Budi Started A Small Boat Repair Service Company During The
Budi Started A Small Boat Repair Service Company During The Current Ye
Budi started a small boat repair service company during the current year. He is interested in obtaining a $100,000 loan from your bank to build a dry dock to store boats for customers. At the end of the year, he prepared the following statements based on information stored in a large filing cabinet:
- Profit for the current year
- Service fees collected in cash during the current year: $55,000
- Cash dividends received: $10,000
- Total income: $65,000
- Expense for operations paid during the current year: $22,000
- Cash stolen: $500
- New tools purchased during the current year (cash paid): $1,000
- Supplies purchased for use on service jobs (cash paid): $3,200
- Total expenses: $26,700
- Profit: $38,300
Assets owned at the end of the current year:
- Cash in checking account: $29,300
- Building (at current market value): $32,000
- Tools and equipment: $18,000
- Land (at current market value): $30,000
- Stock in ABC Industrial: $130,000
- Total assets: $239,300
Additionally, the following transactions are summarized:
a. Contributions from the owner at start-up in exchange for 1,000 shares of $1 par value common stock:
- Building: $21,000
- Land: $20,000
- Tools and equipment: $17,000
- Cash: $1,000
b. Earned service fees during the current year of $87,000; of this, $20,000 was for deposits for future work.
c. Received cash dividends on ABC Industrial stock purchased six years ago (not owned by the company).
d. Operating expenses incurred during the current year totaled $61,000.
e. Supplies on hand (unused) at year-end: $700.
f. Theft of $500 cash by a fired employee, with no insurance coverage.
g. Purchased tools and equipment during the year.
Required Tasks:
1. Determine whether Budi prepared the income statement on a cash basis or an accrual basis, and explain how you can tell. Indicate which basis should be used and why.
2. Reconstruct the correct entries under accrual accounting principles and post the effects to T-accounts.
3. Prepare an accrual-based income statement, a statement of stockholder's equity for one shareholder, and a classified balance sheet, including footnotes explaining changes.
4. Identify additional information needed to assess Budi's loan application.
Paper For Above instruction
Introduction
The financial analysis of Budi’s small boat repair service company necessitates understanding the accounting method used, accurately reconstructing financial records under accrual accounting, and preparing essential financial statements. This comprehensive review evaluates the accounting basis, reconstructs correct accounting entries, and presents summarized financial statements, which are crucial in evaluating the company’s financial health for the loan application.
1. Cash Basis or Accrual Basis? And Which Should Be Used?
Analyzing the figures provided, Budi’s income statement reflects service fees collected (cash basis) and expenses paid (cash basis). The mention of “service fees collected in cash,” along with expenses paid and cash stolen, indicates a cash basis of accounting. The cash dividends received and cash payments for expenses and purchases further suggest simplicity consistent with cash basis accounting.
However, for a detailed and accurate financial assessment, accrual accounting should be used. Accrual basis records income when earned and expenses when incurred, regardless of cash flow, providing a clearer picture of economic activity and financial position. For example, the reported service fee income includes deposits for the next year, which should be deferred under accrual accounting since they are not yet earned.
The purpose of adopting accrual accounting is to align financial reporting with economic reality, enable better decision-making, and satisfy generally accepted accounting principles (GAAP), especially when seeking a substantial loan, as banks require precise financial representations of the company's operations. Therefore, although Budi appears to have prepared his statements on a cash basis, the correct approach for financial reporting and loan assessments is accrual accounting.
2. Reconstruction of Financial Entries and Posting to T-Accounts
The following steps convert Budi’s cash-based figures into accrual accounting entries:
(a) Initial Capital Contribution:
- Dr Building $21,000
- Dr Land $20,000
- Dr Tools and Equipment $17,000
- Dr Cash $1,000
- Cr Common Stock $1,000 (1,000 shares x $1 par value)
- Cr Additional Paid-In Capital $57,000 (balance of contribution)
(b) Revenue Recognition:
- Service revenue earned during the year: $87,000
- Less deposits for future work: $20,000 (deferred revenue)
- Recognized revenue: $67,000 (actual earned services)
(c) Dividends:
- Cash dividends received of $10,000 increase cash and dividend income; these are investing activities and are recorded separately.
(d) Expenses:
- Operating expenses incurred: $61,000
- Less cash stolen: $500 (already included in expenses or theft account)
- Total expenses for accruals should include a provision for the stolen amount if not already accounted for, but as theft of cash, it's reflected as a separate loss.
(e) Purchase of Tools and Supplies:
- Purchase of tools: $17,000 (already recorded at purchase)
- Supplies purchased: $3,200, less ending supplies ($700), thus supplies used: $2,500
- Remaining supplies on hand: $700 (adjusted as asset)
(f) Income Recognition:
- Service fees earned but not yet collected: $67,000 recognized as revenue.
- Collections of deposits for future services are deferred revenue until those services are performed.
(g) Gains and Losses:
- Cash dividends on stock: $10,000 increase cash and dividend income.
- Theft loss: $500 recorded as a Loss due to theft.
T-Accounts:
- Cash: Beginning balance, plus collections, dividends, and sales; minus expenses, supplies, theft, and purchases.
- Accounts Receivable: Recognize earned but uncollected revenue.
- Supplies: Purchases adjusted for usage.
- Equipment and Land: Record additions and depreciation if applicable.
- Revenue and Expense Accounts: Reflect accrual transactions.
These entries, together, accurately portray the company’s financial performance and position under accrual principles.
3. Financial Statements Under Accrual Accounting
a. Income Statement (Accrual):
```plaintext
BUDI COMPANY
Income Statement
For the Year Ended December 31, 202X
Revenues:
Service Fees Earned $67,000
Dividends Received $10,000
Total Revenues $77,000
Expenses:
Operating Expenses (incurred) $61,000
Supplies Used (Purchased - Remaining) 2,500
Theft Loss 500
Total Expenses $64,000
Net Income (Profit) $13,000
```
Footnotes:
- Service fees include revenue earned during the period, excluding deposits for future services.
- The theft is recognized as a loss in expenses, affecting net income.
b. Statement of Stockholder’s Equity (one shareholder):
```plaintext
Beginning Retained Earnings $0
Add: Net Income $13,000
Less: Dividends (assumed to be paid) 10,000
Ending Retained Earnings $3,000
Additional Paid-In Capital $57,000
Total Equity $60,000
```
Footnote: The initial stock issuance and retained earnings are based on owner contributions and profit.
c. Classified Balance Sheet (as at December 31, 202X):
Assets:
- Current Assets:
- Cash: $29,300
- Accounts Receivable (service fees earned but not received): $20,000
- Supplies (remaining): $700
- Long-term Assets:
- Building: $21,000
- Land: $20,000
- Tools and Equipment (net of depreciation if applicable): $17,000
- Investments:
- Stock in ABC Industrial: $130,000
Liabilities:
- Deferred Revenue (from deposits): $20,000
Stockholders’ Equity:
- Common Stock: $1,000
- Additional Paid-In Capital: $57,000
- Retained Earnings: $3,000
- Total Equity: $61,000
Footnotes:
- Deferred revenue reflects customer deposits for future services.
- The net book values of assets are adjusted for depreciation if relevant.
4. Additional Information for Loan Evaluation
To better assess Budi’s ability to repay the loan, several additional data points are necessary:
- Cash flow statement: Detailed inflows and outflows, including operational cash flow, financing, and investing activities.
- Detailed records of accounts receivable and payable to understand working capital management.
- Evidence of ongoing cash flow, including future revenue prospects and receivable collection efficiency.
- Documentation on the value of assets pledged as collateral if any.
- Budi’s credit history and personal financial statements.
- Information on the business’s growth prospects, market conditions, and competitive landscape.
- Details on the company’s insurance policies, especially for theft and property damage.
Conclusion
Applying accrual accounting principles provides a more accurate depiction of Budi’s financial health, which is essential for evaluating his loan application. Proper reconstruction of financial records, including recognition of earned revenues and incurred expenses, reveals the company's true profitability and fiscal position. Supplementary data about cash flows, receivables, and broader economic indicators will further assist the bank in making informed lending decisions.
References
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