Computer Consulting Limited was started in early 2016 and continued to operate until early 2019 when it was wound up due to disputes between the two principal owners. When it started, the company considered two sets of accounting policies. Accounting policy set 1: a. Use straight-line depreciation method on the firm's only asset. The computer cost $1,000,000 and has an estimated useful life of four years. b. Estimate warranty expense of 9% of sales. c. Estimate bad debts expense as 5% of sales. Accounting policy set 2: a. Use 50% declining-balance method for depreciation. b. Estimate warranty expense as 10% of sales. c. The year-end allowance for doubtful accounts should be 40% of gross accounts receivable. 2016 2017 2018 2019 Sales (all on account) $3,000,000 $3,500,000 $4,000,000 $500,000 Warranties paid 250,000 275,000 410,000 180,000 Proceeds on disposal of computer -- -- -- 400,000 Accounts receivable collected during the year 2,600,000 2,800,000 3,800,000 1,200,000 Accounts receivable written off during the year 100,000 125,000 200,000 175,000 All other expenses (paid in cash in the year incurred) 2,100,000 2,500,000 2,700,000 350,000 Required: (Adapted) a. Derive net income for 2016 to 2019 using the first and second sets of accounting policies. For the year-end balance for 2019, assume accounts receivable, allowance for doubtful accounts, and the warranty accrual are $0, as the firm wound itself up during the year and all timing differences have been resolved. b. Derive the annual net cash flows for 2016 to 2019. c. What is the sum of the net income for the four years for the two sets of accounting policies? d. Why were the net incomes different between the two sets of accounting policies? What caused the net income in 2019 to be high for the second set of accounting policies? Derive net income for 2016 to 2019 using the first and the second set of accounting policies. For the year-end balance for 2019, assume accounts receivable, allowance for doubtful accounts, and the warranty accrual are $0, as the firm wound itself up during the year and all timing differences have been resolved. Solution: Sales Operating expenses Warranty expense (9% of sales, except 2019) Bad debt expense (5% of sales, except 2019) Depreciation expense (straight line) Gain on disposal Net income Annual net income with accounting policy set 1 2015 2017 2018 $3,000,000 $3,500,000 $4,000,000 (2,100,000) (2,500,000) (2,700,000) (270,000) (315,000) (360,000) (150,000) (175,000) (200,000) (250,000) (250,000) (250,000) 0 0 0 230,000 200,000 490,000 20 19 $500,000 (350,000) (170,000) (75,000) (250,000) 400 000 + 55,000