The top managers of Hobby Horse Stores seek the counsel of Ernst & Young, the accounting firm, and learn that Hobby Horse must make some changes to bring its financial statements into conformity with generally accepted accounting principles (GAAP). At December 31, 20X1, Hobby Horse’s accounts include the following:

Cash	$ 18,000
Short-term trading investments, at cost	34,000
Accounts receivable	49,000
Inventory	54,000
Prepaid expenses	8,000
Total current assets	$163,000
Accounts payable	46,000
Other current liabilities	69,000
Total current liabilities	$115,000

Assume Ernst & Young drew the following conclusions:

• Cash includes $6,000 that is deposited in a compensating balance account that will be tied up until 20X4.

• The market value of the short-term trading investments is $32,000. Hobby Horse purchased the investments in early December.

• Hobby Horse has been using the direct write-off method to account for uncollectibles. During 20X1, the company wrote off bad receivables of $7,000. Ernst & Young determines that uncollectible-account expense should be 3% of sales, which for 20X1 totaled $400,000. An aging of receivables at year end indicated uncollectibles of $5,000.

• Hobby Horse reported net income of $81,000 for 20X1.

Required

1. Restate all current accounts to conform to GAAP. (Challenge)

2. Compute Hobby Horse’s current ratio and acid-test ratio both before and after your corrections.

3. Determine Hobby Horse’s correct net income for 20X1. (Challenge)