Dian Karen and Kathy Gillen are considering forming a company to purchase a small business that specializes in interior decoration services. The business records show a modest profit over each of the past five years (approximately $5,000 net income per year). However, the past year s operating results appear to be much better, as shown by the unaudited income statement.
Fashion Design, Inc. Income Statement For the Year Ended December 31, 2003
|
Revenues: |
||
|
Consulting revenues. |
51,000 |
|
|
Commissions on furnishings sold. |
18,000 |
|
|
Total revenues . |
$69,000 |
|
|
Expenses: |
||
|
Advertising expense. |
1,200 |
|
|
Rent expense |
4,800 |
|
|
Salaries expense |
36,000 |
|
|
Supplies expense |
500 |
|
|
Utilities expense. |
1,800 |
|
|
Other expenses |
1,500 |
45,800 |
|
Income before taxes |
$23,200 |
|
|
Income taxes (estimated at 25%) |
5,800 |
|
|
Net income |
$17,400 |
|
|
EPS: $17,400 1,000 shares $17.40 per share |
||
In an attempt to verify what appears to be unusually high net income for 2003, Karen and Gillen hire a CPA to audit the records. The CPA discovers the following:
a. The company pays salaries on the 1st and 15th of each month. Salaries amounting to $2,500 have been earned by employees by December 31 but will not be paid until January 1. No adjusting entry has been made.
b. Of the $18,000 in commissions received by December 31, 30% will not be earned until completion of a job in mid February of 2004. All commissions received have been recorded as revenues.
c. A $10,000 payment was received on November 1 for a consulting assignment that is only one half earned at December 31. The total amount was credited to Consulting Revenues when received.
d. The rent is $400 per month and must be paid in advance on a one year lease. A check for $4,800 was given to the landlord on March 1, 2003, and recorded as rent expense on that date.
According to the CPA, except for these data, the income statement appears to accurately reflect the operating results of Fashion Design, Inc.
Answer the following questions:
1. Do the 2003 operating results offer encouragement to Karen and Gillen as potential investors? Explain.
2. What adjustments (if any) are required to make the income statement more accurately reflect the results of operations for the year?
3. What is the impact on the balance sheet (if any) of the data discovered by the CPA?