RelativeResourceManager23

RelativeResourceManager23 - Issues in Accounting Education...

Info iconThis preview shows pages 1–5. Sign up to view the full content.

View Full Document Right Arrow Icon
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 2
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Background image of page 4
Background image of page 5
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: Issues in Accounting Education Vol. 11, No. 2 Fall 1996 Introductory Financial Accounting Instructional Case: Thomas Quinn Manufacturing: Venture Capital Funding for a High-Tech Start-Up Firm Mimi L. Alciatore and Phil Drake ABSTRACT: This case presents an introduction to the primary financial state- ments and related fundamental concepts, such as cash versus accrual account- ing, matching and the usefulness of financial information to decision makers. The case can be used at both the undergraduate and graduate levels. It pro- vides the instructor the opportunity to present a brief overview or an extended introduction to financial accounting and reporting. The case takes the student through the entire accounting process, from prepa— ration to evaluation of financial statements, for a newly formed company that is attempting to obtain venture capital financing. The case begins with a descrip- tion of the business and its beginning balance sheet, followed by a set of pro— jected events for the first year of production. It uses a transactionai analysis approach that does not require the use of debits and credits, and requires no prior knowledge of accounting mechanics. The analysis also demonstrates the interrelations among the financial statements. Finally, the case requests stu- dents to first take management’s perspective in preparing the financial state— ments, and then to switch to an investor's role in evaluating the firm’s financial performance. An innovative feature of this case is that it is based on an actual start-up firm and was prepared in consultation with several venture capitalists. INTRODUCTION OHN Thomas works for a firm that designs and manufactures floppy diskettes and diskette drives. He has worked in this area for 20 years, all the while pursuing the goal of starting his own business. Since beginning his career, John has worked in his spare time on developing advances in diskette technology. In fact, he has successfully patented one of his ideas, and has the rare distinction of being recognized as an "inventor" by the Internal Revenue Service. Frustrated by the management Mimi L. Alcia tore is an Assistant Profes- sor of Accounting at Louisiana State University and Visiting Assistant Profes- sor of Accounting at London Business School and Phil Drake is an Assistant Professor of Accounting at Southern Methodist University. We are grateful for the information and as- sistance from the founders of the company on which this case was based. We also ap- preciate the assistance of Paul Ouifiones, Jerry White, Kirk Tennant and Armand Alciatore. 378 problems and the declining state of the firm where he works, John fears that the firm will soon be acquired or shut down. John views this as the perfect opportu- nity to start his own company. Software firms use diskette dupli- cators to copy their software onto the diskettes they sell to customers. The dis- kette duplicators currently available were designed “from the ground up" and their prices reflect their high devel- opment costs. Consequently, they are prohibitively expensive. Alternatively, software firms can outsource the dupli- cation to ” duplication houses," but that too is expensive. A PC-based duplicator could take advantage of the power and competitive pricing of existing PC tech- nologies. John can design the hardware for a PC-based duplicator, but he needs a partner to develop the software. So, he has approached his long-time associate, Peter Quinn. Peter works at a firm that purchases diskettes and other products from the company where John works. They have often discussed the limitations of exist- ing diskette duplication technology. With years of experience in developing software, Peter has the expertise to in- tegrate the hardware and software as- pects of John's duplicator concept. More- over, Peter welcomes the opportunity to start the new venture. John and Peter have built a proto- type of their PC-based duplicator. It has three diskette drives, which gives their machine significantly more power than the single-diskette-drive duplicators sold by competitors. Designed to control each of the three diskette drives simulta- neously, Peter’s software program can copy a different program (“master”) on each drive. Tests have shown that the duplicator can match the fastest indus- try throughput per drive (that is, dis- kettes per hour). However, their dupli- cator offers three independently con- Issues in Accounting Education trolled drives for the same or less money than competitors' one-drive systems. Their machine is essentially equiva- lent to three of the competitors’ ma- chines. Thus, their product is three times as cost efficient, which would make it feasible for many firms to buy their own duplicator instead of having to outsource the duplication. Moreover, software firms would derive significant additional savings because they could reduce their production costs. A firm could duplicate only the number of copies of a program needed to fill a customer order (i.e., a “just—in—time” inventory system), versus paying duplication houses to duplicate large quantities of diskettes. Any unsold diskettes could be recycled because, unlike the diskettes from the duplication houses, the in-house copies of the pro- grams would not be labeled until shipped. The duplicator also includes a ro— botic diskette loader that automatically inserts and removes the diskettes from the diskette drives. Except for the soft- ware and diskette controller card,1 which Peter developed, all of the com- ponents for the duplicator can be pur- chased directly from manufacturers. Having prototyped their PC-based duplicator and proven its cost and per- formance advantages, John and Peter started Thomas Quinn Manufacturing, "TQM." The following transactions were involved in the initial development (pre-production) stage of the company. I John and Peter each contributed $20,000 to the firm in exchange for 100,000 shares each of Thomas Quinn Manufacturing stock. I TQM paid $15,000 for equipment and $4,000 for raw materials (com~ ponents for the duplicator). I TQM obtained a five-year $25,000 ‘ The controller card is inserted into the duplica- tor like a fax card is added to a PC. Alciatore and Drake loan from a local bank. Secured by John and Peter, the loan was to be repaid in five equal annual install- ments, plus 12 percent interest pay- able annually. - The firm spent $30,000 in traceable costs to develop the software for the commercial version of the duplicator. This model of the duplicator was sig— nificantly more powerful than the prototype machine. After three months, John and Peter had completed the final design, devel- opment and testing of the diskette du- plicator. They had a finished prototype to show to customers, and could quickly assemble additional duplicators upon request. However, they knew that they would need additional financing in or- der to make the transition from the start- up phase of the firm to a full—scale manu- facturing operation. They planned to seek venture capital financing from es- tablished contacts in the venture capi- tal community. Traditionally, venture capital firms have provided financing for many high—tech firms. John and Peter planned to propose that TQM would issue an additional 200,000 shares to the venture capital firm for 50 percent ownership in ex- change for $500,000 in funds (TQM was authorized to issue 1,000,000 shares of stock). The cash infusion was needed primarily for payrolls, purchases of 379 equipment, marketing and distribution costs. Their venture capital contacts in- dicated that they would need to see a business plan for TQM and that the plan should include, among other things, the following financial statements: - A balance sheet listing the pre—pro— duction assets, liabilities and equity; - A pro forma income statement for the first year of operations; - A balance sheet at the end of the first year of operations; and - A statement of cash flows for the first year of operations. Exhibit 1 shows the pre-production balance sheet which is based on the de- velopment stage transactions described above and the assumption that a ven- ture capital firm would invest $500,000 in TOM in exchange for stock as dis- cussed above. They also projected the following (summarized) events for the first year of operations: 1. TQM would sell 100 duplicators dur— ing the first year. The sale price of the duplicator would be $12,000, with an estimated '75 percent of the sales collected during the year of sale, and the remaining 25 percent during the following year. 2. Raw materials totaling $342,000 would be purchased and paid for in the first year of operations. _________________,____.__—————————-—— EXHIBIT 1 Thomas Quinn Manufacturing Pre-Production Balance Sheet Assets Cash $ 51 6,000 Raw Materials 4,000 Equipment 1 5,000 Software 30,000 Total Assets $ 565,000 Liabilities 8: Equities Notes Payable $ 25,000 Common Stock 540,000 Retained Earnings 0 Total Liabilities 8r Shareholders' Equity $ 565,000 ________________————————-— 380 3. 10. The firm would make the required interest and principal payments on the bank loan. Direct labor costs—paid as in— curred—for production in the first year would be $48,000. Selling and marketing costs, including commis- sions to manufacturers' representa- tives, were estimated to be $450,000. General and administrative ex— penses would amount to $120,000. All these expenses would be paid during the year. Additional equipment costing $165,000 would be purchased and paid for near the beginning of the year Raw materials on hand at the end of the first year would total $16,000. The equipment and software were estimated to have a six-year life and a 15-year life, respectively. Because duplicators would only be produced to fill customer orders, the firm would keep no finished inven- tory of duplicators on hand. Income taxes were estimated to be 35 percent of pre-tax income. The firm would pay only 40 percent of the tax during the first year of opera- tions, and the remainder in the next year. John and Peter would receive no sala- ries during the first year of operations. But TOM would pay a cash dividend of $0.35 per share, assuming that prof- its and cash were sufficient. REQUIREMENTS Review the numbers in the pre-pro— duction balance sheet by analyzing the effects of the four pre-production Issues in Accounting Education events and the assumed venture capital investment on TOM'S bal- ance sheet. Using the worksheet provided be- low, show the effect of each of the transactions during the first year of operations (items 1—10) on TOM'S balance sheet. Use the amounts from the pre—production balance sheet to fill in the “ Opening Balances " of the accounts on the worksheet. Note that in the worksheet, the retained earnings account is used to reflect all operating activities and dividend declarations. Prepare the following financial state- ments needed for the business plan: (I) the income statement for the first year of operations; (2) the balance sheet at the end of the first year of operations; (3) the statement of cash flows for the first year of operations. From the venture capitalist’s per— spective, evaluate the overall finan— cial performance of TOM'S first year of operations. That is, how well or poorly is TQM projected to do (finan- cially) in its first year of operations? Be prepared to support your assess- ment with the accounting data. Con- sider the impact of the various ac- counting methods and concepts used in preparing the financial state- ments in your evaluation. Which management assumptions used to prepare the statements would you question? What other issues or questions should the venture capitalist con- sider before deciding whether to in- vest in TOM? 381 Alciatore and Drake .mmmumm.“mummmuammsqmwmegmumwm“mgmmmgn.wnu__“mummmm_mmwm»mma;.gwawwwaammgyga 22535 303mde mvoow .Em .. .. H u aoflmwomamm m H ._ .. u . . _ _ . _ . . . , _ . . ._ .. EmEQSUm n _ _ . _ . . _ . . _ . _. mQEmm u ..... __ , ,. _ .. _ _ . ._ .. . .. “ .Wmflflfi n _ . ..mmmwnuBm _. __ ammflm u mumflmm mfiqmmo mfimhmm nowfiamnmuh 3qu 25m 30¢ 29QO 3me 355mm xoofi umfimumm :oEEoU II cu H (U 3 4:1 0 U3 .9 G d.) E .9 fl 0" £13 ‘5 E U Q} D: .1: U1 ('5 U ammnmiog ummnm 852mm mnunfimuznmfi 5:50 92:23. N BHmHmNH llllllillillllllllll|llll|ll| ...
View Full Document

Page1 / 5

RelativeResourceManager23 - Issues in Accounting Education...

This preview shows document pages 1 - 5. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online