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Accounting - Cases and answers
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Part of the answers to the cases discussed in the accounting course given by J. Kooiman, part of the ICT in Business master's program.
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Maria HMaria Hernandez & Associates In June 2004, Maria Hernandez found herself out of a job for
the second time in six months. As she left the building that had housed her failed dot-com
employer, carrying a small box of personal belongings, her mind was already embracing a
plan that would have her start her own business. At least, in her own business she would
control part of her own destiny instead of being subject to the decisions of others. Hernandez
was a graduate of the Massachusetts College of Art. After working three years for an
advertising agency where she specialized in advertising layout, she used part of her savings to
take a technical course in webpage design. Her first job after completing her training was
with a startup retail dot-com that ran through its initial cash and loans in less that one year. It
took her only one week to find her latest employer, but in less than six months it had folded,
too. She loved her work as a webpage designer, and she had confidence in her own abilities
and skill. Her art training allowed her to blend design, color, and webpage layout in attractive
and effective ways. But having been burned twice by startup dot-com employers, she was
also reluctant to go to work for a third. Within days she had put together a simple business
plan to create a webpage design consultancy to offer webpage designs to anyone. She would
head the company and employ other designers as well to meet demand. There were plenty of
potential customers in Boston, and she knew that several of her former colleagues from art
school could be interested in the better pay that webpage design could support. On June 20,
2004, she transferred all of her savings, $30,000, to a new bank account with the company
name, and two days later she added $20,000 borrowed from her father to the account. After
that things moved quickly as she rented a second floor office for $3,000 a month, paying one
month's rent in advance as a security deposit to apply to the end of the lease, and $3,000 for
July 2004. She purchased some used computer equipment with software from her last
employer, and ordered stationary and office supplies that cost $5,000 when they were
delivered on June 29. Maria Hernandez & Associates opened for business on July 2, 2004.
Although Maria was not an accountant, she took stock of her company's financial position as
she began to seek her first contracts. The company had spent all but $12,000 of the cash that
had been put into the bank account, but it had some assets as well.
Maria was a little worried that the cash had gone so quickly, but she also had confidence in
herself and her willingness to work hard. In the first few days, Maria lined up two webpage
design projects from local businesses. She spent part of each day working on the projects, and
the remainder of her time was spent looking for new clients. By early August she had four
other designers at work and a steady stream of new work coming in by way of referrals. She
also felt far too busy to attend to any financial aspects of the business. When clients paid, the
money went into the bank account. The associates were paid weekly, and she paid rent and
other bills when they were received. In the ninth week of operations, Maria's father
telephoned her to ask how things were going, and she could not answer the question with any
confidence. It was time for an accounting, and the end of August would be a good time to do
it. Hernandez found the following information she had accumulated during the two months of
operations:
1. Clients had paid $40,000 for completed work, and two clients still owed a total of
$7,000 for work that had been completed and delivered to them. There were no
projects underway as the office closed on August 31 for the Labor Day weekend.
2. Additional office supplies had been purchased for cash of $900, and office supplies
and stationery that had cost $4,200 were still on hand.
, 3. Rent of $6,000 for August and September was paid in cash. Utility bills, a repair of
equipment, and the salaries paid to designers (including Maria Hernandez) were paid
in cash totaling $33,000.
4. Additional equipment and software was purchased on August 27 for $11, 000, with
half of that amount being paid in cash and the remainder due one month later.
As Maria Hernandez thought about the first two month's operations, she was perplexed by the
fact that cash in the bank had decreased by $5,400 even though she was sure the business was
operating profitably. She also wondered how to account for the following:
1. She had agreed to pay her father interest on his loan of 6% per year, but no interest
had been paid so far.
2. The equipment and software were working out well, but Hernandez knew that they
had a technological life of no more than three years from the time that she had
purchased them. In brief, Maria Hernandez felt that the first two months had been
successful, but she was puzzled about how to draft meaningful reports to mail to her
father.
Chemalite A
In late 2002, Bennett Alexander, a consulting chemical engineer, applied for and received a
patent for one of his inventions—a Chemalite. A small, fragile glass vial of one chemical was
inserted into a plastic, translucent cylinder that was then filled with a second chemical and
sealed. Bending the cylinder caused the glass vial inside to break, allowing the two chemicals
to mix. When combined, the two chemicals gave off a bright yellow‐green glow. Alexander
anticipated a substantial market for the Chemalite. It had the appeal of being readily available
in case of emergencies, but yet it did not require any form of ignition. He anticipated a
considerable demand from the armed forces and manufacturers of flares and sim
ilar safety equipment. On January 2, 2003, Alexander, together with a number of relatives
and friends, established Chemalite, Inc.; 500,000 shares were issued, of which Alexander
received 125,000 in exchange for his patent, and the remainder were sold to the other
investors at $1 per share. During the period January 2, 2003, through June 30, 2003,
Chemalite, Inc., made the following expenditures:
, • January 15—Paid $7,500 in legal fees, charter costs, and printing expenses associated
with the incorporation of the company.
• June 15
Spent $62,500 building the machinery that would be used to produce the first
commercial models of the Chemalite.
• June 24—Purchased $75,000 worth of plastics and chemicals for use in the
production of commercial Chemalites.
Toward the end of June, Alexander, who had assumed a very active role in the management
of Chemalite, Inc., met with the rest of the stockholders to present a state of the corporation
report and to discuss strategies for the future marketing of the Chemalites. He was hopeful
that the company would be producing Chemalites by the end of August. Susan Peterson, a
friend of Alexander who had invested a substantial sum in the company, indicated at the
meeting that she had received inquiries from an auto parts distributor about the availability of
Chemalites and their expected price. The distributor wished to purchase a substantial number
of the lights as part of a highway safety promotion and was interested in pursuing the
possibility of private branding. At this point in the meeting, Mr. Larson, one of the
stockholders, but a man with very little business experiences and even less understanding of
financial statements, interjected: “All this discussion of what we are going to do is well and
good, but all I can see is that six months ago we had $375,000 and now we have $230,000.
By my reckoning, we’ve managed to lose $145,000 in six months and haven’t much to show
for it.” Some of the stockholders agreed with Larson. Indeed, between January 2 and June 30,
the company’s bank balance had fallen from $375,000 to $230,000. Ms. D’Cruz, a
stockholder, suggested that since Chemalite’s operations were not in full swing, these
preoperating outlays should probably be considered more as investments in the business by
the business rather than as losses. After considerable discussion by all the stockholders, it
was agreed that they would meet again in early January 2004 to study the state of the
corporation. It was generally felt that the company should be in full operation by then and
that the problems created by the preoperating period spoken of would be overcome by year‐
end. During the last half of 2003, Chemalite, Inc., did indeed go into full operation. To
prepare for the shareholders’ meeting in early January 2004, Bill Murray, the firm’s recently
hired bookkeeper, produced the following data:
1. In early July 2003, a consulting engineer delivered the prototypes of the Chemalite
that he had been developing, and he was paid a total of $23,750.
2. During the six months from July to December 2003, Chemalite sold $754,500 of its
product. The largest single purchaser, the auto parts distributor with whom Peterson
had negotiated, still owed Chemalite, Inc., $69,500. All other customers’ accounts
were paid in full by year‐ end.
3. Additional chemicals and plastics were purchased for a total of $175,000. All
of these purchases were paid for in cash.
4. Chemalite, Inc., spent $22,500 on television and trade journal advertising to introduce
the product.
5. During the six months ended December 31, 2003, the company expended $350,000
on direct manufacturing labor and on manufacturing‐
related overhead (rent, utilities, supervisory labor). An additional $80,000 was
spent on corporate salaries and other corporate expenses.
6. In early July, a further $150,000 was spent on machinery to be used in the production
of Chemalites.
7. During the period, the company had borrowed $50,000 for a short time and repaid the
loan by year‐end. The interest paid on the loan amounted to $750.
In preparing his state‐of‐the‐corporation report, Alexander noted with some anxiety that the
company’s bank balance had fallen a further $117,000 from the $230,000 reported in June to
only $113,000. It bothered him because he believed that the company was really doing quite
well, and he failed to understand why the bank account did not appear to reflect this
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