accounting

Like many new graduates in 2014, Marie Little struggled to find a sustained

professional job. In early April she had finally found a good position, but was

laid off by June. This ended her brief corporate career, finding herself once

again without income. Marie packed her personal items from her office

cubicle, passing too many empty spaces created by temporary tan walls. It was

a long walk through the lending company’s hall, but she began to think about

starting her own business…as far away from mortgage institutions as possible.

She began to think; “If I own the business they cannot lay me off and I can

actually create a business where I can use my degree.” Like many hired by the

giant lender, she had no financial experience. Her job had been to sell a

mortgage product and push her customers into a longer term refinance

agreement with upfront profitable fees for her financial institution. Financial

knowledge was not a premium, the institution wanted sales.

Marie had graduated from the University of Michigan-Dearborn’s College of

Arts, Science, and Letters with a bachelor’s degree majoring in art, but had also

taken a few elective courses in web design. During her summer breaks she had

working for a marketing firm in their web advertising department. The job had

been interesting, which was why she enrolled in the three elective web design

and development courses. She decided to rely on her summer job experience in

developing web pages for clients. The five years she spent getting an art degree

would also be helpful, and could be easily applied to her technical web design

skills. And it would certainly be a lot less boring than selling the same

mortgage product…over and over again. After a week of notes and thoughts,

she began to formalize her strategy into a business plan. The purpose of

Marie’s firm would be to create original, edgy web sites, web advertisements,

and consult on existing web page designs. She knew of several similar

companies in the southeast Michigan area, and planned to focus on the metro

area, eventually expanding into most of southern Michigan.

On June 20, 2014, she transferred all of her savings, $35,000, to a new bank

account with the company name, and two days later she added $18,000

borrowed from her uncle to the account. After that things moved quickly as she

rented a second floor office for $3,500 a month, paying one month’s rent in

advance as a security deposit to apply to the end of the lease, and $3,500 for

July 2014. She purchased some used computer equipment with software from

her last employer, and ordered stationary and office supplies that cost $4,000

when they were delivered on June 29.

Websites by Marie opened for business on July 2, 2014. Although Marie was

not an accountant, she took stock of her company’s financial position as she

began to seek her first contracts. The company had spent all but $13,000 of the

cash that had been put into the bank account, but it had some assets as well.

Assets Liabilities and Owner’s Equity

Cash in bank $13,000 Loan $18,000

Office supplies 4,000 Marie’s equity 35,000

Equipment and software 29,000

Prepaid rent 7,000

Marie was a little worried that the cash had gone so quickly, but she also had

confidence in herself and her willingness to work hard.

In the first few days, Marie lined up two webpage design projects from local

businesses. She spent part of each day working on the projects, and the

remainder of her time was spent looking for new clients. By early August she

had four other designers at work and a steady stream of new work coming in by

way of referrals. She also felt far too busy to attend to any financial aspects of

the business. When clients paid, the money went into the bank account. The

associates were paid weekly, and she paid rent and other bills when they were

received. In the ninth week of operations, Marie’s uncle telephoned her to ask

how things were going, and she could not answer the question with any

confidence. It was time for an accounting, and the end of August would be a

good time to do it.

Little found the following information she had accumulated during the two

months of operations:

1. Clients had paid $39,000 for completed work, and two clients still owed a

total of $9,000 for work that had been completed and delivered to them. There

were no projects underway as the office closed on August 31 for the Labor Day

weekend.

2. Additional office supplies had been purchased for cash of $1,000, and office

supplies and stationery that had cost $3,900 were still on hand.

3. Rent of $7,000 for August and September was paid in cash. Utility bills, a

repair of equipment, and the salaries paid to designers (including Marie Little)

were paid in cash totaling $35,000.

4. Additional equipment and software was purchased on August 27 for

$15,000, with half of that amount being paid in cash and the remainder due one

month later.

As Marie thought about the first two month’s operations, she was perplexed by

the fact that cash in the bank had decreased even though she was sure the

business was operating profitably.

She also wondered how to account for the following:

1. She had agreed to pay her uncle interest on his loan of 4% per year, but no

interest had been paid so far.

2. The equipment and software were working out well, but Little knew that

they had a technological life of no more than three years from the time that she

had purchased them.

In brief, Marie felt that the first two months had been successful, but she was

puzzled about how to draft meaningful reports to mail to her uncle.

Instructions and Questions for the

Marie Little Case

You are a friend of Marie and a recent graduate of the University of Michigan-

Dearborn’s MBA program. You are looking for work as a business consultant.

Knowing your excellent credentials, Marie has asked you to help her get her

business finances in order, report on the status of her business and make any

recommendations that you can to help her make her business a success. She

cannot pay you but she would be willing to help you set up your own webpage.

Having taken financial accounting and eager to show off your newly acquired

business skills, you accept her offer. You want the report to be very

professional so you decide to perform the following:

1. Record journal entries to summarize the transactions from June 20 to August

31.

2. Set up T accounts to post the entries with proper references, since the

company (a corporation) does not yet have a general ledger.

3. Prepare an unadjusted trial balance at August 31 from the T accounts. The

trial balance should have extra columns to post adjusting entries and references

to come up with an adjusted trial balance.

4. Prepare adjusting entries and post them to the trial balance and T accounts.

5. Prepare an income statement and a classified balance sheet.

6. Analyze the information you developed in the financial statements. What

risks does Marie’s company face? Can the selection of alternative accounting

policies mitigate these risks? If no, how can the identified risks to be covered?

Defend your position.

7. Had the company made a profit through August 31, 2014 as Marie Little

believed? If so, how would you explain why the cash in the bank had declined?

8. How would you report the status of the business on August 31, 2014?

Other assumptions:

• The books are to be prepared using the accrual method of accounting.

• The tax rate is 22%.

• Depreciation is computed using the straight line method.

• The business started on 6-20-14 when it was formed

• Ratio analysis may be necessary. You should discuss ratios that could be

important.

What other specific recommendations would you give to your friend Marie to

help her get on the road to success? (Analyze and be thorough.)