In early 2012 Paula Lee was made redundant by the investment bank for which she had worked for several years, with a substantial severance payment. She used part of this to finance a new business which is a store selling fancy dress costumes and other supplies for parties. She planned to sell these to a customer base comprising both retail consumers to whom she would sell on cash terms, and other businesses to some of whom she would have to offer trade credit. She opened the store for business on 1st August 2012.
She has asked you to prepare the accounts for her business for its first year’s trading, for the year to 31st July 2013. She has provided you with the following summary of the transactions on the business’s bank account for the year to 31st July 2013:
In addition, you discover the following information from discussions with Ms Lee:
(i) Ms Lee allows 30 days credit to some of her business customers. At 31st July 2013, credit customers (receivables/debtors) owed the business a total of £10,000. She has recently received a letter from an accountant explaining that one of her customers has gone bankrupt and is unlikely to be able to pay their debt of £2,000. In addition her bank manager has advised that in their experience, the usual rate of default by customers where there is no specific prior reason to suspect their credit-worthiness is currently running at about 5% of the credit balances originally owing.
(ii) Ms Lee has negotiated credit terms with her suppliers. At 31st July 2013 she has unpaid invoices on hand from them totalling £10,000.
(iii) Ms Lee held an inventory count on 31st July 2013 and found that her business was holding inventory that had originally cost £18,000. Included in this was £8,000 (at historic cost) of last season’s stock which she will be able to sell only if she discounts the selling price down to £6,000.
(iv) Rent is payable in advance on a quarterly basis at the ends of each of March, June, September and December respectively, at an annual rate of £18,000.
v) Business rates (i.e. local government tax on property) are currently charged at a rate of £14,400 per annum for the current UK government financial year, which runs from 1st April to 31st March. The amount of cash paid during the year to 31st July 2013 represents £8,000 for the period from 1st August 2012 to 31st March 2013 (when the annual rate was lower), plus the full amount of £14,400 which was payable in advance for the year from 1st April 2013 to 31st March 2014.
(vi) The cash which Ms Lee has paid for insurance includes £2,400 covering the 12 months from 1st May 2013 to 30th April 2014.
(vii) At 31st July 2013 the electricity meter showed that £100 of electricity had been consumed but had not yet been billed to the business by the supplier.
(viii) Ms Lee expects to use the fixtures and fittings that she purchased during the year for 5 years, after which they are expected to have a residual value of £2,000. Depreciation is to be charged using the straight line method.
(ix) At 31st July 2013 Ms Lee’s professional advisers (accountant and lawyer) have provided her with services to the value of £3,000 in total, which they have not yet billed.
(x) The expenditure on advertising was for a major campaign when the business was first launched, to establish its name in its local target market. This was very successful, and the business is now well recognised and respected locally. From her days as an investment banker, Ms Lee is well aware of the business value of marketing assets such as consumer brands and considers this was a wise investment to have made, and that the consequent strong reputation of her company’s brand will be one of its most valuable assets for several decades into the future.
(xi) During July Ms Lee signed a contract with a construction company to refurbish her store. This will commence on 1st September 2013 and will cost £8,000.
(xii) Shortly before the year-end Ms Lee received letters from lawyers representing two of her customers, advising that they were making claims against her business due to faulty products supplied. The first claim was from a company which had run a corporate event on a Star Wars theme, at which several employees had received mild burns from a batch of faulty light sabres and had had to take time off work, for which the customer was claiming compensation of £8,000. Ms Lee’s lawyer has advised her that if this claim went to court then it was very likely to be decided in favour of the plaintiff. He has therefore advised her to agree and pay this without delay in order to minimise legal costs.
The second claim was from the mother of a boy who had attended a Christmas fancy-dress party at which several of the guests were dressed in Santa Claus costumes. Her claim is that this simultaneous presence of multiple Santas at a single event had destroyed her son’s belief in the credibility of the character and is therefore claiming £10,000 damages for loss of childhood innocence. Ms Lee’s lawyer has advised that this claim is frivolous and has no chance of succeeding.
(xiii) On professional advice Ms Lee has decided not to incorporate her business but to run it as a sole trader. However she has requested that so far as relevant her business’s financial statements should be drawn up to comply with current accounting standards (IFRS) since she is familiar with these.
Prepare an income statement for the year ended 31st July 2013, and a statement of financial position (balance sheet) as at that date, for Ms Lee’s business. These statements and income statement should where relevant follow IFRS principles.
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