Eugene Company is a small private company that sells computers and provides consulting services. The owner of the company, Eugene, wants to expand and has asked you to become his business partner. Eugene has prepared financial statements for the year ended December 31, 2017. These financial statements reported the following:
Current assets................................................$90,000
Current liabilities..............................................65,000
Net sales and consulting revenue..........................650,000
Cost of goods sold..........................................475,000
Total operating expenses....................................106,000
You are trying to decide if you will invest in the business and you are reviewing the financial statements. During your review, you have discovered the following:
1. On December 1, 2017, Eugene signed a $24,000, one-year consulting contract with a new customer starting December 1. Eugene reported the $24,000 in sales and consulting revenue because the customer paid the full amount on December 1.
2. During 2017, Eugene started a new warranty program. Under this program, customers can buy a five-year extended warranty for $500 and 20 customers purchased the warranty. Eugene reported the warranty sales in sales and consulting revenue. No warranty service was provided in 2017.
3. Included in sales is $55,000 for computers that a customer had paid for but had not picked up from the company by December 31, 2017. The customer was picking up the computers on January 2. The cost of these computers is $35,000 and Eugene included this cost in merchandise inventory because the computers were still in the warehouse.
4. During the last week of December, the company ran a promotional campaign in the local newspaper. The cost of the campaign was $4,800. Eugene recorded it as a prepaid expense because he anticipates that January 2018 sales will be higher as a result of the campaign.
Instructions
(a) Explain how financial statements help you with your decision on whether or not to invest in the company.
(b) Calculate the correct amounts for current assets, current liabilities, sales and consulting revenue, cost of goods sold, and total operating expenses. Explain each of your corrections. Eugene uses the contract-based approach to revenue recognition.
TAKING IT FURTHER
Based on your review of the financial statements, would you invest in Eugene Company? Explain. What other information might help with your decision?