Case Study

One year ago, Sarah started a new business, House Tech, with her husband, Paul. They came up with an innovative business strategy, taking a unique approach to interior design. Their goal was to give customers an IKEA-like "feel" to what their home might look like, but with the use of virtual reality and their home.

It started with an idea to take virtual reality goggles into customers homes so they could see how a renovation may look. Sarah takes a high-definition camera to her initial no-cost, no-obligations meeting with customers and records the tour of the house with explanations of what her customers want done. Then, her and Paul watch the footage and make virtual modifications, adding their own expertise to the customer's vision along with specific products they can build or buy. Sarah meets with the customers again and shows them what their home may look like with the virtual reality goggles.

Nearly always, the customers are amazed by the experience and agree to the work done with little or no alterations. Some customers are more insistent on sticking with exactly what they envisioned, but Sarah is always happy to help them realize their dreams. She estimates that in 95% of cases, she does end up securing immediate work. A small portion of the homeowners end up contacting her in coming weeks or months for the same work she quoted earlier.

Most of the work is done by the couple, but they do hire contractors for certain jobs. On average, contractors accounted for 35% of the costs last year, while purchased appliances and furniture made up 55%. The remaining 10% was for other supplies, small tools, and materials for projects. Sarah estimates that there is a profit margin of 30% on each job, but she has not taken vehicle expenses into account. Paul suspects this expense will total $2,000 a month (they use the vehicles for personal errands 20% of the time). She wonders if they might be overlooking other expenses as well.

Sarah is specifically wondering what the correct accounting treatment for the high-end technology is. A year ago, House Tech purchased two virtual reality goggles for $700 each, a high-definition camera for $600, and two MacBooks for $1,750 each (everything on account). Although the equipment is expected to last five years with no salvage value, Sarah plans to sell everything after two years of use for half its original cost (cash sale). This will allow her to keep using the best technology for her work and sales pitches. She is looking for guidance on all journal entries on this equipment, including purchase, payment, annual usage, and eventual sale.

In addition to construction, Paul has some experience with building furniture, so he has started making tables and chairs himself. After customers saw his work, they also requested custom pieces, which he started charging a premium for. In the first year, House Tech completed 30 interior design engagements. Two-thirds of these were engagements where all major pieces were purchased. On average, the revenues totaled $6,000 for these jobs. The remaining third heavily involved Paul's specialty items, resulting in higher revenue of $9,000.

Paul estimates he spends $200 of material and 4.5 hours on average per piece. He believes he made 25 pieces last year. He wonders if the extra money is worth pursuing more higher revenue jobs. By advertising $2,500 a month, the annual numbers could be increased to 40 engagements, half of them including significant specialty items made by him.

Sarah and Paul's own basement was unfinished, so they did some work on it to have a similar setup to IKEA. Basically, they added new furniture and appliances, which customers might find appealing. Then, customers are invited to the basement to view and even try furniture and appliances. Even though House Tech only recently started the practice, many customers have purchased pieces on the spot and Paul later delivered them to their houses. Sarah is wondering if the construction of the basement should be considered a business expense. She wants to be as ethical as possible and is leaning towards only including the furniture and appliances sold as expenses. However, some guidance on correct and ethical accounting treatments would be appreciated.

Sarah and Paul are thinking of buying or renting another house to showcase even more products and ideas. They are wondering if the house could be partially rented out to a tenant who would agree to keep things clean and permit customers to visit with advance notice. The tenant could also help with adding or removing furniture and appliances once sales have been completed to customers. Sarah estimates that the monthly rental income of $1,000 would potentially make up half of the mortgage payment (35% interest on average over ten years) and four-fifths of the entire rental payment. In both a rental and ownership scenario, House Tech would incur additional monthly expenses of $500 a month. Sarah expects the new house will boost current sales by 10%. She also expects its value to increase by $30,000 over ten years. Sarah is asking for your input on whether they should rent, buy, or avoid the house altogether.

Required:

COMPUTE a well-organized business report for House Tech. Discuss all relevant issues, including pros and cons of each course of action. Outline any questions or inquiries which should be directed to Sarah or Paul and why the information is important to certain decisions. Please make sure your quantitative analysis is supported with a qualitative analysis.