Cash Flow versus Net Income Shelia Young started a real estate business at the beginning of January. After approval by the state for a charter to incorporate, she issued 1,000 shares of stock to herself and deposited $20,000 in a bank account under the name Young Properties. Because business was booming, she spent all of her time during the fi rst month selling properties rather than keeping fi nancial records.

At the end of January, Shelia comes to you with the following plight:

I put $20,000 in to start this business at the beginning of the month. My January 31 bank statement shows a balance of $17,000. After all of my efforts, it appears as if I’m “in the hole” already! On the other hand, that seems impossible—we sold fi ve properties for clients during the month. The total sales value of these properties was $600,000, and I received a commission of 5% on each sale. Granted, one of the fi ve sellers still owes me an $8,000 commission, but the other four have been collected in full. Three of the sales, totaling $400,000, were actually made by my assistants. I pay them 4% of the sales value of a property. Sure, I have a few offi ce expenses for my car, utilities, and a secretary, but that’s about it. How can I have possibly lost $3,000 this month?

You agree to help Shelia fi gure out how she did this month. The bank statement is helpful. The total deposits during the month amount to $22,000. Shelia explains that this amount represents the commissions on the four sales collected so far. The canceled checks reveal the following expenditures:

Check No. Payee—Memo at Bottom of Check Amount 101 Stevens Offi ce Supply $ 2,000 102 Why Walk, Let’s Talk Motor Co.—new car 3,000 103 City of Westbrook—heat and lights 500 104 Alice Hill—secretary 2,200 105 Ace Property Management—offi ce rent for month 1,200 106 Jerry Hayes (sales assistant) 10,000 107 Joan Harper (sales assistant) 6,000 108 Don’s Fillitup—gas and oil for car 100 According to Shelia, the $2,000 check to Stevens Offi ce Supply represents the down payment on a word processor and a copier for the offi ce. The remaining balance is $3,000 that must be paid to Stevens by February 15. Similarly, the $3,000 check is the down payment on a car for the business. A $12,000 note was given to the car dealer and is due along with interest in one year.
Required 1. Prepare an income statement for the month of January for Young Properties.
2. Prepare a statement of cash fl ows for the month of January for Young Properties.
3. Draft a memo to Shelia Young explaining as simply and clearly as possible why she did in fact have a profi table fi rst month in business but experienced a decrease in her Cash account. Support your explanation with any necessary fi gures.
4. The down payments on the car and the offi ce equipment are refl ected on the statement of cash fl ows. They are assets that will benefi t the business for a number of years. Do you think that any of the cost associated with the acquisition of these assets should be recognized in some way on the income statement? Explain your answer.AppendixLO1