Group Case: SmartM Inc.

Sarah has taken over as the new Controller of SmartM Inc. Inc, a revolutionary manufacturing business in BC. Despite not having a solid accounting background, Sarah is looking to lead the way in making some long-overdue organizational changes. She has been with SmartM Inc. for almost three years, so she has some ideas for improving processes.

Sarah's direct supervisor, Amy, also doesn't have an accounting background. When the previous CFO retired suddenly last month, Amy was immediately promoted to the Chief Financial Officer role. She, in turn, promoted Sarah, who had been in the finance department and had helped her with a few projects, to Controller. The Controller role was a new one created by Amy to help deal with the company's growing accounting demands.

Since Amy had worked as an administrative assistant to the previous CFO for five years, Sarah had assumed she was fit to take over. Still, she wondered if perhaps the company lacks accounting expertise/leadership. Seeing how the only other accounting employee in SmartM Inc. is Susan, an Accounting Assistant working under her, Sarah wonders if an external candidate would be better suited for her Controller role.

The first thing for Sarah is to complete the budget for the year 2022. Because of the sudden leave of the CFO, the budget for 2022 is not finished.

SmartM Inc. Inc. has completed all operating budgets except the income statement for 2022. Selected data from these budgets follow.

• Sales: $280,000
• Purchases of raw materials: $80,000
• Ending inventory of raw materials: $15,000
• Direct labor: $40,000
• Manufacturing overhead: $73,000, including $3,000 of depreciation expense
• Selling and administrative expenses: $36,000, including depreciation expense of $1,000
• Interest expense: $5,000
• Principal payment on long term note: $20,000 each year
• Dividends declared: $18,000
• Income tax rate: 30%

Other information:

• Assume that there are no work-in-process or finished goods inventories.
• Year-end accounts receivable: 4% of 2022 sales.
• Year-end accounts payable: 50% of ending inventory of raw materials.
• Interest, direct labor, manufacturing overhead, and selling and administrative expenses other than depreciation are paid as incurred.
• Dividends declared and income taxes for 2022 will not be paid until 2023.

	SmartM Inc.
	Balance Sheet
	31-Dec-21
Assets
Current assets
Cash		$20,000
Raw materials inventory		10,000
Total current assets		30,000
Long term investment		88,000
Property, plant, and equipment
Equipment	$40,000
Less: Accumulated depreciation	4,000	36,000
Total assets		$154,000
Liabilities and Stockholders' Equity
Liabilities
Accounts payable	$5,000
Long-term notes payable	110,000
Total liabilities		$115,000
Stockholders' equity
Common stock	25,000
Retained earnings	14,000
Total stockholders' equity		39,000
Total liabilities and stockholders' equity		$154,000

Sarah wants to prepare budgeted financial statements, but she needs some help.

SmartM Inc. is considering an investment of $180,000 in new equipment. The new equipment is expected to last ten years. It is estimated to have a zero salvage value at the end of its useful life. SmartM Inc. expects the same total net cash flows of $270,000 over the life of the investment. But, because of declining market demand for the product over the life of the equipment, the net annual cash flows are higher in the early years and lower in the later years,as below illustration:

Year	Assumed Net Annual Cash Flows
1	40000
2	38000
3	35000
4	32000
5	28000
6	22000
7	21000
8	20000
9	19000
10	15000
	270000

Sarah has to determine whether to add new equipment or not. The required return is 10% for SmartM Inc. Amy mentioned the critical of the loan from the Bank. Accepting the opportunity would mean an immediate investment of $180,000 by SmartM Inc. Those funds can be borrowed from the Bank at 5% per annum. Sarah recalled the email from the bank manager as follows:

COVENANT COMPLIANCE

The undersigned certifies that they have not contravened any of the terms and conditions of the Bank's credit facility pursuant to the Facility Letter and that they are in compliance with the following financial covenants and the other conditions stipulated therein.

1. Total debt to tangible net worth ratio not to exceed 2.00 to 1.00. Actual ___________

2. Current ratio to be maintained at a minimum of 1.25. Actual ___________

The bank manager said the ratios could be based on the budgeted financial statement for 2022 without the new equipment.

Sarah's new contract promises that she will receive, as a year-end bonus, 1% of all growth in SmartM Inc.'s pre-tax net income over the prior year. Hence, she is excited about expanding operations and taking on the equipment. She is also wondering if specific accounting policies can be implemented to increase income on paper, even if no significant changes are made in the business.

Assist Sarah in preparing a budgeted multiple-step income statement and a budgeted classified balance sheet as of December 31, 2022.

Advise Sarah on her career path and the current outlook on SmartM Inc. Produce a business report, including comprehensive analysis, recommendations, and any questions you may need to ask your client.