One year ago, James Johnson started a small business to produce high-quality optical items for the scientific and military markets. At the time there was keen demand for a high-quality product, and Johnson thought he could build a substantial business by stressing this quality element. He started his business January 1. After experiencing some difficulties in meeting customers’ high standards, he thought he had things going well. By working hard and personally satisfying all complaints, he knew he had created much goodwill for the firm.

Mr. Johnson had begun his business with $45,000 of savings, including some money he had inherited. On April 1, he borrowed $20,000 on a one-year, 12 percent note from his uncle, who had intimated he would renew the note every year as long as Johnson needed the money. Mr. Johnson had paid the first 12 months’ interest on this loan in advance. He had had large bills for materials, but had been able to keep from falling too far behind in his payments. Except for the accounts indicated below as unpaid, all bills had been paid in cash.

Mr. Johnson purchased some production equipment on April 1, agreeing to make a down payment of $10,000 and to pay $2,500 quarterly (starting July 1) for four years, plus interest at 15 percent on the amount unpaid. During the current year, he made two principal payments of $2,500 each and paid interest totaling $2,906. The next payment was due on January 1.

When the equipment was bought, the company insisted on Johnson’s taking out four years’ insurance that cost a total of $1,200 cash. The equipment would be operable for at least 10 years; however. Mr. Johnson contemplated that if all went according to plan, he would trade in the equipment after 5 years and buy some with a greater operating capacity. He estimated that the equipment could probably be sold for $3,000 at that time. He used straight-line depreciation from the date of equipment acquisition for all purposes except income tax reporting.

By the end of the first year, Mr. Johnson had three employees. Ms. Strong took care of the office work and spent about one third of her time packing the delicate products as they were completed in the shop. The other two employees spent all of their time in the shop. About 20 percent of Mr. Johnson’s time was spent in office work and on selling trips, but the rest of the time he was in the shop working with the other workers. These four persons’ earnings are shown in Exhibit 1, along with the company’s end-of-year records. Of the total salaries, $87,500 had been paid to the employees, $23,650 had been paid to the U.S. Treasury for FICA and withholding taxes, $8,000 was due the employees, and $2,150 was due the U.S. Treasury.

Most of the company’s sales were to two buyers, the U.S. Navy and the Universities Scientific Supply Company. Mr. Johnson had sold some $3,400 worth of goods to another firm earlier in the year when business was slow; and when the firm became bankrupt with no assets whatsoever and without having paid its bill, Mr. Johnson promised himself, “Never again.” Other companies, he was told, protected themselves against such losses by use of a charge of 2 percent of year-end accounts receivable as an allowance for bad debts. . . .

Assignment

1. Prepare the company’s income statement for the year and its ending balance sheet. You should show clearly how any figure not taken directly from the case has been determined and/or discuss any number that you think is open to question. Ignore income taxes and round calculations to the nearest dollar.