Repair & maintenance expense.............................................. 1,800
Travel expense....................................................................... 7,000
Miscellaneous expense........................................................... 2,200
Interest expense...................................................................... 3,000 142,100
Income before income taxes.............................................................. $ 19,900
Income taxes payable......................................................................... 500
Net income......................................................................................... $ 19,400

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 WEAKLINK, INC.
Statement of Retained Earnings
for the Year Ended December 31, 2002
Retained earnings (per adjusted trial balance)......................................................... $20,000
Add: Income............................................................................................................ 19,400
Less: Income taxes expense.................................................................................... 3,000
Retained earnings (12/31/02).................................................................................. $36,400

WEAKLINK, INC.
Balance Sheet
December 31, 2002
Assets
Cash.................................................................................................... $13,600
Supplies.............................................................................................. 600
Auto.................................................................................................... $35,000
Less: Depreciation expense; auto....................................................... 6,000 29,000
Equipment and music......................................................................... $42,000
Less: Depreciation expense; equipment............................................. 5,000 37,000
Total assets......................................................................................... $80,200
Liabilities & Stockholders’ Equity
Liabilities:
Accounts payable................................................................... $ 3,000
Notes payable......................................................................... 35,000
Salaries payable..................................................................... 800
Prepaid rent............................................................................ 1,000
Unexpired insurance.............................................................. 2,000
Total liabilities....................................................................... $41,800
Stockholders’ Equity:
Capital stock........................................................................... 2,000
Retained earnings................................................................... 36,400
Total stockholders’ equity...................................................... $38,400
Total liabilities and stockholders’ equity........................................... $80,200

Instructions
a. Prepare a corrected set of financial statements dated December 31, 2002. (You may assume
that all of the figures in the company’s adjusted trial balance were reported correctly except for
Notes Payable, which is some other amount other than $35,000.)
b. Prepare the necessary year-end closing entries.
c. Using the financial statement prepared in part a, briefly evaluate the company’s profitability
and solvency.
Problem 4.2
Preparing Financial Statements and Closing Entries of a Profitable Company

Pool Power, Inc., provides swimming pool services to both commercial and residential customers. The
company performs adjusting entries on a monthly basis, whereas closing entries are prepared annually
at December 31. An adjusted trial balance dated December 31, 2002, follows.

POOL POWER, INC.

Balance Sheet
December 31, 2002
Debits Credits
Cash.................................................................................................... $ 33,400
Accounts receivable........................................................................... 5,200
Unexpired insurance.......................................................................... 9,100
Prepaid rent........................................................................................ 2,800
Supplies.............................................................................................. 1,600
Trucks................................................................................................ 120,000
Accumulated depreciation; trucks...................................................... $ 70,000
Equipment.......................................................................................... 30,000
Accumulated depreciation; equipment.............................................. 17,000
Accounts payable............................................................................... 2,700
Notes payable..................................................................................... 40,000
Salaries payable................................................................................. 800
Interest payable.................................................................................. 200
Income taxes payable......................................................................... 1,300
Unearned service revenue.................................................................. 1,000
Capital stock....................................................................................... 15,000
Retained earning................................................................................ 27,000
Dividends........................................................................................... 4,000
Service revenue earned...................................................................... 180,000
Insurance expense.............................................................................. 2,100
Office rent expense............................................................................ 32,000
Supplies expense................................................................................ 4,100
Salary expense................................................................................... 65,000
Depreciation expense; trucks............................................................. 20,000
Depreciation expense; equipment...................................................... 5,000
Repair and maintenance expense....................................................... 4,200
Fuel expense....................................................................................... 1,900
Miscellaneous expense....................................................................... 3,000
Interest expense.................................................................................. 3,600
Income taxes expense........................................................................ 8,000 _______
$355,000 $355,000

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Instructions
a. Prepare an income statement and statement of related earnings for the year ended December 31,
2002. Also prepare the company’s balance sheet dated December 31, 2002.
b. Prepare the necessary year-end closing entries.
c. Prepare an after-closing trial balance.
d. Using the financial statement prepared in part a, briefly evaluate the company’s profitability
and solvency.
Problem 4.3
Preparing Financial Statements and Closing Entries of an Unprofitable Company

Medical Wonders, Inc., provides medical advice over the Internet. In recent years the company has
experienced severe financial difficulty. Its accountant prepares adjusting entries on a monthly basis,
and closing entries on an annual basis, at December 31. An adjusted trial balance dated December
31,2002, follows.

MEDICAL WONDERS, INC.

Adjusted Trial Balance
December 31, 2002
Debits Credits
Cash.................................................................................................... $ 300
Accounts receivable........................................................................... 150
Unexpired insurance.......................................................................... 1,500
Prepaid rent........................................................................................ 2,000
Supplies.............................................................................................. 400
Furniture and fixtures......................................................................... 9,000
Accumulated depreciation; furniture and fixtures............................. $ 6,000
Accounts payable............................................................................... 7,000
Notes payable..................................................................................... 21,550
Salaries payable................................................................................. 1,800
Interest payable.................................................................................. 200
Unearned client revenue.................................................................... 400
Capital stock....................................................................................... 5,000
Retained earning................................................................................ 1,000
Client revenue earned........................................................................ 54,000
Insurance expense.............................................................................. 5,000
Office rent expense............................................................................ 10,000
Supplies expense................................................................................ 400
Salary expense................................................................................... 50,000
Depreciation expense; furniture and fixtures..................................... 1,000
Office and telephone expense............................................................ 3,200
Internet service expense..................................................................... 5,000
Legal expense..................................................................................... 2,000
Interest expense.................................................................................. 3,000
Miscellaneous expense....................................................................... 4,000 ______
$96,950 $96,950

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Instructions
a. Prepare an income statement and statement of related earnings for the year ended December 31,
2002. Also prepare the company’s balance sheet dated December 31, 2002. (Hint: The
company incurred no income taxes expense in 2002.)
b. Prepare the necessary year-end closing entries.
c. Prepare an after-closing trial balance.
d. Using the financial statement prepared in part a, briefly evaluate the company’s performance.
e. Identify information that the company is apt to disclose in the notes that accompany the
financial statements prepared in part a.
Problem 4.4
Interim Financial Statements

Golden Real Estate adjusts is accounts monthly but closes them only at the end of the calendar year.
Below are the adjusted balances of the revenue and expense accounts at September 30 of the current
year and at the ends of two earlier months:

Sept. 30 Aug. 31 June 30

Commissions earned........................................................ $150,000 $135,000 $100,000
Advertising expense......................................................... 30,000 26,000 20,000
Salaries expense............................................................... 42,000 38,000 30,000
Rent expense.................................................................... 18,000 16,000 10,000
Depreciation expense....................................................... 2,500 2,200 1,600

Instructions
a. Prepare a three-column income statement, showing net income for three separate time period,
all of which end September 30. Use the format illustrated below. Show supporting
computations for the amounts of the revenue in the first two columns.

GOLDEN REAL ESTATE

Income Statement
For the Following Time Periods in 2002
Month Quarter 9 Months
Ended Ended Ended
Sept. 30 Sept. 30 Sept. 30
Revenue:
Commissions earned............................................... $______ $______ $______
Expenses:

b. Briefly explain how you determined the dollar amounts for each of the three time periods.
Would you apply the same process to the balances in Golden’s balance sheet accounts?
Explain.
c. Assume the Golden’s adjusts and closes its accounts at the end of each month. Briefly explain
how you then would determine the revenue and expenses that would appear in each of the three
columns of the income statement prepared in part a.

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Problem 4.5
Short Comprehensive Problem Including Both Adjusting and Closing Entries

Fred Schwartz Dance Studio, Inc. adjusts its accounts monthly, but performs closing entries annually
on December 31. This is the studio’s unadjusted trial balance dated December 31, 2002.

FRED SCHWARTZ DANCE STUDIO, INC.

Unadjusted Trial Balance
December 31, 2002
Debits Credits
Cash........................................................................................$ 10,800
Clients fees receivable........................................................... 58,000
Supplies.................................................................................. 7,000
Prepaid studio rent................................................................. 5,000
Studio equipment................................................................... 96,000
Accumulated depreciation: studio equipment........................ $ 45,000
Accounts payable................................................................... 7,000
Notes payable......................................................................... 25,000
Interest payable...................................................................... 500
Unearned client fees............................................................... 10,000
Income taxes payable............................................................. 3,000
Capital stock........................................................................... 40,000
Retained earnings................................................................... 30,000
Client fees earned................................................................... 87,000
Supply expense...................................................................... 6,000
Salary expense....................................................................... 19,000
Interest expense ..................................................................... 500
Studio rent expense................................................................ 26,000
Utilities expense..................................................................... 4,200
Depreciation expense: studio equipment............................... 9,000
Income taxes expense............................................................ 6,000 ________
$247,500 $247,500

Other Data
1. Supplies on hand at December 31, 2002, total $2,500.
2. The studio pays rent quarterly (every 3 months). The last payment was made November 1,
2002. The next payment will be made early in February 2003.
3. Studio equipment is being depreciated over 96 months (8 years).
4. On October 1, 2002, the studio borrowed $25,000 by signing a 12-month, 12% note payable.
The entire amount, plus interest, is due on September 30, 2003.
5. At December 31, 2002, $4,000 of previously unearned client fees had been earned.
6. Accrued, but unrecorded and uncollected client fees earned total $700 at December 31, 2002.
7. Accrued, but unrecorded and unpaid salary expense totals $900 at December 31, 2002.
8. Accrued income taxes payable for the entire year ending December 31, 2002, total $8,000.
The full amount is due early in 2003.
Instructions
a. Prepare the necessary adjusting journal entries on December 31, 2002. Prepare also an
adjusted trial balance dated December 31, 2002.
b. From the adjusted trial balance prepared in part a, prepare an income statement and statement
of retained earnings for the year ended December 31, 2002. Also prepare the company’s
balance sheet dated December 31, 2002.
c. Prepare the necessary year-end closing entries.
d. Prepare an after-closing trial balance.
e. Has the studio’s monthly office rent remained the same throughout the year? If not, has it gone
up or down? Explain.

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