Income statements for Art Staff, Cookie Lane, Deep Creek, Gap Co

1. Art Staff sells paintings either for cash or notes receivable that earn interest. The business uses the direct write-off method to account for bad debts. Lisa Orr, the owner, has prepared Art's financial statements. The most recent comparative income statements for 2003 and 2004 are as follows:
2004 2003

Total Revenue $210,000 $195,000
Total Expenses 157,000 153,000
Net Income $53,000 $42,000

Based on the increase in net income, Staff seeks to expand his operations. He has asked you to invest $50,000 in the business. You have several meetings at which you learn that notes receivable from customers were $200,000 at the end of 2002 and $400,000 at the end of 2003. Also, total revenues for 2004 and 2003 include interest at 15 percent on the year's beginning notes receivable balance. Total expenses include a doubtful accounts expense of $2,000 each year, based on the direct write-off basis. Staff estimates that doubtful accounts expense would be 2 percent of sales revenue if the allowance method were used.

A. Prepare for Art Staff a comparative single-step income statement that identifies sales revenue, interest revenue, doubtful accounts expense, and other expenses, all computed in accordance with generally accepted accounting principles.

B. Is Art Staff's future as promising as his income statement makes it appear? Why or why not?

2. Suppose you are considering investing in two businesses, Cookie Lane
(a jewelry business) and Watch Repairs. The two companies are virtually identical, and both began operations at the beginning of the current year. During the year, each company purchased inventory as follows:

February 8 12,000 units @ 4 = $48,000
May 6 5,000 units @ 5 = 25,000
July 9 7,000 units @ 6 = 42,000
December 27 10,500 units @ 7 = $ 73,500

TOTALS 34,500 units $188,500

Over the first year, both companies sold 25,000 units of inventory. In early Feb, both companies purchased equipment costing $200,000, having a 10-year estimated useful life and a $20,000 residual value. Cookie Lane uses a FIFO method for its inventory and straight-line depreciation. Watch repairs uses a LIFO method and double-declining-balance depreciation. Both companies' trial balances on Dec. 31 included the following:

Sales Revenue $300,000
Purchases 188,500
Operating Expenses 80,000

A. Prepare both companies' income statements.

B. Prepare a schedule that shows why one company appears to be more profitable than the other. Explain the schedule and amounts in your own words. What accounts for the different amounts?

C. If both companies pay federal and state income taxes of 55 percent (combined), how much will be paid by each company?

3. (The following questions are unrelated except that they apply to fixed assets and intangible assets:)

A. The manager of Deep Creek, Inc., regularly buys plant assets and debits the cost to repairs and maintenance expense. Why would he do that since he knows this action violates GAAP?

B. The manager of Gap Co. regularly debits the cost of repairs and maintenance of plant assets to plant and equipment expense. Why would she do that since she knows she is violating GAAP?

C. It has been suggested that, since many intangible assets have no value except to the company that owns them, they should be valued at $1.00 or zero on the balance sheet. Many accountants disagree with this view. Which view do you support? Why?

4. On March 2, 2001, Home Goods purchased store fixtures for $8,700 cash, expecting the fixtures to remain in service for 10 years. Home Goods depreciated the fixtures on a double declining balance method, assuming no estimated residual value. On Sept. 30, 2008, Home Goods sold the fixtures for $950. Make the necessary journal entries to bring the depreciation expense current and record the sale of the fixtures.