(Period ticket sold: period of flight) Sales on account: In June 2015, a San Die
ID: 2575134 • Letter: #
Question
(Period ticket sold: period of flight) Sales on account: In June 2015, a San Diego-based furniture store had a big sale, featuring "No payments until 2016." (Period furniture sold; periods that payments are received fronm b. customers c. Magazine subscriptions revenue: Most magazine publishers sell subscriptions for future deliv- ery of the magazine. (Period subscription sold: periods that magazines are mailed to customers) Kim Morris purchased Print Shop, Inc., a printing business, from Chris Stanley. Morris made a cash down payment and agreed to make annual payments equal to 40 percent of the company's net income in each of the next three years. (Such "earn-outs" are a common means of financing the purchase of a small business.) Stanley was disappointed, however, when Morris reported a first LO3-6, LO3-7, LO3-10 CASE 3.2 Measuring Income Fairly year's net income far below Stanley's expectations. The agreement between Morris and Stanley did not state precisely how net income was to be measured. Neither Morris nor Stanley was familiar with accounting concepts. Their agreement stated only that the net income of the corporation should be measured in a "fair and reasonable manner." In measuring net income, Morris applied the following policies. 1. Revenue was recognized when cash was received from customers. Most customers paid in cash, but a few were allowed 30-day credit terms. 2. Expenditures for ink and paper, which are purchased weekly, were charged directly to Sup- plies Expense, as were the Morris family's weekly grocery and dry cleaning bills. 3. Morris set her annual salary at $60,000, which Stanley had agreed was reasonable. She also paid salaries of $30,000 per year to her husband and to each of her two teenage children. These family members did not work in the business on a regular basis, but they did help out when things got busy Income taxes expense included the amount paid by the corporation (which was computed cor- rectly), as well as the personal income taxes paid by various members of the Morris family on 4. the salaries they earned working for the business.Explanation / Answer
a.
b. net cash flow generated by this business will be higher than the net income reported by morris.
Because,
The net cash generated by business will not include the salary payments to her family members and personal income taxes paid. To that extent net cash generated by this business will be higher than the net income computed by the morris
Sl no Reasonableness Reason 1 Reasonable As per standards revenue is recorded when it is earned rather on collection basis, in this case the deviation is less hence reasonable 2 Not reasonable Unused ink and paper costs should be capitalised, not charged to income statement. It overstates expense. Hence unreasonable 3 Not reasonable Salaries of family members should have been paid on hourly basis rather a fixed amount as they do not worked all the time. 4 Not reasonable Personal income taxes are not borne by the corporation, they are personal liabilities, even when they are paid by corporation they should be shown as drawings and reduce capital balance but not charged to income statement. Hence not reasonable 5 Not reasonable Depreciation should be charged to income statement, not the cost of the equipment. By charging cost it distorts income for the year. Clearly not reasonableRelated Questions
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