Should Lucy retain the business or sell it, given her requirement that the profit margin must be 10%? Explain the reason for your conclusion, showing calculations.
Retain or sell a business Lucy Chan owns an online financial services company called RightFinance.com. She has some idea about accrual accounting but is not very clear on what to do, so she has come to you for help. Lucy aims to achieve a profit margin on her business of 10%. That is, she expects profit divided by total revenue to be at least 10% or more. Lucy has provided the income statement below, which shows a profit margin of 7% ($29 000/$414 285). If the profit margin falls below 10%, Lucy intends to sell the business. Lucy knows that some accrual accounting adjustments need to be made and that is why she is seeking your help.
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RIGHTFINANCE.COM Income Statement for the year ended 30 June 2016 |
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INCOME Revenues: Fees revenue EXPENSES Salaries Subcontracting expenses Council rates expense Insurance expense Advertising expense Rent expense Sundry expenses |
$283 170 57 815 2 600 7 000 12 500 19 800 2 400 |
$414 285 |
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385 285 |
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PROFIT |
$ 29 000 |
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To determine the adjustments that need to be made, you have a long discussion with Lucy that reveals the following:
1. The fees revenue includes $900 for cash received but the services have not yet been provided to the customer.
2. A staff member went on holidays at the end of June and his July wages of $2300 are included in ‘salaries’.
3. A prepayment of rent of $1400 for June is still shown in the as an asset.
4. Depreciation expense of $6000 for the year has not yet been charged to the accounts.
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