The Accounting System and Financial Statement Preparation CASE 1.1 Ecotronics, Inc.* Ecotronics, Inc., a small Arizona-based manufacturer and distributor of solar energy panels, was in its first year of operation. The company was conceived and controlled by two retired executives. John Torson, an engineer by profession, developed the basic patent for the solar panels. He lacked adequate liquid re- sources to finance the venture, although he did control a fair amount of wealth. Pete Mathis' chosen field of endeavor was real estate. He, too, possessed few liquid assets. However, he owned a variety of real property including a small unoccupied building that could easily be converted into a plant for the manufacture of solar panels. An independent appraisal valued the lot at $40,000 and the building at $26,000. The two men decided to create Ecotronics, Inc., with (no par) stock issued in the amount of $100,000. Convinced that there existed excellent market opportunities for the solar panels, Torson approached a local bank in order to obtain the necessary capital. The loan officer admitted that Ecotronics appeared to be a profitable and timely venture. He claimed, however, that the bank was in no position to commit funds unless certain essential financial statements were submitted and each of the two major stockholders would agree to be personally liable for the loan amount. He informed Torson that the bank's policy would require the following information to be pre- sented: A statement of financial position (balance sheet) classifying Ecotronics assets and equities as they would appear in the preproduction stage. . An income statement for the first year of normal operations. A projected balance sheet as it would appear at the close of the first opera- ting year. Feeling that they had little effective choice, the two executives acquiesced. Aided by some additional guidelines set forth by the bank, they identified the following * This case was written by M. Edgar Barrett. Copyright 1991 by M. Edgar Barrett. All rights reserved to the author. categories of financial data related to transactions occurring during Ecotronics organizational stage: 1. Torson would receive 34,000 shares of common stock in exchange for the right to the patent. Mathis, on the other hand, would receive 66,000 shares of common stock in exchange for the lot and building, 2. Incorporation fees, attorney's fees, and officers' salaries during the orga- nizational stage would amount to $11.500. 3. Costs of purchasing specially tooled machinery, including consulting fees and overhead, were estimated at $25,000. Raw material purchases during that stage were estimated at $3,000. 4. Ecotronics would borrow $50,000 from the bank. Interest, at the rate of 10 percent, would be payable annually, with the principal to be repaid in five annual installments. Using the preceding information, Torson and Mathis derived the following pro- jected balance sheet: $ 50,000 EXHIBIT 1 ECOTRONICS, INC. Projected Preproduction Balance Sheet Assets Equities Cash $ 10,500 Notes payable Raw material Inventory 3,000 Machinery 25,000 Building 26,000 Land 40,000 Organizational costs 11,500 Common stock Patent 34,000 Retained earnings Total assets $150,000 100,000 --- $150,000 In order to comply with the remaining requirements, the executives estimated that the following transactions would occur during the first year of operations: 1. Revenue derived from the sales of finished goods during the first calen- dar year, $160,000. All sales during this first year of operations would be on a cash basis. 2. Supplemental purchases of supplies and raw materials estimated for the year, paid for by the close of the year, would amount to $50,000. 3. Payment of accrued interest on bank loan, $5,000. Repayment of princi- pal on bank loan, $10,000. 4. Payroll expenses for direct labor involved in production would amount to $45,000. Selling and administrative expenses incurred during said year would amount to $10,000. 5. Projected cash outlays for the purchase of new equipment and machin- ery, $5,000 6. Closing inventory of raw materials expected to amount to $10,000. 7. Accumulated depreciation was calculated as follows: Machinery, with an estimated useful life of 10 years, $3,000; building, with an estimated useful life of 20 years, $1,300. 4 PART ONE The Fundamentals of Accounting 8. The organizational costs incurred during the developmental stage were to be charged against income earned in the current year. 9. Solar panels were to be produced to fill firm orders paid for in cash. All solar panels produced during the operating year were to be purchased by consumers, leaving no closing inventory of finished goods. 10. The cost of the patent would be amortized over its legal life of 17 years. 11. Income taxes would be calculated at $5,880. Ecotronics would pay 75 percent of its tax bill by the end of the year. 12. Dividends paid to shareholders would amount to $20,000. It should be noted that the above events are interrelated and would occur through- out the year. For example, the initial cash balance would provide funds for produc- tion, and, as the finished goods were sold, the funds received would be used to pay for cash expenses and continuing operations. QUESTIONS 1. Starting with the opening balance sheet shown on Exhibit 1, determine the net effect of each of the above summary transactions on that financial state- ment. For purposes of this question, you should imagine that the firm's only financial statement was a balance sheet. 2. Prepare the following financial statements, per the request of the loan officer: an income statement for the first year of operations and a closing balance sheet for that same year. e Type here to search ECOTRONICS: 2006 NOTE tooooo 0 000 Buy Equip to closing nr. Rm Accum Dopr Inv. Fin 9 Amort 10 Tax 11. Dividends CLOSING BALANCE The Accounting System and Financial Statement Preparation CASE 1.1 Ecotronics, Inc.* Ecotronics, Inc., a small Arizona-based manufacturer and distributor of solar energy panels, was in its first year of operation. The company was conceived and controlled by two retired executives. John Torson, an engineer by profession, developed the basic patent for the solar panels. He lacked adequate liquid re- sources to finance the venture, although he did control a fair amount of wealth. Pete Mathis' chosen field of endeavor was real estate. He, too, possessed few liquid assets. However, he owned a variety of real property including a small unoccupied building that could easily be converted into a plant for the manufacture of solar panels. An independent appraisal valued the lot at $40,000 and the building at $26,000. The two men decided to create Ecotronics, Inc., with (no par) stock issued in the amount of $100,000. Convinced that there existed excellent market opportunities for the solar panels, Torson approached a local bank in order to obtain the necessary capital. The loan officer admitted that Ecotronics appeared to be a profitable and timely venture. He claimed, however, that the bank was in no position to commit funds unless certain essential financial statements were submitted and each of the two major stockholders would agree to be personally liable for the loan amount. He informed Torson that the bank's policy would require the following information to be pre- sented: A statement of financial position (balance sheet) classifying Ecotronics assets and equities as they would appear in the preproduction stage. . An income statement for the first year of normal operations. A projected balance sheet as it would appear at the close of the first opera- ting year. Feeling that they had little effective choice, the two executives acquiesced. Aided by some additional guidelines set forth by the bank, they identified the following * This case was written by M. Edgar Barrett. Copyright 1991 by M. Edgar Barrett. All rights reserved to the author. categories of financial data related to transactions occurring during Ecotronics organizational stage: 1. Torson would receive 34,000 shares of common stock in exchange for the right to the patent. Mathis, on the other hand, would receive 66,000 shares of common stock in exchange for the lot and building, 2. Incorporation fees, attorney's fees, and officers' salaries during the orga- nizational stage would amount to $11.500. 3. Costs of purchasing specially tooled machinery, including consulting fees and overhead, were estimated at $25,000. Raw material purchases during that stage were estimated at $3,000. 4. Ecotronics would borrow $50,000 from the bank. Interest, at the rate of 10 percent, would be payable annually, with the principal to be repaid in five annual installments. Using the preceding information, Torson and Mathis derived the following pro- jected balance sheet: $ 50,000 EXHIBIT 1 ECOTRONICS, INC. Projected Preproduction Balance Sheet Assets Equities Cash $ 10,500 Notes payable Raw material Inventory 3,000 Machinery 25,000 Building 26,000 Land 40,000 Organizational costs 11,500 Common stock Patent 34,000 Retained earnings Total assets $150,000 100,000 --- $150,000 In order to comply with the remaining requirements, the executives estimated that the following transactions would occur during the first year of operations: 1. Revenue derived from the sales of finished goods during the first calen- dar year, $160,000. All sales during this first year of operations would be on a cash basis. 2. Supplemental purchases of supplies and raw materials estimated for the year, paid for by the close of the year, would amount to $50,000. 3. Payment of accrued interest on bank loan, $5,000. Repayment of princi- pal on bank loan, $10,000. 4. Payroll expenses for direct labor involved in production would amount to $45,000. Selling and administrative expenses incurred during said year would amount to $10,000. 5. Projected cash outlays for the purchase of new equipment and machin- ery, $5,000 6. Closing inventory of raw materials expected to amount to $10,000. 7. Accumulated depreciation was calculated as follows: Machinery, with an estimated useful life of 10 years, $3,000; building, with an estimated useful life of 20 years, $1,300. 4 PART ONE The Fundamentals of Accounting 8. The organizational costs incurred during the developmental stage were to be charged against income earned in the current year. 9. Solar panels were to be produced to fill firm orders paid for in cash. All solar panels produced during the operating year were to be purchased by consumers, leaving no closing inventory of finished goods. 10. The cost of the patent would be amortized over its legal life of 17 years. 11. Income taxes would be calculated at $5,880. Ecotronics would pay 75 percent of its tax bill by the end of the year. 12. Dividends paid to shareholders would amount to $20,000. It should be noted that the above events are interrelated and would occur through- out the year. For example, the initial cash balance would provide funds for produc- tion, and, as the finished goods were sold, the funds received would be used to pay for cash expenses and continuing operations. QUESTIONS 1. Starting with the opening balance sheet shown on Exhibit 1, determine the net effect of each of the above summary transactions on that financial state- ment. For purposes of this question, you should imagine that the firm's only financial statement was a balance sheet. 2. Prepare the following financial statements, per the request of the loan officer: an income statement for the first year of operations and a closing balance sheet for that same year. e Type here to search ECOTRONICS: 2006 NOTE tooooo 0 000 Buy Equip to closing nr. Rm Accum Dopr Inv. Fin 9 Amort 10 Tax 11. Dividends CLOSING BALANCE