Question

Prime Essentials Ltd. is a small private corporation. The owner plans to approach the bank for an additional loan or a line of credit to facilitate expansion. The company bookkeeper, after discussion with the owner of the company, has prepared the following draft SFP for the fiscal year ended 30 September 20X3, the company’s first full year of operations:

The bookkeeper has provided some notes on the amounts included in the draft SFP:

a. The owner invested $60,000 of his own money to start the business.

b. The patent was purchased from the owner’s brother in law for $17,000. The owner believes that the patent could easily be sold for $30,000, and probably more.

c. The equipment is being depreciated at the same rate as allowed for income tax. Depreciation represents a source of financing for the company because it is added back to net income and increases the operating cash flow.

d. The owner uses his personal automobile for occasional business errands. He estimates that the company owes him $6,000 for his use of the car.

e. Because the business has been profitable from the very first, the owner estimates that he could sell the company at a $50,000 premium, thereby almost doubling his initial investment after only one year.

f. The bank gave a five year loan to the company, with the provision that the company had to maintain a 25% “compensating balance” in its cash account until the loan is repaid.

g. The company holds publicly traded shares in other companies. The value of these securities was $10,000 when the owner’s brother in law gave them to the company as a loan on 1 April 20X3. On 30 September 20X3, their market value was $14,000. The company is free to sell the securities, but $10,000 plus one half of any proceeds above $10,000 must be passed on to the brother in law. The brother in law also lent $10,000 cash to the company, repayable on demand.

h. One of the customers is a bit unsteady, financially. That customer owes $3,000.

 

Required:

Redraft the SFP. Provide an explanation for each change you make. Explain any note disclosures you think are needed.

 

Answer 1

Prime Essentials Limited Statement of Financial Position 30 September 20X3
Assets
Current assets:
Cash (a)		$ 9,000
Accounts receivable	$ 32,000
Allowance for doubtful accounts(b)	(3,000)	29,000
Short-term investments (c)		14,000	$ 52,000
Capital assets:
Equipment	120,000
Accumulated depreciation	24,000	96,000
Patent (d)		17,000	113,000
Other asset:
Restricted cash (a)			3,000
Total assets			$ 168,000
Liabilities and shareholder’s equity
Current liabilities:
Accounts payable		$ 28,000
Loans payable to related party (e)		22,000
Payable to shareholder (f)		6,000	56,000
Long-term liabilities:
Bank loan payable			26,000
Total liabilities			82,000
Shareholder’s equity:
Common shares		60,000
Retained earnings (g)		26,000	86,000
Total liabilities and shareholder’s equity			$ 168,000

Notes:

a.   

The $12,000 cash includes $3,000 that must be held as the compensating balance as long as the bank loan is outstanding, which must be shown as a non-current asset.

 

b.   

The receivable from the doubtful customer should be set up as a valuation allowance.

 

c.   

The securities should be shown at market value of $14,000.

 

d.   

The patent must be recorded at its cost. There seems to be no impairment since its value is estimated to be much higher than cost.

 

e.   

The value of the loan from the brother-in-law is really for $10,000 cash plus another $10,000 value of the securities at the date of donation plus his half-share of the $4,000 unrealized profit (at the balance sheet date), a total of $22,000.

 

f.    

Assuming that there is justification for the automobile expenses, this is legitimate. However, it should not be shown as an account payable because it is not an arms-length transaction.

 

g.   

Retained earnings is (1) reduced by the $3,000 bad debt allowance and (2) increased by the net unrealized $2,000 profit on the securities.

 

The $67,000 “increases in value” is washed out by removing the $50,000 goodwill and the $17,000 overstatement of patent.

The $67,000 “increases in value” is washed out by removing the $50,000 goodwill and the $17,000 overstatement of patent.