Lara Knoffs, a qualified commercial artist, had worked as an employee of a large advertising agency for a number of years. She decided to resign her position and set up her own business which would be coordinated from the new home she and her husband had bought.

To establish the business, she invested \($25\) 000 of her cash savings as capital. From this capital, she then purchased for the business equipment worth \($15\) 000 with an expected life of 10 years and no residual value. Other specialist equipment cost \($6600\) (estimated life 6 years — expected residual value of \($600).\) Lara charged competitive prices, produced quality work and built up a good clientele. Most customers paid a deposit before work started and bad debts had never been a problem.

Although there was a general feeling that the business was going well, Lara was concerned that she always seemed to have cash problems when trying to withdraw cash from the business at the same levels and above that she had earned as an employee. You have been asked by Lara to examine her business as she feels that it is not profitable.

An analysis of the Cash at Bank account for the financial year ended 30 June 2026 revealed the following.

This analysis highlighted Lara’s major concern in that the \($31\) 000 she had withdrawn was several thousand dollars below the wage which she had earned as an employee of the advertising firm. She believed, given her assessment of the poor profitability of her business, that perhaps she should return to work as an employee.
Other enquiries reveal the following.

1. Cash received from clients (\($88\) 750) included payments for work done in the financial year ended 30 June 2025 to the value of \($6750\) and also \($8000\) prepaid for work to be done in the next financial year.

2. Materials and stationery on hand at 30 June 2026 were costed at \($4500\).

3. \($14\) 250 was yet to be collected from clients for work done during the year ended 30 June 2026.

(a) trial balance columns of its worksheet for the year ended 30 June 202 (a) and (c) Report should emphasise that profitability is best disclosed in an income statement prepared under the accrual basis assumption and not by a cash analysis. Profitability is concerned with revenues (not only received in cash) and expenses in the financial year (not only paid in cash). Report should include an income statement as below.

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Balance of cash at 1 July 2025 Cash received from clients Cash payments: Accounts payable Insurance prepaid (2 years from 1 July 2025) Materials and stationery $25 750 3600 10000 Electricity and telephone Drawings for personal use Sundry expenses Balance of cash at 30 June 2026 5500 31 000 14 700 $ 3100 88750 91 850 90550 $ 1300