North Ltd. plans to manufacture cross- country skiing equipment. Its cash flows are highly dependent on the winter weather. North operates under ideal conditions of uncertainty. On August 1, 2015, the beginning of its first year in business, North acquires equipment to be used in its operations. The equipment will last two years, at which time its salvage value will be zero. The company finances the equipment by means of a $ 500 bank loan at 3% interest, with the balance financed by issuing common shares.

North’s annual net cash flows will be $ 900 if the weather is snowy and $ 300 if it is not snowy. Assume that cash flows are received at year- end. In each year, the objective probability that the weather is snowy is 0.7 and 0.3 that it is not snowy. The interest rate in the economy is 3% in both years. North Ltd. will pay a dividend of $ 50 at the end of each year of operation.

Required

a. In the 2015– 2016 skiing season, the weather is snowy. Prepare a balance sheet at July 31, 2016, the end of North Ltd.’ s first year of operations, and an income statement for the year.

b. What timing of revenue recognition is implicit in the income statement you have prepared in part a? When ideal conditions do not hold, is this timing of revenue recognition relevant? Is it reliable? Explain.

c. Assume that North Ltd. paid the present value you calculated in part a for its equip-ment. Calculate North’s net income for the year ended July 31, 2016, on a historical cost basis, assuming that equipment is amortized on a straight line basis. Under the more realistic assumption that ideal conditions do not hold, which measure of net income— present value basis or historical cost basis— is most relevant? Which is most reliable? Why?