Question

QUESTION 1 : (15 Marks)

Adanna Ghany is the founder and manager of Ceramics Unlimited. Adanna has approached the local bank for a loan to expand her business. As part of the loan application, Adanna was asked to prepare Financial Statements for the business. She prepared the following balance sheet and income statement based on the first month of operations (see below).

Ceramics Unlimited.

BALANCE SHEET

November 30, 2019

Cash	$ 1,400		Equity	$ 1,400
	$ 1,400			$ 1,400

Ceramics Unlimited.

INCOME STATEMENT

For the Month Ended, November 30, 2019

Sales		$4,400
Rent	$300
Kiln	4,500	4,800
Net Income		($400)

Adanna stated that she was not pleased with the first month’s results. But she believes she will show a greater profit next month as she will not have large expenses for items such as purchasing a new Kiln (Oven).

In discussions with Adanna and by reviewing the accounting records of Ceramics Unlimited, you discover the following facts

1.    Adanna opened Ceramics Unlimited (a ceramic studio) on November 1st 2019 in leased office space, paying the first month's rent of $300 and a $1,000 security deposit with a check on her personal account.

1.    Ceramics Unlimited sells ceramic pieces as well as offers training courses that teach participants how to make their own ceramics pieces.

2.    Adanna had been making ceramic pieces as a hobby. She took molds and tools, worth about $7,500, from her home in order to start the studio.

3.    Adanna also bought a new firing kiln (oven) to start the business. The new kiln had a list price of $5,000. Adanna wrote a check on her personal checking account.

1.    The first customer of Ceramics Unlimited’s paid a total of $1,400 to attend classes for two months. Adanna opened a checking account in the company's name with the $1,400.

4.    Ceramics Unlimited has conducted classes for one month and has sold some ceramic pieces for $3,000 cash. Cost incurred in making the ceramic pieces was $1,000. Adanna paid these cost with her personal credit card.

As the person to decide whether or not to grant Adanna the requested loan. You have to decide if Adanna prepared the financial statements of Ceramics Unlimited correctly. You need to determine if she violated any accepted accounting principles, assumptions or concepts.

Required

a. Either justify Adanna’s treatment of each event and her preparation of the financial statements based on your understanding of the generally accepted accounting principles

or

b. Identify the generally accepted accounting principles, assumptions or concepts that were violated.

i. Explain how each event should have been handled in accordance with the generally accepted accounting principles.

ii. Prepare a corrected Classified balance sheet and income statement based on your understanding of the generally accepted accounting principles.

QUESTION 2 : (15 Marks)

AJ Ventures Ltd is a company engaged in the manufacture of water bottles which are bought mainly for sporting activities. Present sales are direct to retailers, but in recent years there has been a steady decline in output because of increasing foreign competition. In the last business year (2019) the company produced its lowest profit in ten (10) years. The forecast for 2020 indicates that the present deterioration in profits is likely to continue.

The company considers that a profit of $80,000 should be achieved to provide an adequate return on capital. The managing director has asked that a review be made of the present pricing and marketing policies. The marketing director has completed this review, and passes the proposals on to you for evaluation and recommendation, together with the Income statement for the year ending December 31, 2019 (see below).

AJ Ventures limited.

INCOME STATEMENT

For the Year Ending, December 31, 2019

Sales Revenue (100,000 Bottles at $10)			$1,000,000
Cost of goods sold
Direct Materials	$100,000
Direct Labour	350,000
Variable Manufacturing overheads	60,000
Fixed Manufacturing overheads	220,000
		$730,000
Administrative Overhead		140,000
Selling and Distribution Overhead
Sales commission (2% of sales)	20,000
Delivery cost (variable per unit sold)	50,000
Fixed costs	40,000
		110,000
			$980,000
Income			$20,000

The information to be submitted to the managing director includes the following three proposals:

(i) To proceed on the basis of analyses of market research studies that indicate that the demand for the bottles is such that a 10% reduction in selling price would increase demand by 40 %.

(ii) To proceed with an enquiry that the marketing director has had from a mail order company about the possibility of purchasing 50,000 bottles annually if the selling price is right. The mail order company would transport the bottles from AJ ventures to its own warehouse, and no sales commission would be paid on these sales by AJ ventures. However, if an acceptable price can be negotiated, AJ ventures would be expected to contribute $60,000 per annum towards the cost of producing the mail order catalogue. It would also be necessary for AJ ventures to provide special additional packaging at a cost of $0.50 per bottle. The marketing director considers that in 2019 the sales from existing business would remain unchanged at 100,000 bottles, based on a selling price of $10 if the mail order contract is undertaken.

(iii) To proceed on the basis of a view held by the marketing director that a 10% price reduction, together with a national advertising campaign costing $30,000, may increase sales to the maximum capacity of 160,000 bottles.

Required

a. The calculation of break-even sales value based on the 2019 results. (1 Marks)

b. A financial evaluation of proposal (i) (3 Marks)

c. A calculation (under proposal (i)) of the number of bottles AJ ventures would need to sell at $9 each to earn the target profit of $80.000. (2 Marks)

d. A calculation of the minimum prices that would have to be quoted to the mail order company to

1.              I.    ensure that AJ ventures would at least break even on the mail order contract (2 Marks)

1.             II.    ensure that the same overall profit is earned as in proposal (i) from the mail order contract. (2 Marks)

1.           III.    Ensure that the overall target profit is earned, from the mail order contract. (2 Marks)

e. A financial evaluation of proposal (iii) (3 Marks)

Answer 1

Question 1:

Adanna's Treatment has violated the generally accepted accounting policies and principles. so we have to choose option B.

i. How each situation must be handled according to generally accepted accounting policies and principles:

1. Adanna opened a Ceramic studio in a leased office space with security deposit of $1,000 and Rent of $300 and she paid it from her personal account.

usually the security deposit is refundable and it will be returned at the time of vacating the office space. So the amount of $1,000 is still business money held with the owner of the office space. so it should be treated as an asset and mentioned in the Balance sheet assets column.

Rent of $300 is an expense and Adanna has rightly entered it in the income statement.

The total of $1,300 was spent by Adanna from her personal account for the business. According to ' SEPARATE ENTITY CONCEPT' Business and owner are two separate entity. Adanna's money cannot become business money similarly business money cannot be Adanna's money. The amount of $1,300 which Adanna has spent for the business should be returned to her at some point of time. As she is the owner of the business this $1,300 should be considered as Capital invested by Adanna and credited to her equity account.

2. Adanna took Molds and tools worth $7500 from her home for the business. As mentioned in the earlier point Adanna's assets cannot become Business. As she has brought Tools and molds into the business, the business has to pay adanna its cost of $7,500. Business owns Adanna $7,500 for the tools brought in by her so this $7,500 has to be credited to her equity and Tools and molds are assets to the business and should be shown in the assets side of the balance sheet.

3. Adanna has brought a Kiln and List Price of $5,000. Klin is an asset to the company and she should have entered it in the assets side of the balance sheet but she wrongly entered in the income statement. Not only she entered it in the wrong place but also entered the amount wrongly as $4,500.

So, The purchase of Kiln should be removed from Income statement and to be shown in the balance sheet assets side at $5,000. Again she paid for the kiln from her personal account and as discussed earlier company owes her $5,000 for purchase of kiln. so this $5,000 should also be added to her equity.

4. The company's first customer has paid $1,400 for the classes and she opened an account in the company name and deposited it. She has treated this transaction correctly. $1,400 included in sales in income statement and cash of $1,400 shown in the assets side of the balance sheet.

5. The Second sales for the company is $3,000 in cash which is correctly added to the sales in the income statement but she didnt increase the cash in the balance sheet by $3,000.

The cost of goods sold $1,000 should have been shown in the Income statement but it is omitted and Adanna paid it through her personal credit card so again company owes $1,000 to her for this and it should have beeen added to her equity.

ii. Correct Financial Statements:

With the Understanding of the accounting Principles and rectifying the above mistakes the following is the correct Financial statements for Adanna Ghany's Ceramic Studio - Ceramics Unlimited.

Income Statement For the month ended November 30, 2019
Particulars	Amount ($)
Sales	4,400
- Cost of Goods sold	1,000
Gross Profit	3,400
- Rent	300
Net Profit	3,100

As we have discussed above the purchase of Kiln ( which is an asset ) is removed from the income statement and added the balance sheet. Cost of goods sold is included in the income statement. so the correct Net profit of Ceramics unlimited is $3,100

Balance Sheet As on November 30, 2019
Liabilities	Amount ($)	Amount ($)	Assets	Amount ($)
Owner's Equity	14,800		Kiln	5,000
+ Net profit	3,100	17,900	Molds and tools	7,500
			Security Deposit	1,000
			Cash	4,400
Total		17,900	Total	17,900

Kiln is removed from income statement and added to the assets side of the balance sheet. similarly Molds and tools and security deposit which was not entered in the financial statements are included in the assets. Cash received from 2 sales ( $1,400 + $3,000) is entered as cash in the assets side.

In the explanation above i have mentioned the amounts that needed to be added to owner's equity with reasons. with that in Mind Owner's equity is calcualted below.

Particulars	Amount ($)
Security Deposit	1,000
Rent	300
Molds and tools	7,500
kiln	5,000
Cost of Goods sold	1,000
Total	14,800

Though Adanna has not brought in any cash into the business the above are the expenses she paid from her personal account and assets purchased or brought in by her. so all these are added to her equity account.

And Last time is Net Profit which is transferred from income statement to the balance sheet and added to the owner's equity in the Balance sheet.