Financial Statement Evaluation You have been retained by the Headeddown Company to straighten out the company’s accounting records. It seems that the company’s trusted accountant for the past forty-two years, Prunella Drebits, has just run off with the new office boy, Freddy Fresh, on an extended around-the-world cruise. Unfortunately, in her rush, she seems to have misplaced the company’s books. Now the bank is asking for the latest financial statements so it can determine whether to renew the company’s loan. Luckily, you manage to find a listing of accounts and balances she left on the back of a travel brochure for Tahiti:

Because Prunella was always very meticulous, you feel certain the list is complete except for the amount of the owners’ equity in the business. You know, however, that the owners’ equity is equal to the amount of the assets remaining after deducting the amount of the creditors’ claims.

a. Using the information Prunella left behind, prepare a balance sheet and an income statement for the Headeddown Company. Is the company profitable?

b. How do the company’s debts compare with the amount of the owners’ equity? Why might a comparison of a company’s debt with its owners’ equity be useful?

c. The listing of accounts includes equipment. Do you think some or all of the cost of equipment used in operations should be included in the computation of income? Explain.

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Cash on hand (in third desk drawer) Accounts receivable from customers Sales to customers Loan balance owed to Last National Bank Wages owed to employees (not yet paid) Cash in bank account Wage expense Interest income Equipment Goods held for sale to customers (Inventory) $ 120 24,200 71,500 15,000 1,215 725 3,500 515 51,500 15,750