7-33 Effect of a line of credit on financial statements Melvin Company has a lin

Question

7-33 Effect of a line of credit on financial statements Melvin Company has a line of credit with Bay Bank. Melvin can borrow up to any time over the course of the 2014 calendar year. The following table shows the $500,000 at prime rate expressed as an annual percentage along with the amounts borrowed and repaid during 2014 Melvin agreed to pay interest at an annual rate equal to I percent above the bank's prime rate Funds are borrowed or repaid on the first day of each month. Interest is payable in cash on the last day of the month. The interest rate is applied to the outstanding monthly balance. For example, Melvin pays 6 percent (5 percent+ I percent) annual interest on $60,000 for the month of January Amount Borrowed or (Repaid) Prime Rate for the Month, % Month January February March April through October November December $ 60,000 120,000 (50,000) No change (30,000) (50,000) No change Melvin earned $54,000 of cash revenue during 2014. Required a. Organize the information in accounts under an accounting equation b. Prepare an income statement, balance sheet, and statement of cash flows for 2014. c. Write a memo discussing the advantages to a business of arranging a line of credit.

Explanation / Answer

Let us first compute the interest expense and the loan outstanding at the end of the period Month Balance OS Borrowed/(repaid) Interest % Interest payable January 60,000 120,000 6 3600 February 180,000 (50,000) 6 10800 March 130,000 0 7 9100 April to October 130,000 (30,000) 7 9100 November 100,000 (50,000) 7 7000 December 50,000 0 6 3000 42,600 a. Accounting equation of Melvin Company Assets* = Liabilities** + Equity 54,000 + 50000 = 50,000 + 42,600 + Equity Equity = 11,400 *represents cash revenue of 54,000 and net loan outstanding of 50,000 It is assumed that the net amount borrowed is retained by the company in the form of cash. ** It is assumed that the total interest is outstanding as at the year end b. Income statement , balance sheet and cash flows Income statement of Malvin Company Particulars Amount Revenue 54,000 Total revenue 54,000 Interest expense 42,600 Net income 11,400 Balance Sheet of Malvin Company Particulars Amount Cash 104,000 Total assets 104,000 Loan outstanding 50,000 Interest payable 42,600 shareholders' equity 11,400 Total liabilities & shareholders' equity 104,000 Cash flow of Malvin company Cash and cash equivalents at the begnning of the year 0 Income fom operations 54000 Cash from financing activities Loan borrowed 180,000 Loan repaid 130,000 Increase in cash and cash equivalents 104,000 Csah at the end of the year 104,000 c. Advantages of arranging a line of credit 1. They are flexible and helps the company to deal with occasional cash flow problems 2. They are less expensive compared to other a;ternatives and hence can help in better margins for a company 3. It helps to build a positive credit history for a company which helps in future funding for the company

Related Questions

Navigate

• Browse (All)
• Browse 7
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.