Shelia Young started a real estate business at the beginning of January. After approval by the state for a charter to incorporate, she issued 1,000 shares of stock to herself and deposited $20,000 in a bank account under the name Young Properties. Because business was booming, she spent all of her time during the first month selling properties rather than keeping financial records.
At the end of January, Shelia comes to you with the following plight:
I put $20,000 in to start this business at the beginning of the month. My January 31 bank statement shows a balance of $17,000. After all of my efforts, it appears as if I’m ‘‘in the hole’’ already! On the other hand, that seems impossible—we sold five properties for clients during the month. The total sales value of these properties was $600,000, and I received a commission of 5% on each sale. Granted, one of the five sellers still owes me an $8,000 commission, but the other four have been collected in full. Three of the sales, totaling $400,000, were actually made by my assistants. I pay them 4% of the sales value of a property. Sure, I have a few office expenses for my car, utilities, and a secretary, but that’s about it. How can I have possibly lost $3,000 this month?
You agree to help Shelia figure out how she did this month. The bank statement is helpful. The total deposits during the month amount to $22,000. Shelia explains that this amount represents the commissions on the four sales collected so far. The canceled checks reveal the following expenditures:
According to Shelia, the $2,000 check to Stevens Office Supply represents the down payment on a word processor and a copier for the office. The remaining balance of $3,000 must be paid to Stevens by February 15. Similarly, the $3,000 check is the down payment on a car for the business. A $12,000 note was given to the car dealer and is due along with interest in one year.
Required
1. Prepare an income statement for the month of January for Young Properties.
2. Prepare a statement of cash flows for the month of January for Young Properties.
3. Draft a memo to Shelia Young explaining as simply and clearly as possible why she did in fact have a profitable first month in business but experienced a decrease in her Cash account. Support your explanation with any necessary figures.
4. The down payments on the car and the office equipment are reflected on the statement of cash flows. They are assets that will benefit the business for a number of years. Do you think that any of the cost associated with the acquisition of these assets should be recognized in some way on the income statement? Explain your answer.