QUESTION:

Would you extend a loan to the Shipleys in the amount of $200,000 in order to open two new restaurants? Why or Why Not?

EVERYTHING NEEDED TO ANSWER THE QUESTION IS GIVEN BELOW

Preparing Financial Statements from Accounting Events:

In January 2015, Susan and Clark Shipley, co-owners of Island Foods, Inc. began discussing the possibility of expanding their restaurant business from a single location in Glendale, Arizona, to two additional locations - one in Scottsdale and a second in Phoenix. Although the Glendale restaurant had only been open for about two years, it had attracted a loyal customer base from neighborhood businesses and schools. Despite the success of the Glendale restaurant in its first two years of operations, the Shipleys would still need to borrow money to finance the two new restaurants. Susan and Clark knew that they would be expected to present a set of recent financial statements as part of any loan proposal. So, the co-owners spent an afternoon compiling data regarding the key transactions of the two preceding years.

Background

In early 2013, Clark and Susan Shipley moved from the damp, gray environment of Seattle, Washington, to the dry, sunny climate of Phoenix, Arizona. After some reflection on their life in Seattle, as well as an analysis of the local business environment in the Phoenix area, they concluded that they would like to own and manage a restaurant. Glendale was Arizona's third largest city, but it was not noted for a plethora of eating establishments, and those that did exist were principally Italian, Mexican, or fast food. The Shipleys concluded that their restaurant would feature Japanese rice bowls and operate under the name Island Teriyaki.

With that decision made, Clark and Susan began the long and difficult process of setting up their restaurant. In March 2013, they formed Island Foods, Inc. by contributing $10,000 in cash in exchange for all of the company 's 1,000 shares of stock. Clark convinced his parents to loan the new venture $120,000 in cash, with principal payable at the rate of $12,000 per year over ten years and interest payable at a rate of 7.5 percent on the outstanding balance as of the beginning of the loan's year. The loan agreement was signed on March 31, 2013, and provided that both principal and interest would be paid only once a year on March 31.

During March, the Shipleys searched for a suitable location for the restaurant. Clark negotiated a lease for approximately 2,000 square feet of retail space at a rate of $1,400 per month. The lease agreement ran for five years, with an option to renew for five more years. The landlord agreed to give the Shipleys three months of free rent on the front end of the lease in order to help the new business survive the critical start-up period.

Also during the month of March, Clark arranged to buy a commercial refrigerator, range, and grill for $26,000 in cash, to be delivered and installed on March 31. Discussions with the seller indicated that the kitchen equipment should last for five years. Clark and Susan also purchased a computer system, with restaurant-specific software already installed, at a cost of $12,000 cash. While the system could last indefinitely, Susan suggested that it be depreciated over six years. Other purchases included food preparation equipment at a cost of $1,200 cash and various restaurant furniture and fixtures at a cost of $2,700 in cash; the equipment, furniture, and fixtures were expected to have a useful life of three years.

To enable the restaurant to be fully operational on April 1, the landlord allowed the Shipleys' carpenter, electrician, painters, and plumbers to begin renovations to the leased store on March 30 and 31. Working round-the-clock, the workers completed all necessary improvements and renovations to the leased space at a cost of $68,000 in cash. On March 31, the purchased kitchen equipment was delivered and Island Teriyaki opened for business as planned on April 1, 2013.

First Two Years of Operations:

Although Susan and Clark had prepared a timely U.S. income tax return in April of 2014 (for 2013 income taxes), they had not bothered to prepare a full set of financial statements using the accrual method of accounting. Since Clark had "backed up" the hard drive on their computer system on a weekly basis, he had a CD containing all of the 2013 transactions and one for the 2014 transactions. Working from the CDs, Clark generated the necessary accounting information regarding the first two years of operations; he assembled the cash flow information in columnar form (see below) and relevant accrual information by each income statement account:

2013 S 212,000 S 327,000 2014 Revenues In general, all restaurant sales were cash transactions; however, the Shipleys had developed a personal relationship with the general manager of one of Glendale's local businesses. As a courtesy to him, they had agreed to cater the company 's New Year 's Eve party each year and to bill the company directly. The billings totaled $3,000 in 2013 and $5,000 in 2014, and were paid by the company within 15 days of the following month Expenses S 60,000 S 105,000 Food costs Susan usually sat down once a week to write checks for any recent bills. Consequently, by year-end, only one week of food costs remained unpaid, totaling S9,000 in 2013 and $12,000 in 2014 Supply costs Since payment on delivery was required for these miscellaneous restaurant supplies (such as ice, napkins, etc.), Susan usually paid this bill directly out of petty cash Utility charges At year-end one month's payment for electricity, telephone, and water remained due Employee wages Because Clark did much of the cooking himself while Susan worked on food and sauce preparation, the Shipleys were able to keep their labor costs fairly low. They also made a conscious decision to hire local high school and college students. At year-end, Clark determined that one week of wages, amounting to $1,100 in 2013 and $1,400 in 2014, were due to employees. Licenses Clark paid the one-time Glendale "new business license" fee at 9 a.m. on April 1, 2013, to enable the business to immediately begin operations. Insurance On April 1, 2013, the Shipley s purchased a three-year "all risks" insurance policy for $18,000 cash. The policy was very comprehensive, covering loss due to theft , fire, or storm damage; as well as such business related risks as lawsiits arising from customer injury while on the restaurant premises. Income taxes For purposes of preparing the accrual financial statements, Clark and Susarn decided to assume that income taxes would be paid on April 15 at a rate of 15 percent. Owner compensation A review of the stored data revealed that the Shipleys had withdrawn S25,000 in cash for personal use in 2013 and $40,000 in 2014. For pur- poses of the loan proposal, Susan decided to treat these withdrawals as dividends S4,800 S6,200 $8,000 S12,000 S 44,000 S76,000 900 $ S 18,000 $ S25,000 S40,000