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Assignment 2 - The Caddie Shack Driving Range

Murray opened a driving range business and invested $20,000 of his own savings. For the first month of operations: - Revenues were $4,700 while expenses totaled $2,250, resulting in accrual-based income of $2,450. - However, looking only at the cash balance, which fell to $15,100 from the initial $20,000, Murray thought he may have lost $4,900. - For a potential partner to assess future profitability, accrual income is a more useful measure than cash flow, as it follows IFRS principles of expense and revenue recognition.

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205 views

Assignment 2 - The Caddie Shack Driving Range

Murray opened a driving range business and invested $20,000 of his own savings. For the first month of operations: - Revenues were $4,700 while expenses totaled $2,250, resulting in accrual-based income of $2,450. - However, looking only at the cash balance, which fell to $15,100 from the initial $20,000, Murray thought he may have lost $4,900. - For a potential partner to assess future profitability, accrual income is a more useful measure than cash flow, as it follows IFRS principles of expense and revenue recognition.

Uploaded by

Kevin Deswanda
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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2.

The Caddie Shack Driving Range

William Murray achieved one of his life-long dreams by opening his own business,
The Caddie Shack Driving Range, on May 1, 2015. He invested $20,000 of his own
savings in the business. He paid $6,000 cash to have a small building constructed to
house the operations and spent $800 on golf clubs, golf balls, and yardage signs.
Murray leased 4 acres of land at a cost of $1,000 per month. (He paid the first month’s
rent in cash.) During the first month, advertising costs totaled $750, of which $150 was
unpaid at the end of the month. Murray paid his three nephews $400 for retrieving golf
balls. He deposited in the company’s bank account all revenues from customers
($4,700). On May 15, Murray withdrew $800 in cash for personal use. On May 31, the
company received a utility bill for $100 but did not immediately pay it. On May 31, the
balance in the company bank account was $15,100.Murray is feeling pretty good
about results for the first month, but his estimate of profitability ranges from a loss
of $4,900 to a profit of $2,450.

 Accounting
Prepare a statement of financial position at May 31, 2015. (Murray appropriately records
any depreciation expense on a quarterly basis.) How could Murray have determined that
the business operated at a profit of $2,450? How could Murray conclude that the business
operated at a loss of $4,900?

Answer:

Income Statement

Revenue $ 4,700
Rent Expense - $ 1,000
Advertising Expense - $ 750
Retrieving Expense - $ 400
Utility Expense - $ 100
Accrual income $ 2,450

Contributed Capital $ 20,000


Accrual Income + $ 2,450
Cash Withdrew - $ 800
Owner’s Capital Balance: $ 21,650

Caddie Shack Driving Range


Statement of Financial Position
May 31, 2015

Assets Liabilities
Cash $ 15,100 Advertising payable $ 150
Building $ 6,000 Utilities payable $ 100
Equipment $ 800 Owner’s Equity
Owners’s Capital $ 21,650
Total Assets $ 21,900 Total Liabilities & Equity $ 21,900
Murray could conclude that his business earned a profit of $2,450 because of his accrual
income for the month. The conclusion that his business lost $4,900 ($20,000- $ 15,100)
might come from the change in the business’s cash balance, which started at $20,000 and
ended the month at $15,100.

 Analysis
Assume Murray has asked you to become a partner in his business. Under the partnership
agreement, after paying him $10,000, you would share equally in all future profits. Which
of the two income measures above would be more useful in deciding whether to become a
partner? Explain.

Answer:

For profit distribution, it is more appropriate to use accrual income. Because accrual
income reflects actual profits. If we use cash basic, for example the money is reduced but
we get a building. This means we don't experience losses.
The income measure of $2,450 is most relevant for assessing the future profitability
and hence the payoffs to the owners. For example, charging the cost of the building and
equipment to expense in the first month of operations understates income in the first
month. These costs should be allocated to future periods of benefit through depreciation
expense. Similarly, although not paid, the utilities were used to generate revenues so they
should be recognized when incurred, not when paid.

 Principles
What is income according to IFRS? What concepts do the differences in the two income
measures for The Caddie Shack Driving Range illustrate?

Answer:

According to IFRS, income means increases in economic benefits during the


accounting period in the form of inflows or enhancements of assets or decreases of
liabilities that result in increases in equity, other than those relating to contributions from
equity participants.
Accrual-basis accounting: They recognize revenue when the performance obligation is
satisfied and expenses in the period incurred, without regard to the time of receipt or
payment of cash.
Under the strict cash basis, companies record revenue only when they receive cash, and
they record expenses only when they disperse cash. Determining income on the cash basis
rests upon collecting revenue and paying expenses. The cash basis ignores two principles:
the revenue recognition principle and the expense recognition principle. Consequently,
cash-basis financial statements are not in conformity with IFRS.
IFRS income is the accrual income computed above as $2,450. The key concept
illustrated in the difference between the loss of $4,900 and profit of $2,450 is the expense
recognition principle, which calls for recognition of expenses when incurred, not when
paid. Excluding the cash withdrawal from the measurement of income is an application of
the definition of basic elements. Cash withdrawals are distributions to owners, not an
element of income (expenses or losses).
References:

- Kieso, Weygandt, Warfield. 2014. Intermediate Accounting: The Accounting Information


System, 2nd ed., Wiley, United States.
- Brown J, Kapsis M. 2016. IFRS Staff Paper: IASB Meeting Definitions of income and
expenses.

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