Question

3. Business transactions and the balance sheet: 19 marks Optimus Prime is the owner (a sole-trader) and manager of Shockwave Company. The business has become quite successful and needs to obtain an extra bank loan so that they can extend the current working space. As part of the loan application, Optimus Prime was asked to prepare a balance sheet and he prepared the following statement, but believes that there could be errors. He has asked for your help before submitting the statement to the bank. Shockwave Company Balance Sheet as at 31 August 2019 Assets Cash 28,000 Accounts Receivable 2,400 Prepaid insurance 1,800 Inventory 32,800 Working space 100,000 Equipment 5,000 Total assets $170,000 Liabilities and equity Loan payable Optimus Prime capital Total liabilities and equity 100,000 70,000 $170,000 After reviewing many documents and after several hours of discussion with Optimus Prime, you have discovered the following facts: 1. The asset cash indudes the balances of all bank accounts, both business related and personal. Optimus Prime's personal bank account has a balance of $2,000, Shockwave Company has exported some products to a client for $20,000 in June, and the cost of the inventory was $12,000. The cash has not be received for this so Shockwave Company has not recorded anything relating to this $20,000. Shockwave Company received $10,000 from a customer at the beginning of August, but the products will not be shipped until the end of October. Optimus Prime recorded the cash amount of this transaction correctly but nothing else. Shockwave Company purchased inventory from an overseas supplier at a cost of $8,000 on credit. The goods were received in July but the supplier allow the firm to delay payment until the end of September. Nothing has been recorded for this transaction. The working space that Optimus Prime is looking at purchasing has market value of $100,000. He would like to record his property plant and equipment at market value. The balance of loan payable is $100,000, which is the amount of financing that Optimus Prime is seeking this time. 2 The owner removed some inventory and gave them to his friends as gifts. The cost of the Inventory was $500 and Nothing has been recorded for this transaction.

Answer 1

Item no 1 - Cash account and capital accounts are incorrect

Reason: Cash account includes personal bank account balance of $2,000 therefore it should be deducted as the firm is separate entity . The capital will also decresde by $2,000.

Item no 2- Accounts receivable and inventory accounts are incorrect.

Reason: Since the goods has been exported in June.The ownership has been transferred even though the payment for the same has been received or not it should be recorded following the accrual basis of accounting.

• Accounts receivable account will increase by $20,000
• Inventory will decrease by $12,000
• Optimus prime capital will increase by $8,000 as profit on sale of goods will increase the capital.

Item no 3 - capital accounts is incorrect

Reason: As per the accrual basis of accounting sales should be recorded when all the risk has been transferred. In current situation cash was received but goods were not delivered by the end of month therefore cash received is a liability and should be shown as cash advances on liabilty side and deducted from capital.

Item no 4 - Inventory account is incorrect

Reason: The goods were purchased in July . Even though the payment has not been made ownership of goods has been transferred therefore following rectification should be made

• Create Accounts payable of $8,000
• Increase inventory by $8,000

Item no 5 - Working space account is incorrect

Reason: He is planning to expand his business.He doesn't own any workspace therefore it is incorrect to show workspace value in balance sheet.

Item no 6 - Loan payable account is incorrect

Reason: He is seeking this loan which may be granted by bank in future. He is not liable to bank currently therefore it is incorrect to show this account.

Item no 7 - Inventory and capital accounts are incorrect

Reason: Inventory given as gift should be recorded therefore following rectification should be made.

• Decrease inventory by $500

Decrease capital by $500 since goods given as gift are considered as drawings.

Correct Balance sheet after rectification

Shockwave company

Balance sheet as at 31 Aug 2019

Assets $

Cash 26,000

Accounts receivable 22,400

Prepaid insurance 1,800

Inventory 28,300

Equipment. 5,000

Total Assets 83,500

Liabilities and equity $

Cash Advances. 10,000

Accounts payable. 8,000

Optimus prime capital . 65,500

Total liabilities and equity . 83,500