Lydia Trottier has prepared baked goods for sale since 1998. She started a baking business in her home and has been operating in a rented building with a storefront since 2003. Trottier incorporated the business as MLT Inc. on January 1, 2020, with an initial share issue of 1,000 common shares for $2,500.

Lydia Trottier is the principal shareholder of MLT Inc.

Sales have increased by 30% annually since operations began at the present location, and additional equipment is needed for the continued growth that is expected. Trottier wants to purchase some additional baking equipment and to finance the equipment through a long-term note from a commercial bank. Fidelity Bank & Trust has asked Trottier to submit a statement of income for MLT Inc. for the first five months of 2020 and a statement of financial position as at May 31, 2020.

Trottier assembled the following information from the corporation’s cash basis records to use in preparing the financial statements that the bank wants to see:

1. The bank statement showed the following 2020 deposits through May 31:

Issuance of common shares ......................................... $ 2,500
Cash sales ......................................................................... 22,770
Rebates from purchases of raw materials ........................ 130
Collections on credit sales ................................................ 5,320
Bank loan proceeds ......................................................       2,880
                                                                                              $33,600

2. The following amounts were disbursed through May 31, 2020:

Raw materials ................................................................  $14,400
Rent ...................................................................................... 1,800
Salaries and wages ............................................................. 5,500
Repairs and maintenance ..................................................... 110
Utilities ................................................................................. 4,000
Insurance premium ............................................................ 1,920
Equipment ........................................................................... 3,600
Principal and interest payment on bank loan .................... 298
Advertising ......................................................................          424
                                                                                               $32,052

3. Unpaid invoices at May 31, 2020, were as follows:
Raw materials ....................................................................... $256
Utilities ...................................................................................  270
                                                                                                   $526

4. Accounts receivable records showed uncollected sales of $4,336 at May 31, 2020.

5. Raw materials inventory costing $2,075 was on hand at May 31, 2020. There were no materials in process or finished goods on hand at that date. No raw materials were on hand or in process and no finished goods were on hand at January 1, 2020.

6. The note for the three-year bank loan is dated January 1, 2020, and states a simple interest rate of 8%. The loan requires quarterly payments on April 1, July 1, October 1, and January 1. Each payment is to consist of equal principal payments [$2,880 ÷ (3 × 4) = $240] plus accrued interest since the last payment.

7. Employees have been paid through May 25, 2020, and are due an additional $270 on May 31, 2020.

8. Equipment costing $3,600 was purchased on January 2, 2020, and has an estimated useful life of five years with no residual value. Straight-line depreciation is used.

9. Rent was paid for six months in advance on January 2, 2020.

10. A one-year insurance policy was purchased on January 2, 2020.

11. MLT Inc. is subject to an income tax rate of 20%. No tax instalments have been paid.

12. Payments and collections from the unincorporated business through December 31, 2019, were not included in the corporation’s records, and no cash was transferred from the unincorporated business to the corporation.

Instructions

a. Using the accrual basis of accounting, prepare a statement of income for the five months ended May 31, 2020.

b. Using the accrual basis, prepare a statement of financial position as at May 31, 2020.

*c. Digging Deeper Finance Assume the role of a bank manager at Fidelity Bank & Trust. Based only on MLT’s current ratio as a measure of liquidity, and times interest earned ratio as a measure of MLT’s ability to pay interest, would you recommend extending a long-term note for financing of MLT’s purchase of additional baking equipment?