the artwork for 10 times the cost of your investment is subject to considerable uncer- tainty. Both investments, in a college education and in an art gallery, require an assess- ment of the risks and returns. The profit split between you and your friend if you decide to open the art gallery is a matter of negotiation. You will certainly want a significant share of the profits for the risk you are taking in investing your savings. However, other factors must be considered as well, such as the amount of time each of you will spend in running the business. LO 2 DECISION CASE 1-5 PREPARATION OF PROJECTED STATEMENTS FOR A NEW BUSINESS 1. REMOTE DVD WORLD INC. PROJECTED INCOME STATEMENT FOR THE FIRST MONTH Revenues: Daily rentals ($3 × 800) $2,400 Monthly memberships ($25 × 200) 5,000 $7,400 Expenses: Wages ($5 per hour × 15 hours × 4 weeks × 4 employees) $1,200 Rent 1,000 2,200 Net income $5,200
1-34 FINANCIAL ACCOUNTING SOLUTIONS MANUAL DECISION CASE 1-5 (Concluded) 2. REMOTE DVD WORLD INC. PROJECTED BALANCE SHEET END OF FIRST MONTH Assets Liabilities and Stockholders’ Equity Cash $ 200* Notes payable $10,000 Accounts receivable 5,000 Capital stock 10,000 DVDs 20,000 Retained earnings 5,200 Total liabilities and Total assets $25,200 stockholders’ equity $25,200 *$10,000 + $10,000 – $20,000 + 800($3) – $1,200 – $1,000 3. On the surface, the decision to invest in the business appears to be an easy one. With net income of $5,200 per month, it seems as if the $10,000 loan from the bank could be repaid in two months (of course, interest would have to be paid also). How- ever, net income is not always the same as cash flow from operations. In this case, the ability to generate $5,200 in cash flow each month depends on whether the $5,000 in monthly memberships can be collected each month (the assumption is that the first month’s memberships will not be collected until the second month). A second concern is whether the company will be able to attain and then sustain the projected sales forecasts of 800 rentals per month and 200 monthly memberships. Will the demand for rentals and memberships increase, decrease, or stay relatively stable in the future? A third issue concerns the useful life of the DVDs. A sizable investment of $20,000 has been made in the initial inventory of DVDs. How long will it be before more DVDs will need to be purchased to keep customers returning to the store? Also, will the company be able to rent space in the area for $1,000 per month in the future? What is the possibility that the rent will be increased? Finally, is it likely that someone else will open a rental store in the area? What effect would this have on sales? ETHICAL DECISION MAKING LO 1,2,4 DECISION CASE 1-6 IDENTIFICATION OF ERRORS IN FINANCIAL STATE- MENTS AND PREPARATION OF REVISED STATEMENTS 1. Errors made in preparing the financial statements: a. The recognition of the 2008 season ticket sales as revenue in 2007. Because Lakeside has not provided these fans with any service yet (the games), the sale of the 2008 season tickets does not result in revenue in 2007.
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