One of Natalie’s friends, Curtis Lesperance, runs a coffee shop where he sells specialty coffees and prepares and sells muffins and cookies. He is eager to buy one of Natalie’s fine European mixers,

One of Natalie’s friends, Curtis Lesperance, runs a coffee shop where he

sells specialty coffees and prepares and sells muffins and cookies. He is eager to

buy one of Natalie’s fine European mixers, which would enable him to make larger batches of

muffins and cookies. However, Curtis cannot afford to pay for the mixer for at least 30 days. He asks

Natalie if she would be willing to sell him the mixer on credit. Natalie comes to you for advice.

Natalie is also thinking of buying a van that will be used only for business.

Natalie is concerned about the impact of the van’s cost on her income statement

and balance sheet. She has come to you for advice on calculating the van’s depreciation.

solution

Part 1

1. My advice to Natalie on financial statements

The financial statements you have received from Curtis should help you evaluate his business and get helpful information for deciding if you should extend credit to him for the European mixer. You will see if his business makes a profit, the financial position, and the cash available to fulfill obligations. You can study the income statement, balance sheet, and cash flow statement (Franklin et al., 2019). The income statement will tell you if he is making profits. The balance sheet will show if he is in the position to pay his creditors and the cash flow statement will indicate the level of cash and cash equivalents available to pay you. Analysis ratios can be used on these financial statements to calculate and determine whether Curtis is capable of fulfilling his credit obligations. For example, the liquidity ratios will determine his ability to convert assets into cash and pay you on time.  Profitability ratios will determine if his business is growing financially and the ability to cover creditors. The Leverage ratios will compare his business’ level of debt against financial statements to measure the ability to repay his debts.

2. Alternatives to extending credit to Curtis for 30 days.

There are several alternatives to extending credit to choose from and I will provide a few here. The first one is Factoring Receivables and it involves selling your receivables (What you sold customers on credit) to a factor (another financial institute) and that factor pays you part of the amount. The factor will then be responsible for collecting the receivables and once the customers pay, you will be paid the remaining amount minus the factoring fee. Another alternative is Accounts receivable loans which involve securing a short-term loan from a bank using your accounts receivables as your collateral. Cash flow Management is another one and it involves tracking, analyzing, and improving the amount of cash coming in and moving out of your business, to anticipate how much cash will be available in the future helpful in covering all your operating expenses, investments, and for planning

3. Advantages and disadvantages of letting customers pay by credit cards

For your business to grow and accommodate all kinds of customers you have to add a credit card option because lots of customers shop on credit and you don't want to lose them. According to Weygandt et al (2011), once you accept credit cards, the issuer (business providing you will the service) will be responsible for most of the work: investigation of customers, maintaining customer accounts, undertaking the collection process, and absorbing losses. Your business will receive cash quickly from credit card issuers. Therefore, your business sales will increase. The disadvantages of adding a credit card option to your business are: you will witness extra expenses like setup fees, monthly fees, interchange, and processing rates. Lastly, the biggest drawback of credit cards is fraud and security issues. Your business can be at risk when you accept stolen cards and you will be responsible for the safe guide of sensitive personal information stored on those cards.

Part II

1. Determining the cost of the van = Van at cost $36,500 + Cost of painting the van $ 2,500 + cost of installing shelving units $ 1,500 = $40,500

2. Preparing depreciation tables for the years 2020, 2021, and 2022 see the excel file attached

In the year 2020 the van will be used only for 3 months (September-December) Therefore:

• Under straight line method -depreciation expense will be $33,000*20%*3/12 =$1,650

• Under Double-declining - annual depreciation expense is 40,500 * 40%* 3/12 = $4,050

• Under Unity of activity depreciation - $0.17*15,000 miles*3/12 = $638

3. The impact of the methods of depreciation on Natalie’s balance sheet on December 31, 2020.

Natalie’s balance sheet will be affected by the accumulated depreciation once she buys assets such as the van. In addition, the choice of depreciation method can impact the book value of the net fixed assets on the balance sheet, like property, furniture, and equipment (Hermanson et al., 2018). On December 31, 2020, depreciation is likely to reduce the fixed assets’ book value on the balance sheet, and this will result in a proportionate reduction in the equity of shareholders (Franklin et al., 2019).

Impact of depreciation method on Natalie’s Income statement on December 31, 2020.

The depreciation will affect depreciation expenses in the income statement and the choice of depreciation method will impact the income of Natalie’s business. Depreciation expenses will reduce net income in the income statement and the method that gives the higher depreciation expenses will have the highest reduction in the net income and retained earnings of a business.

4. Impact of the methods of depreciation on Natalie’s income statement over the van’s total 5-year useful life.

In that period of 5-years, the depreciation expense will be affected by the depreciation of this fixed asset. In turn, this will be reflected in her net income and retained earnings. A depreciation method (like the straight-line method) shows a constant depreciation expense over the 5 years, while others might show a declining or increasing expense. Higher depreciation expense in the first years may reflect higher production value while lower expense in its last years of useful life may reflect lower production value.

5. What method of depreciation is recommended for Natalie to use, and why

I would recommend you use the units-of-activity method because it is suited to factory machinery and it allows you to measure production in units of output or machine hours, for this case you can use it to measure miles covered by the van to its production. This method is also the best for matching expenses with revenue because the productivity and miles of the van vary significantly from one period to another. The only drawback you will face using this method is that it can be often challenging to reasonably estimate total activity (or miles).

References

• Franklin, M., Graybeal, P., & Cooper, D. (2019). Principles of Accounting Volume 1 - Financial Accounting. Van Duuren Media.

• Weygandt, J. J., Kimmel, P. D., & Kieso, D. E. (2011). Accounting Principles (10th ed.). Wiley.

• Hermanson, R. H., Edwards, J. D., & Maher, M. W. (2018). Accounting Principles: A Business Perspective. 12th Media Services.