Question

In 2017, Otis Knight opened a small business that he called The Corner Coffee Cart. The Corner Coffee Cart sells a variety of coffee-based beverages from a portable cart. Otispur chased the cart for $12,000 cash when he began the business. All of The Corner Coffee Cart's transactions with suppliers and customers are for cash. At the end of 2017, Otis decided he wanted to get an idea about how well The Corner Coffee Cart performed in its first year. He assembled the following information:
i. Sales to customers $22,000
ii. Cost of providing coffee to customers $13,000


From this information Otis concluded that he had made $9,000, which he was satisfied with. A friend who had recently taken an accounting course told Otis that his profit of $9,000 wasn't correct because he didn't depreciate the coffee cart. Otis asked his friend to help him calculate the "correct" amount of profit based on the friend's knowledge of accounting.

Required:
a. Why did Otis' friend tell Otis that his measure of profit wasn't correct without a depreciation expense for the cart? Do you agree with this?
b. If Otis assumes that the useful life of the cart is six years and he depreciates the cost of the cart using the straight-line method (an equal amount is expensed each year), what would The Corner Coffee Cart's net income for 2017 be? Assume that the cart wouldn't have any value at the end of its life.
c. Calculate The Corner Coffee Cart's net income assuming the cost of the cart is de preciated over three years. Calculate net income assuming the cost of the cart is de preciated over ten years. Assume straight-line depreciation in both cases.
d. What is the difference in The Corner Coffee Cart's net income using the three different periods for depreciating the cart in (b) and (c)?
e. How is your evaluation of how The Corner Coffee Cart performed during 2017 affected by using different periods for depreciating the cart?
f. Assume that the different periods used for depreciating the cart simply represent different reasonable estimates of the cart's useful life. Is the actual performance of The Corner Coffee Cart really different even though the net income under each estimate is different? Explain.
g. What is the "correct" number of years over which to depreciate the cart?


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  • CreatedFebruary 26, 2015
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