Financial accounting 16th Edition by Jan Williams,Susan Haka,Mark Bettner ,Joseph Carcello

تمرين 65

Measuring Income Fairly

Kim Morris purchased Print Shop, Inc., a printing business, from Chris Stanley.orris made a cash down payment and agreed to make annual payments equal to40 percent of the company's net in come in each of the next three years.Such "earn-outs" are a common means of financing the purchase of a small business.) Stanley was disappointed, however, when Morris reported a first year's net income far below Stanley's expectations.
The agreement between Moms and Stanley did not state precisely how "net income" was to be measured.either Morris nor Stanley was familiar with accounting concepts.heir agreement stated only that the net income of the corporation should be measured in a "fair and reasonable manner."
In measuring net income, Morris applied the following policies:
1.evenue was recognized when cash was received from customers.ost customers paid in cash, but a few were allowed 30-day credit terms.
2.xpenditures for in k and paper, which are purchased weekly, were charged directly to Supplies Expense, as were the Morris family 's weekly grocery and dry cleaning bills.
3.orris set her annual salary at $60,000, which Stanley had agreed was reasonable.he also paid salaries of $30,000 per year to her husband and to each of her two teenage children.
These family members did not work in the business on a regular basis; but they did help out when things got busy.
4.ncome taxes expense included the amount paid by the corporation (which was computed correctly), as well as the personal income taxes paid by various members of the Morris family on the salaries they earned working for the business.
5.he business had state-of-the-art printing equipment valued at $150,000 at the time Morris purchased it.he first-year income statement included a $150,000 equipment expense related to these assets.
Instructions
a.iscuss the fairness and reasonableness of these income-measurement policies.Remember, these policies do not have to conform to generally accepted accounting principles.ut they should be fair and reasonable.
b.o you think that the net cash flow generated by this business (cash receipts less cash outlays) is higher or lower than the net income as measured by Morris Explain.