St. Paul Warthogs, Inc. is a minor-league baseball organization that has just completed its first season. You and three other investors organized the corporation; each put up $10,000 in cash for shares of capital stock. Because you live out of state, you have not been actively involved in the daily affairs of the club. However, you are thrilled to receive a dividend check for $10,000 at the end of the season - an amount equal to your original investment! Included with the check are the following financial statements, along with supporting explanations.
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St. Paul Warthogs, Inc.
Income Statement
For the Year Ended December 31, 2007
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Revenues:
Single-game ticket revenue
Season-ticket revenue
Concessions revenue
Advertising revenue
Expenses:
Cost of concessions sold
Salary expense - players
Salary and wage expense - staff
Rent expense
Net income
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$ 420,000
140,000
280,000
100,000
$ 110,000
225,000
150,000
210,000
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$ 940,000
695,000
$ 245,000
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St. Paul Warthogs, Inc.
Statement of Retained Earnings
For the Year Ended December 31, 2007
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Beginning balance, January 1, 2007
Add: Net income for 2007
Deduct Cash dividends paid in 2007
Ending balance, December 31, 2007
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$ 0
245,000
(40,000)
$ 205,000
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St. Paul Warthogs, Inc.
Balance Sheet
December 31, 2007
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Assets Liabilities and Stockholders' Equity
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Cash
Accounts receivable:
Season tickets
Advertisers
Auxiliary assets
Equipment
Player contracts
Total assets
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$ 5,000
140,000
100,000
80,000
50,000
125,000
500,000
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Notes payable
Capital stock
Additional owners' capital
Parent club's equity
Retained earnings
Total liabilities and
Stockholders' equity
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$ 50,000
40,000
80,000
125,000
205,000
$ 500,000
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Additional information:
Single-game tickets sold for $4 per game. The team averaged 1,500 fans per game. With 70 home games X $4 per game X 1,500 fans, single-game ticket revenue amounted to $420,000.
No season tickets were sold during the first season. During the last three months of 2007, however, an aggressive sales campaign resulted in the sale of 500 season tickets for the 2008 season. Therefore, the controller (who is also one of the owners) chose to record an Account Receivable - Season Tickets and corresponding revenue for 500 tickets X $4 per game X 70 games, or $140,000.
Advertising revenue of $100,000 resulted from the sale of the 40 signs on the outfield wall at $2,500 each for the season. However, none of the advertisers have paid their bills yet (thus, an account receivable of $100,000 on the balance sheet) because the contract with the Mudhens required them to pay only if the team averaged 2,000 fans per game during the 2007 season. The controller believes that the advertisers will be sympathetic to the difficulties of starting a new franchise and be willing to overlook the slight deficiency in the attendance requirement.
The Warthogs have a working agreement with one of the major-league franchises. The minor-league team is required to pay $5,000 every year to the major-league team for each of the 25 players on its roster. The controller believes that each of the players is certainly an asset to the organization and has therefore recorded $5,000 X 25, or $125,000, as an asset called Player Contracts. The item on the right side of the balance sheet entitled Parent Club's Equity is the amount owed to the major league team by February 1, 2008, as payment for the players for the 2007 season.
In addition to the cost described in (d), The Warthogs directly pays each of its 25 players a $9,000 salary for the season. This amount ( $225,000) has already been paid for the 2007 season and is reported on the income statement.
The items on the balance sheet entitled Auxiliary Assets on the left side and Additional Owners' Capital on the right side represent the value of the controller's personal residence. She has a mortgage with the bank for the full value of the house.
The $50,000 note payable resulted from a loan that was taken out at the beginning of the year to finance the purchase of bats, balls, uniforms, lawn mowers, and other miscellaneous supplies needed to operate the team (equipment is reported as an asset for the same amount). The loan, with interest, is due on April 15, 2008. Even though the team had a very successful first year, The Mudhens are a little short of cash at the end of 2007 and has therefore asked the bank for a three-month extension of the loan. The controller reasons, "By the due date of April 15, 2008, the cash due from the new season ticket holders will be available, things will be cleared up with the advertisers, and the loan can be easily repaid."
Required
- Identify any errors that you think the controller has made in preparing the financial statements.
- On the basis of your answer in (1), prepare a revised income statement, statement of retained earnings, and balance sheet.
- On the basis of your revised financial statements, identify any ethical dilemma you now face. Does the information regarding the season ticket revenue provide reliable information to an outsider? Does the $100,000 advertising revenue on the income statement represent the underlying economic reality of the transaction? Do you have a responsibility to share these revisions with the other three owners? What is your responsibility to the bank?