Question

Mr. and Mts. Patel, local golf stars, opened the Patel Chip‐Shot Driving Range Company on March 1, 2020. They invested $25,000 cash and received common stock in exchange for their investment.

A caddy shack was constructed for cash at a cost of $8,000, and $800 was spent on golf balls and golf clubs. The Patels leased five acres of land at a cost of $1,000 per month and paid the first month's rent. During the first month, advertising costs totaled $750, of which $150 was unpaid at March 31, and $400 was paid to members of the high‐school golf team for retrieving golf balls.

All revenues from customers were deposited in the company's bank account. On March 15, the Patels received a dividend of $1,000. A $100 utility bill was received on March 31 but was not paid. On March 31, the balance in the company's bank account was $18,900. The Patels thought they had a pretty good first month of operations. But, their estimates of profitability ranged from a loss of $6,100 to net income of $2,450. Instructions

a. How could the Patels have concluded that the business operated at a loss of $6,100? Was this a valid basis on which to determine net income?

b. How could the Patels have concluded that the business operated at a net income of $2,450? (Hint: Prepare a balance sheet at March 31.) Was this a valid basis on which to determine net income?

c. Determine the actual net income for March.

d. What was the revenue recognized in March?

Answer 1

a) The business operation loss of  $6,100 ($25000-$18900): was based on the variance between the $25,000 cash invested in the Patel Chip‐Shot Driving Range Company and balance in the company's bank account of $18,900 at March 31.

This is not a valid basis to determine the net income as this variance or difference shows only the alteration of cash between two points in time/dates.

b)

Patel Chip‐Shot Driving Range Company
Balance sheet
31-Mar-20
Liabilities and Stockholders’ Equity	($)	($)	Assets	($)	($)
Stockholders’ equity			Assets
Common stock	25,000.00		Cash	18,900.00
Retained earnings	2,450.00		Caddy shack	8,000.00
Total Stockholders’ equity		27,450.00	Equipment (Golf balls + clubs)	800.00
Liabilities
A/cs payable (150+100)	250.00
($150 ad costs+100 utility cost)
Total liabilities		250.00
Total Liabilities and Stockholders’ Equity		27,700.00	Total Assets		27,700.00

As per the prepared balance sheet, the total stockholders’ equity at March 31 is $27,450 and the amount of $2,450 of the net income is the difference between the initial investment of $25,000 and $27,450.

Again this is not a valid basis for determining net income.

Here the modification in stockholders’ equity between two points in time/dates could have happened due to some reasons which are not related to net income,,like, an additional capital funds or investments could have been pumped in by stockholders to business or there may be receipt of dividends etc.

3) Actual Net income for march=dividends+variance in stockholder's equity during the month

Particulars (Month: March)		($)
Stockholders’ equity(as per balance sheet mar 31)		27,450.00
Stockholders’ equity( March 1)		25,000.00
Increase in stockholders’ equity	=27450-25000	2,450.00
Add:   Dividends received		1,000.00
Net income		3,450.00

4) Revenue recognised in March: $ 5700

Particulars (for march month)	($)	($)
Cash (balance at beginning) (A)		25,000.00
Less: Cash payments
Caddy shack	8,000.00
Golf balls and clubs	800.00
Rent	1,000.00
Advertising (750-150)	600.00
Wages	400.00
Dividends (paid to Patel)	1,000.00
Total cash payments (B)		11,800.00
Cash balance before revenues (C=A-B)		13,200.00
Cash (balance at end of month) (D)		18,900.00
Revenues earned (D-C)		5,700.00

**Utilities incurred but not paid, hence not taken in table above.

**Advertising costs only $600 considered as $150 was not paid out of$ 750.