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Case 1-1

Case 1-1
Issues.............................................................................................................
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Facts...............................................................................................................
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Analysis..........................................................................................................
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Conclusions/solutions/recommendations.......................................................
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Issues:
1.
a. How would you report on the three-month operations of Ribbons an'
Bows, Inc., through June 30?
b. Was the company profitable? (Ignore income taxes.)
c. Why did its cash in the bank decline during the three-month operating
period?
2. How should you report the financial condition of the business on June
30, 2010?
3. Do you believe Carmen's first three months of operation could be
characterized as "successful"? Explain your answer.
Facts
1. Carmen Diaz decided to open a small ribbon shop. Two of her cousins
agreed to loan the business $10,000 for one year at a 6 percent interest
rate.

2. On March 1, 2010, Carmen's uncle help him formally incorporated her


business and waive her legal fee.
3. On March, 2010, Carmen deposited the cousins' $10,000 loan and her
$1000 equity distribution. She also signed an agreement to rent store
space for $600 per month, paid on the last day of the month. The
agreement was for an 18-month period beginning April 1. The agreement
called for a prepayment of the last two months' rent, which Carmen paid out
of the company bank account at the signing.
4. On March 31, Carmen reviewed the activity in the company's cash bank
account. She paid the following payment: the last two months rent $1,200,
opening the merchandise inventory $3,300, cash register deposit $250,
store supplies $100, April 2 edition advertising $150, and used computer
purchase $2,000.
5. On May 1, Carmen purchased a used commercial sewing machine for
$1,800 cash.
6. On July, Carmen sends the financial report covering the four-month
period from March 1 to June 30 to her cousins. It includes customers had
paid $7,400 cash for ribbons and accessories, but she was still owed $320
for ribbon agreements for a large wedding delivered to the customer. A
part-time employee had been paid $1,510 but was still owed $90 for work
performance. Rent for the three-month period had been paid in cash the
end of each month. Inventory replenishments costing $2,900 had been
delivered. Carmen estimated the June 30 merchandise inventory on hand
had cost $4,100. The small opening office supplies inventory was nearly all
gone. She estimated supplies costing $20 had not been used.
7. She was puzzled by the fact that the cash in the company's June 30
bank account was $3,390, which was less than the April 1 balance of
$4,000.
8. Carmen was concerned about how she should reflect the following in her
financial report which are no interest had been paid on the cousin's loan
and the free legal performance by her uncle and the free cash register
provided by the local credit-card charge processor.

9. Carmen had not paid herself as salary or dividends during the four
months of operations. And she prepared to get some compensation in July
if cash was available. Before staring her business, she had worked for
$1,300 a month as a cashier in a local grocery store.
Analysis
1a.
Customer has paid ($7,400) cash for ribbons and accessories and credit
sales ($320). Cost of sales is derived from the following equation:
beginning merchandise inventory ($3,300) plus purchases ($2,900) less
ending merchandise inventory $4,100 equals cost of sales $2,100. Rent
expense is $1,800 of $600 per month times three months. Part-time
employee expenses ($1,600) is the sum of cash paid ($1510) plus amount
owed ($90). The prepaid advertising ($150) was run by the local paper on
April2. The benefit of the asset expired so the asset became an expense.
The commercial sewing machine purchased led to a $1,800 asset being
recorded. The asset's benefit was partly consumed during May and June
resulting in a $60 depreciation charge. Some of the future benefits of the
computer and related software asset were consumed during the three
month period. A $250 depreciation charge must be recognized. Carman
has rented the cousins money for four month. The cousins loan is
$10,000. ($10,000*0.6*4/12)=200. Thus, the interest for four month is $200.
Figure 1
Ribbons an Bows Income Statement
For the period April 1 to June 30, 2010
Sales | $7,720 |
Cost of Sales | (2,100) |
Gross Margin | $5,620 |
Employee Wages | (1,600) |
Rent | (1,800) |

Office Supplies | (80) |


Depreciation - Computer | (250) |
Depreciation - Sewing Machine | (60) |
Interest | (200) |
Advertising | (150) |
Profit Before Taxes | $1,480 |
1b Was the company profitable?
According to Exhibit 1, the company earned $1,480 before taxes. Thus, the
company was profitable.
1c. Why did its cash in the bank decline during the three-month operating
period?
Figure 2
Ribbon an Bows Cash Flows Analysis for the Period
April 1 to June 30, 2010
Beginning Cash | $4,000 |
Sales | 7,400 |
Wages | -1,510 |
Rent | -1800 |
Merchandise Inventory | -2,900 |
Sewing Machine | -1,800 |
Ending Cash | $3,390 |
According to income statement, the main reasons why the cash balance
declined during the three-month operating period are the commercial
sewing machine purchase reduced cash by $1,800 while the related

depreciation charge only reduced income by $60. Ending inventory was


higher than beginning inventory and the increase was paid with cash. That
is, more inventories were brought for cash ($2,900) than the cost of goods
sale ($2100).
2. How would you report the financial condition of the business on June 30,
2010?
Ribbons an Bows
Balance Sheet as of June 30, 2010
Assets | | Liabilities | |
Cash | $3,390 | Wages Owed | $90 |
Accounts Receivable | 320 | Interest Owed | 200 |
Merchandise Inventory | 4,100 | Cousins Loan | 10,000 |
Supplies | 20 | | $10,290 |
Prepaid Rent | 1,200 | Owners Equity | |
Computer | 1,750 | Carmens Equity | $1,000 |
Sewing Machine | 1,740 | Earnings | 1,480 |
Cash Register Deposit | 250 | | $2,480 |
Total | $12,770 | | $12,770 |
3. Do you believe Carmen's first three months of operation could be
characterized as "successful"? Explain your answer.
I believe Carman's business is "successful". But, in order to do better over
the rest of the year, Carman should pay herself some meaningful
compensation and repay the cousin's loan at the end of the year.
Conclusions (solution and/or recommendation: issue)

Ribbons an Bows Inc., within its three months of the operation its shows
that the company has a good start off. The income statement shows that
the company is profitable with the sales totaling $7,720. The cash flow
statement shows that the cash ending balance is less than the beginning
balance and that is because Carmen decided to expand her business,
which has reduced the cash. The balance sheet on the other hand shows
that companys debt is not excessive.
There is still some potential for Ribbon an' Bows Inc., increasing their profit.
They should have more effective market plan and use advertisement to
promote their service