Smith and Jones start a business to build custom bicycles. Smith invests personal funds of $100,000 and Jones invests $70,000. Grandma Smith loans the company $24,000 with the provision it is to be paid back in 12 equal monthly payments plus 1.5% monthly interest on her original contribution. Smith and Jones agreed that ownership would be proportional to their equity investments. In addition, they borrow $40,000 from the bank at interest of 1.5% per month payable monthly. (They do not have to pay back the principal for five years, so ignore it.) They buy $120,000 worth of parts. They use $80,000 of those parts in the first month. They pay factory workers a total of $15,000 for the first month. They pay rent of $4,000 for the month for a factory. They each (not Grandma) draw salaries of $4,000 per month. They sell the resulting bicycles for $150,000. a. Prepare a balance sheet for day zero, that is, store is ready, people hired, parts on hand, money collected from bank, Grandma, Smith, and Jones. b. Prepare an income statement for the first month. c. Prepare a balance sheet for the last day of the first month. d. What is the percent ownership by Smith, Jones, and Grandma on the first day of the month.

See answers below.

Explanation:

Question a

The balance sheet for day 0 will have the following balances.

Asset side

Parts $120,000

Cash $114,000

Total assets $234,000

Liabilities and Equity side

Capital $170,000

Short term loan $24,000

Long term loan $40,000

Total liabilities $234,000

Question b

The income statement for the first month will have the following balances.

Revenue (credit) side

Sales $150,000

Expenses (debit) side

Parts used $80,000

wages to factory workers $15,000

rent $4,000

salary $8,000

Interest on grandma's loan $360

Interest on bank loan $600.

Profit for the month $42,040.

Question c

The balance sheet for the last day of the month will have the following balances.

Asset side

Parts $40,000

Cash $234,040

Total assets $274,040

Liabilities and Equity side

Capital $170,000

Profit (added to reserves) $42,040

Short term loan $22,000

Long term loan $40,000

Total liabilities $274,040

Question d

Grandma is not an equity owner since she will be repaid after 1 year.

Therefore, percentage ownership by Smith, Jones and Grandma will be as follows in the ratio of their equity contribution.

Total capital contributed = 100,000 + 70,000 = 170,000

Smith percentage ownership = = 58.8%

Jones percentage ownership = = 41.2%

Grandma's ownership = 0% (no equity contribution).

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