Question

Question 1
Solar Power Ltd., a small Kumasi –based manufacturer and distributor of solar energy panels, was in its first year of operation. The company was conceived and controlled by two retired executives. Nana Darkwa, an engineer by profession, developed the basic patent for the solar panels. He lacked adequate liquid resources to finance the venture, although he did control a fair amount of wealth. Yaw Manu’s chosen field of endeavor was real estate. He, too, possessed few pied real property including building that could easily be converted into a plant for the manufacture of solar panels. An independent appraisal valued the lot at GH¢40,000 and the building at GH¢26,000. The two men decided to create Solar Power Ltd., with (no par) ordinary shares issued in the amount of GH¢100,000.

Convinced that there existed excellent market opportunities for the solar panels. Nana Darkwa approached a local bank in order to obtain the necessary capital. The loan officer admitted that Solar Power Ltd appeared to be a profitable and timely venture. He claimed, however that the bank was in no position to commit funds unless certain essential financial statements were submitted and each of the two major stockholders would agree to be personally liable for the loan amount. He informed Nana Darkwa that the bank’s policy would require the following information to be presented:
• A statement of financial position (i.e. balance sheet) classifying Solar Power Ltd’s assets and equities as they would appear in the preproduction stage.
• A statement of profit or loss for the first year of normal operations.
• A projected balance sheet as it would appear at the close of the first operating year.

Feeling that they had little effective choice, the two executives acquiesced. Aided by some additional guidelines set forth by the bank, they identified the following categories of financial data related to transactions occurring during Solar Power Ltd’s organisational stage:
• Nana Darkwa would receive 34,000 ordinary shares in exchange for the right to the patent. Manu, on the other hand, would receive 66,000 ordinary shares in exchange for the lot and building.
• Incorporation fees, attorney’s fees and officers’ salaries during the organisational stage would amount to GH¢11,500.
• Costs of purchasing specially tooled machinery, including consulting fees and overhead, were estimated at GH¢25,000. Raw material purchases during that stage were estimated at GH¢3,000.
• Solar Power Ltd would borrow GH¢50,000 from the bank. Interest, at the rate of 10 percent, would be payable annually, with the principal to be repaid in five annual installments.
Using the preceding information, Nana Darkwa and Yaw Manu derived the following projected balance sheet/ statement of financial position:









1
Solar Power Ltd
Projected Preproduction Statement of Financial Position
Assets GH¢
Cash ................................................... 10,500
Raw material inventory.............. …… 3,000
Machinery......................................... 25,000
Building............................................. 26,000
Land.................................................... 40,000
Organisational costs.....................    11,500
Patent................................................ 34,000                                     150,000
Equities                           GH¢
Notes payable.................               50,000
Stated Capital....... …………….. 100,000
Income Surplus..... ……………..     0
150,000

In order to comply with the remaining requirements, the executives estimated that the following transactions would occur during the first year of operations:
i) Revenue derived from the sales of finished goods during the first calendar year, GH¢160,000. All sales during this first year of operations would be on cash basis.
ii) Supplemental purchases of supplies and raw materials estimated for the year, paid for by the close of the year, would amount to GH¢50,000.
iii) Payment of accrued interest on bank loan, GH¢5,000. Repayment of principal on bank loan, GH¢10,000.
iv) Payroll expenses for direct labor involved in production would amount to GH¢45, 000, selling and administrative expenses incurred during said year would amount to GH¢10,000.
v) Projected cash outlays for the purchase of new equipment and machinery, GH¢5,000.
vi) Closing inventory of raw materials expected to amount to GH¢10,000.
vii) Accumulated depreciation was calculated as follows: Machinery, with an estimated useful life of years, GH¢3,000; building, with an estimated useful life of 20 years, GH¢1,300.
viii) The organizational cost incurred during the development stage were to be charged against income earned in the current year.
ix) Solar panels were to be produced to fill firm orders paid for in cash. All solar panels produced during the operating year were to be purchased by consumers, leaving no closing inventory of finished goods.
x) The cost of the patent would be amortized over its legal life of 17 years.
xi) Income taxes would be calculated at GH¢5,880. Solar Power Ltd., would pay75 percent of its tax bill by the end of the year.
xii) Dividends paid to shareholders would amount to GH¢20,000.

It should be noted that the above events are interrelated and would occur throughout the year. For example, the initial cash balance would provide funds for production, and, as the finished goods were sold, the fund received would be used to pay for cash expenses and continuing operations.


Required
A) Starting with the operating statement of financial position (balance sheet) shown in Exhibit 1, determine the net effect of each of the above summary transactions on that financial statement. For purposes of this question, you should imagine that the firm’s only financial statement was a statement of financial position (i.e. balance sheet).       
B) Prepare the following financial statements, per the request of the loan officer: a statement of profit or loss for the first year of operations and a closing statement of financial position (balance sheet) for the same year.                     

Answer 1