Problem - Shenzhen Inn

In February, Siu and Kalok Chan purchased Shenzhen Inn.  Located on the shore 20 kilometers outside of town, the inn had been in operation since 1984 when it was converted from a farmhouse.  The inn has nine guest rooms on the second and third floors.  The main floor has two sitting rooms, one with a large fireplace, a dining room, and kitchen.  The price of a room includes breakfast, which is served "family style'' each morning in the dining room.  The inn serves no lunch or dinner, and breakfast is available only to overnight guests.  This "bed and breakfast" format is popular among guests from Hong Kong and many guests return regularly.

The Chans had no formal business training or experience.  However, Siu was a gourmet chef and Kalok was an experienced carpenter able to handle most repairs.  The Chans worked full time operating the inn.  In addition, they hired a half-time employee to help with cleaning and miscellaneous chores.  Overall, they were pleased with the success of their business and felt that they had learned a great deal about running an inn during their first year.

On New Year's Day, Kalok read an article in the local newspaper stating that, due to cool summer weather, the previous year had been bad for tourism.  The article noted that several businesses had declared bankruptcy and many others had been forced to renegotiate loans.  Kalok was concerned, and decided to call his accountant.

OT Wong, C.P.A., had been retained by the Chans to prepare the Inn's tax return.  Nevertheless, he was surprised to see Kalok enter his office.  Kalok explained:  "This article has me a bit upset.  You see, Siu and I plan to close the inn for two weeks in March, when business is slow, and take a trip to Haiku.  Now I'm wondering if we can afford a vacation."

"It sounds as if you could use a set of financial statements," OT said.  "You know, a income statement and a balance sheet.  They will tell you how well your business did last year and where you stand at year end."

Kalok interjected:  "But isn't an income statement the same as our tax statement?"

"Not exactly," replied OT. "The objectives of the tax return and income statement are somewhat different.  I think it will be easier to explain after I prepare your statements.  I'll stop by the inn tomorrow to get the information I need."

The only records the Chans kept for their business were a checkbook, which included detailed explanations of all checks drawn, and a file of all invoices received.  Siu explained to OT that she was sure that the inn earned a profit during the year because the cash balance in the checking account had increased by $150,000.  OT gathered the information he needed and returned to his office to prepare the financial statements.

The first thing OT did was to prepare a balance sheet as of February 28, when the Chans took ownership of Shenzhen Inn (see Exhibit 1). Next, he prepared a summary of cash deposits and withdrawals based on the Inn's checkbook (see Exhibit 2). Once he had completed these statements, OT began to piece together the information he needed to prepare an income statement for the 10 months ending December 31.

a. The Chans did not accept credit cards or other forms of credit.  Also, when they began operating the inn, they instituted a policy of requiring a $500 deposit for advance reservations. By December 31, they had collected deposits totalling $39,000 for reservations in January and February of the following year.  These advance payments had been deposited in the Inn's checking account and were included in the $594,000 total collected from customers.

b. OT determined that, out of the $100,800 paid toward the Inn's mortgage, $98,000 was interest and the remaining $2,800 was principal.

c. The $6,000 paid for insurance provided fire and casualty coverage for the period from March 1, when they reopened the inn, through February 28 of the following year.

d. The Inn purchased food and supplies on account.  At year-end, it owed a total of $17,500 to various suppliers.  In addition, the Chans estimated that year-end inventories of food and supplies totalled $4,900.

e. Utilities and advertising expenses had been paid in full by year-end. Only 80% of employee wages had been paid by year-end.

f. Kalok estimated that the firewood remaining in the woodpile at December 31 had cost $5,500.

g. The Inn purchased new equipment for $50,000, which was paid in full at year-end.

h. OT determined that depreciation of the building, furnishings, and equipment totalled $76,800 during the 10-month period ending Dec. 31.

OT had just about completed the financial statements for the Shenzhen Inn when he received a phone call form Siu.  She explained that she had just received a tax statement form the City Government of Shenzhen.  According to the statement, the Inn owed property taxes totalling $12,600 for the 12-month period extending through next February.

Required -

1. Record the information provided in "journal entries" and then "post" these journal entries to ledger "T" accounts.  Prepare an income statement for the 10-month period from March 1 through December 31, and a balance sheet as of December 31. In the balance sheet, you may show all the depreciable assets together by adding the costs of buildings, furnishings, and equipment. Accumulated depreciation is a deduction of depreciable assets.

2. Prepare a statement of cash flows using the direct approach.

3. Write a short essay (one page is adequate) to the Chans, which answers the following questions:

• Did Shenzhen Inn have a "good" year or a "bad" year? Explain.
• How do the three primary financial statements (i.e., Balance Sheet, Income Statement, and Statement of Cash Flows) relate to each other? Under what circumstances would they focus on the information provided by each statement?

Attachment:- Assignment.rar