jeremy langer case-online submission

8/4/2019 Jeremy Langer Case-Online Submission

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Executive Summary:

This case is written by me, bank accountant, on Jeremy Langer’s request to

analyse the performance of his business in first three and half weeks. His

business is not public so my analysis is not going to be constraint by GAAP. I

am assuming that except Jeremy, Bank, CRA department, or may be festival

committee would be using these statements. I have tried to find numbers of

accounting issues namely: Nature of Business, Cost of Development of

Business, licence fee- Expense or Asset, Interest Recognition, Expense

Recognition, Van cost and Depreciation, Revenue Recognition, Value of

unsold Inventory, Bank Covenant, and Tax payment and provided different

alternatives for each. Most appropriate alternative is recommended. Effect of

these alternatives on the financial statements is also provided.

Jeremy Langer has not been performing on expected lines. He is able to sell

only 1,500 souvenirs and need to sell 2565 (appendix 4) souvenirs more to

breakeven. He is facing a cash flow issue too. He has been selling on credit

and expects to receive cash at the end of the business. Jeremy Langer

should convert his receivables to cash as early as possible in the business.

Jeremy should put more efforts or increase marketing of his product to be

able to sell rest of the 3,500 souvenirs in next two and half weeks.

Last but not the list, I have taken some significant assumptions in analysis

and request you contact me if you find any of these assumption incorrect.

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Contents

Executive Summary: ............................................................................................... 1Contents ..................................................................................................................... 2

Accounting Issues: ...................................................................................................... 4

Appendix 1: Statement of income ........................................................................ 11

Appendix 2: Statement of cash flow ...................................................................... 12

Appendix 3: Balance sheet as of July 2014 ............................................................ 13

Appendix 4: Sales to Breakeven ............................................................................ 14

Appendix 5: Expected Earnings ............................................................................. 15

Acronyms:

You Jeremy Langer

GAAP Generally Accepted Accounting

CRA Canada Revenue Department

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To: Jeremy Langer

From: Bank Accountant

Re: To know the performance of the business for first three weeks.

Before we can proceed to discussing the treatment of specific issues, I

assume that you are naïve user of financial statements and I need to

determine the context for the recommendations that will be made. These

financial statements are made as of July 3rd 2014. Your business is not public,

so it may be possible to prepare financial statements outside of the

constraints of GAAP. Financial statements are essentially a communication

tool, and GAAP offers a set of rules and principles that constrain what is

reported on the financial statements when they are intended for public

distribution. However, it may be possible to prepare more useful statements

outside of the confines of GAAP. To make this decision, we must consider the

users of the statements. From the information I have, there might be three

primary users of the financial statements of your business: Bank, Canada

Revenue Association and may be Festival Organizing Committee. Each

approaches the statements with different needs and objectives. Bank is a

secured creditor and would want to make sure that it is able to obtain its

money on time. CRA department, like bank, would like business to do well so

that you pay higher taxes. Festival Organizing Committee would want more

people to buy souvenirs as token of remembrance. You as an owner would

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be interested in knowing the real performance of the business and some

recommendations to improve profit from the venture.

So I recommend that the statements not be constrained by GAAP. It is

imperative that you confirm with Banks, CRA and Organizing Committee that

they will be willing to receive non-GAAP financial statements and they will

not need an audit. I have some accounting issues and I will try to associate

them with accounting items you provided me.

Accounting Issues:Nature of Business: I am assuming that business life is six months from

January 2014 to July 2014.

Costs of Development of Business: I am assuming that the $15,000 you

originally invested was used to develop the business. If any costs were paid

by you personally, it must be added to $15,000.

Accounting item 1: In January 2014, $15000 deposited in bank in the name

of venture is an asset and owner’s equity. Design cost of $1,200 paid in cash

can be recognized as:

Alternative 1: Assume $1,200 to be expense and decrease net income by

$1,200.

Alternative 2: $1,200 is the expense for 5000 souvenirs; recognize expense

for only 1,500 sold souvenirs. Decrease net income by $600 and consider

$1,400 be prepaid design cost in balance sheet.

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Recommendation: I would recommend you to use first alternative as it is

business development cost.

Expense or Asset: In February 2014, you paid a licence fee of $2,000. This

can be recognized on the financial statement as:

Alternative 1: Total $2,000 is an expense as cash has been paid. Considering

it as an expense net income will decrease by $2,000 and cash will decrease

by same amount.

Alternative 2: Recognizing licence fee as an asset and depreciating it as per

straight line method over six week period of business. It will be considered as

an asset on balance sheet and depreciated.

Recommendation: I would recommend you to follow first alternative as it is

one of the expenses of developing business.

Interest Recognition: You took a loan of $30,000, for which you have to

pay interest of $1,000 with principal.

Alternative 1: Interest of $1,000 can be recognized as per cash based

accounting at the end of business. There will be no entry in financial

statement under this alternative.

Alternative 2: Interest $1,000 can be recognized as an expense on income

statement as per accrual accounting and it can be reflected on balance sheet

as a liability.

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Recommendation: This is a cost of raising money which is used in the

business. I would recommend you to use second alternative.

Expense Recognition: You had 5,000 souvenirs produced before the

festival started. We can recognize the expense on the financial statement as:

Alternative 1: We recognize the expense for 1,500 souvenirs and consider

unsold souvenirs as an asset. By this we will have expense for 1,500 sold

souvenirs on the income statement and rest of the souvenirs will be

recognized on balance sheet as an asset.

Alternative 2: As the cost of all the 5000 souvenirs has to be paid so we can

consider all of them as an expense and decrease income statement by cost

price $50,000.

Recommendation: I would recommend using first alternative as rest of the

3,500 souvenirs are an asset of $49,000 (Appendix 3).

Van Cost and Depreciation: You purchase a van to transport souvenirs for

$5,000. There is uncertainty over the depreciation of the Van.

Alternative 1: Consider Van to be an asset. Since life of Van is much longer

than the Festival period of six weeks, depreciation on Van can be considered

to be 20%. This is going to add an expense of $1,000 (Appendix 1) to income

statement and $4,000 will be added to assets in the balance sheet.

Alternative 2: Consider Van to be an expense. Whatever is the amount Van

sold can be taken as gain later.

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Recommendation: I would recommend using alternative 1 as it is practical

and gives better performance of the business. Van be sold after the festival

or could be used for personal purchases with the asset value of $4,000

(Appendix 3).

Revenue Recognition: Because the product and cash are not changing

hands at the same time, there is some uncertainty as to when the revenue

generated should be recognized.

Alternative 1: “ At the point of supplying it to vendor.” At this point the costs

are known. However, there is uncertainty regarding the sales. Sales of

$70,000 will be recognised in income statement under this alternative.

Alternative 2: “ At the point when customer has sold it to final customer.”

This will give a better picture of earning but vendors might request for more

discount at the end of business. Under this alternative sales will be $21000

(Appendix 1) and rest souvenirs will be $35,000 (Appendix 3) asset as per purchasing

value.

Alternative 3: “ At cash collection.” This would reduce the estimation for

discount request from vendor. Total $70,000 will be asset as vendors will be

handing over the total cash after the festival gets over.

Recommendation: In order to capture performance, we want to record

revenues at the point at which the economic exchange, when customer pays

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to the vendor, occurs. Alternative 2 is recommended as discounted offered

to vendor, if any, will be negligible.

Value of unsold Inventory : It is not known what will be the value of finally

unsold souvenirs.

Alternative 1: Unsold inventory should be written off after the business get

over as the economic value of those souvenirs will be negligible as compare

to the cost.

Alternative 2: There might a chance to use them for something or returned

them to recycle at lower rate but substantial as compare to cost.

Recommendation: I would recommend using first alternative as it is difficult

to assume the resale value, if any, right now. You should try to sell all the

souvenirs by the end of the festival. Only 1,500 souvenirs are sold in first

three and half weeks and 3,500 souvenirs are left to sell in last two and half

weeks. 3,500 souvenirs taken as assets of negligible value after the festival.

Bank Covenant: I am not sure about the covenant bank had with you

during providing loan to your business. I don’t see you following any bank

covenant and I am assuming that you did not have any business specific

covenant with the bank. If any, I recommend you to make sure that your

business abides by the covenant.

Tax Payments: There was no information provided regarding the tax

payment so I am assuming that there is no tax paid of any kind.

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Feedback and Advice: So far your venture has not performed on expected

lines. You have been able to sell 1500 souvenirs out of 5000 in first three and

half weeks of the festival. It might be a challenge for you to sell 3,500

souvenirs in next two and half weeks. Even though I realise that souvenir is a

symbol of remembrance and more people are expected to buy souvenirs in

last week but you should aim to sell before business approach to last few

days. Having said that, if you see large number of souvenirs left in last few

days, you should offer special discounts so make sure you are able to sell all

the souvenirs, as left over souvenirs will be of no economics value to you.

For request to withdraw money from venture, I would advise against that as

your venture is undergoing a critical stage and is credited with $9,200

(Appendix 2). It is very important to have extra cash in hand to face any

unexpected expenses. I would also suggest you to recover cash from

vendors at the earliest.

Financial statements for me: As a banker, these financial reports are very

helpful to me as they present me a present picture of business and give me

an idea of what is expected in future. I am concerned that you are not

collecting cash during the event and postponing it to the end. It is not a sign

of a good business, you should try to reduce the account receivables and

convert that to cash as early as possible. Another concern I have is over

dependent on the sales in last week. You should try to advertise more and

put more efforts in selling them before the end of festival to avoid last

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minutes changes in business strategy. You have to make sure to sell 2565

(Appendix 4) souvenirs more in next two and half weeks to breakeven the

business.

These are the recommendations I have for you. Please note again that I have

made some significant assumptions in my analysis. If these assumptions are

incorrect, the analysis on which they are based has to be revisited. If that is

the case, please contact me.

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Appendix 1: Statement of income

JEREMY LANGERIncome Statement

As of July 3rd, 2014Sales $21,000.00

Cost Goods sold $15,000.00

Gross Profit $6,000.00

ExpensesSouvenir Design

Cost $1,200.00License Cost $2,000.00

Other Costs $1,000.00

Van Depreciation $1,000.00

Int Exp $1,000.00

Total Expense $6,200.00

Gross Income -$200.00

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Appendix 2: Statement of cash flow

JEREMY LANGERStatement of Cash Flow

As of July 3rd, 2014Cash from Operating Activities

Net Income -$200.0

Sales¹ -$21,000.0

Depreciation $1,000.0

Interest Expense $1,000.0

Cash from Financial Activities

Common shares $15,000.0Bank loan $30,000.0

Cash from Investment Activities

Equipment -$5,000.0

Souvenirs' Cost -$30,000.0

Total -$9,200.0

Cash at the beginning $0.0

Cash balance on 3rd July -$9,200.0

¹ Assumed that sales were on credit and cash will be received in lump sum after the festival

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Appendix 3: Balance sheet as of July 2014

JEREMY LANGERBalance sheet

As of July 3rd, 2014

Assets Cash -$9,200.00Account

Receivable¹ $21,000.00

Equipment² $4,000.00

Inventory $35,000.00

Total $50,800.00

Liability and Owner's Equity

Bank Loan $30,000.00

Account Payable $6,000.00

Common shares $15,000.00

Retained earnings -$200.00

Total $50,800.00

¹ Assumed that sales were on credit and cash will be received in lump sum after the festival

² Considering that we will be able to sell Van for $4000 after the Festival

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Appendix 4: Sales to Breakeven

Minimum Sales to breakevenCash Outflow

Interest on loan $1,000

Inventory cost $50,000

Other expenditure¹ =1000*6/3.5 $1,714

License Fee $2,000

Design cost $1,200

Van Depreciation $1,000

Total $56,914

Cash Inflow

Souvenir sale price $14Number of souvenir to be sold to

breakeven =56200/14 4065More souvenir to be sold tobreakeven =4014-1500 2565

¹Other expenditure is considered as a continuous process.

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Appendix 5: Expected Earnings

Expected EarningsCash Outflow

Interest on loan $1,000

Inventory cost $50,000Other

expenditure $1,714

License Fee $2,000

Design cost $1,200

Van Depreciation $1,000

Total $56,914

Cash InflowSouvenir sale

price $14Number of

souvenir 5000

Total Sales $70,000Expected NetIncome $13,086

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