Question

CAC 510 FINANCIAL ACCOUNTING

Assignment 7 Questions

Case: The 10 Beach Hut by Dana Gillett and Julie Harvey, Richard Ivey School of Business

1. What was Mandy Arlington’s business?

2. What was Mandy Arlington’s brand name?

3. Explain what “sole proprietorship” is.

4. Would you say the idea of sole proprietorship was in line with the vision of the protagonist? Advise Mandy on this issue.

                5. Losses were incurred in the first few years. a. Comment about this.

                b. After how many years was a profit made?

                c. How do you explain the fact that the business made losses for all the years you have indicated and yet was able to survive?

6. In exhibit 2, there is an item “drawings”. Explain its meaning in regard to (1) sole proprietorship and (2) Company

7. Using Exhibit 3;

(a) Explain what is meant by “prepaids.”

(b) Compute the working capital of the business for 2003 and 2004. Explain what your figures mean.

THE 10 BEACH HUT

Upon graduation, a young business school student, Mandy Arlington, decided to follow her dream of becoming a clothing designer. After much thought, she decided to design her own line of beachwear to be sold in beach towns across the province of Ontario in Canada. Arlington would design the clothing and have it produced by a local manufacturer. After researching suppliers, manufacturers, vendors and office locations, Arlington’s clothing line, The 10 Beach Hut, was launched as a sole proprietorship in January of 2001, in time for the upcoming spring season. Operations started slowly and losses were incurred in the first few years; however, by 2004, sales resulted in a profit as demand grew for the 10 beach Hut wear. Selected financial statements for 2003 and 2004 are shown in Exhibits 1, 2 and 3.

Exhibit 1

STATEMENT OF EARNINGS

For the year ending December 31, 2004

Net Sales                                                                            $   296,475

Cost of goods sold                                                                    221,109

Gross profit                                                                                  75,366

Operating expenses

Selling and administration                     $   48,384

Amortization                                                  6,106

Interest                                                        14,115

                                                                                                    68,605

Net income                                                                              $    6,761

Additional note regarding 2004 operations:

The owner made an additional $5,580 capital in October 2004 (see Exhibit 2).

Exhibit 2

STATEMENT OF CAPITAL

For the year ending December 31, 2004

Beginning Capital (2003)                                      $ 45,627

Net income                                                                 6,761

Capital investment                                                      5,580

                                                                                 57,968

Less: drawings                                                           3,283                

Ending capital (2004)                                            $ 54,685

Exhibit 3

BALANCE SHEETS

For the years ending December 31, 2003 and 2004

ASSETS                                       2004                                       2003

Current assets:

Cash                                                   $ 3,939                                                      $ 1,970

Accounts receivable                             73,856                                                        60,726

Inventory                                               65,322                                                        58,100

Prepaids                                                  1,313                                                          1,641

Total current assets                                             $144,430                                                  $122,437                

Fixed assets¹:

Land                                                       16,084                                                       16,084

Building & fixtures                $ 79,764                                  $ 72,543

Less: accum.amortization        20,548     59,216                     14,442                       58,101

Total net fixed assets                                             75,300                                                        74,185

Total assets                                                    $    219,730                                                 $ 196,622

LIABILITIES & OWNER’S EQUITY

Current liabilities:

Bank indebtedness                                          $     32,760                                                  $   23,962

Accounts payable                                                    40,375                                                      31,840

Total current liabilities                                              73,135                                                      55,802

Long-term debt                                                         91,910                                                     95,193    

Total Liabilities                                                          91,910                                                    95,193

   

Owner’s equity:

Owner, capital                                                           54,685                                                   45,627

Total liabilities and owner’s equity                    $   219,730                                              $   196,622

  

¹ Several fixed assets worth $7,221 were purchased throughout the year, however, no fixed assets were sold during the year.

Answer 1

Solution 1

Mandy Arlington’s business was of a clothing designer. She used to design her own line of beachwear to be sold in beach towns across the province of Ontario in Canada

Solution 2

Mandy Arlington’s business brand name was 'The 10 Beach Hut'

Solution 3

Sole proprietorship is a form of business wherein it is owned and managed by a single person. He is the sole person responsible of contributing capital, running the business, and has 100% right on both the profits and losses of the business. It is different from partnership form and company form wherein more than 1 person are co-owners.

Solution 4

Yes the idea of sole proprietorship was right for Mandy as she was the lone member who was responsible for the idea and execution of the business. The idea was correct as she wanted to be clothing designer, and product beachwear was apt for beachside towns in Ontario district for upcoming spring season

Solution 5

(A) Losses was incurred for first three years of operations (2001-2003) due to lack of demand in initail years as the business had just started in 2001. It takes time to build brand and awareness about the product

(B) Profit was made in year 2004 after 3 years of starting business (in 4th year)

(C) The business had made losses for first three years and still survived as it had contributed a good initial capital, which did not erode away due to the losses in three years. Alternatively, combined losses of three years was less than initial capital contributed. Moreover fresh capital was again introduced in 2004

Solution 6

(1) Drawings for sole proprietor business would be withdrawl of capital from the business for personal use and expenses. It reduces the capital of the business

(2) Drawings from company's perspective would be share buyback program wherein there is paying off to the shareholders consequent to share re-purchase

Solution 7

(A) Prepaid as shown in Exhibit on asset side means expenses which do not relate to current financial year yet has been paid in advance hence an asset for the current year. It means advance payment of future expenses, which are recorded as assets currently and recognised as expenses in the time to which it relates to

(B) Working capital = (Current Assets - Current liabilities)

For year 2004, Current assets = 144430 and current liabilities = 55802

Hence working capital 2004 = (144430-55802) = 88628

For year 2003 Current assets = 122437 and current liabilities = 73135

Hence working capital 2003 = (122437-73135) = 49302

Working capital is the amount of capital invested in the daily operations of the business (to purchase raw materials, sell goods, and payoff vendors etc)' There is an increase in working capital in 2004 due to higher inventory, higher accounts receivables, lower accounts payables