Megan Teal began working for Quoveaer LTD, a marketing consulting firm in 2016. She had earned her
Question:
Megan Teal began working for Quoveaer LTD, a marketing consulting firm in 2016. She had earned her undergraduate degree from MSU degree in art and language. In her current job she worked on client’s website screen designs. In 2018, a senior member of Quoveaer LTD sent her to the University of Michigan-Dearborn to earn a Master’s degree in User Experience, or UX. One of the things a UX degree teaches students is how to design interaction between software and people, focusing on efficient and effective screen designs. In essence it prepares students to work in with the digital architecture community. After earning her masters in 2020, Megan realized that the UX degree would pay a much higher salary than her current firm’s compensation. She began to look for other career opportunities. The UX division in her firm’s Troy office was being absorbed by their Seattle office, eliminating half of Megan’s department, but still requiring the same overall workload. On her last day of work, Megan packed her personal items from her office. She was happy that the firm had paid for her graduate degree. She also thought about whether her level of experience and education would allow her to start her own digital architecture firm. While in school, her classmates often talked about starting their own business. However, her UX job at Quoveaer had become tedious. Megan had become accustom to a faster pace workload, balancing school and work. She often found herself waiting for others to complete their tasks before she could complete her own assignments. If she owned her own consulting firm, she could use all of her UX degree, not just screen design. She would also be involved in running a business, and further expanding her skills.
After a week of notes and thoughts, she began to formalize her strategy into a business plan. Megan’s firm, Midori Digital Architecture Consulting (M-DAC), would be a UX research group for the gaming industry. She had experience and contacts with several major gaming companies such SnowStorm and Ai-A. Megan also knew several software companies in Michigan and Ohio that hire UX research firms. From past experience, she knew that her prior employer had passed up smaller gaming research projects that would have been perfect for her M-DAC start-up. Being a diabetic, she also wanted to move into the medical device industry…designing device information and interaction screens for patients.
On August 18th, 2021, she borrowed $30,000 from her brother, Kelly to start the business. Three days later she opened the company’s bank account, depositing the loan plus $30,500 of her own money. Later that week she signed a one year lease for a third floor office. The office lease was considered a good deal, placing her in a technology business park. The lease cost was $2,800 per month, requiring a standard two month’s rent payment in August for September and October’s rent, plus a $3,500 security deposit. She also purchased computer equipment, software, and office furniture needed for her business. She ordered business stationery, cards, and various other office supplies, costing $1,550 that were delivered on August 28th. On August 30th, she signed a one year umbrella business insurance policy for $2,100 that covered a state required liability insurance, plus renters insurance for everything in her leased office.
Teal Digital Consulting opened for business on September 1, 2021. During a hangout chat, her brother (an accountant) helped her list out the new company’s resources and obligations before she began to seek her first contracts. On the first day the business opened, Megan had spent all but $23,050 of the company’s cash. Below is Megan’s list of her company’s assets and liabilities as of September 1st, 2021… the first day of business.
Assets, Liabilities, and Owner’s Equity
Cash in bank $23,050, Loan $30,,000
Office supplies 1,550, Megan’s equity $30,500
Computers $10,000, Software $6,200, Furniture and fixtures $8,500
Prepaid rent $2,800, Prepaid insurance $2,100, Lease Deposit $3,500
Megan was a little worried that the cash had gone so quickly, but she also had confidence in herself and her willingness to work hard.
In the first few days, Megan lined up two UX research projects, one for the game Diablo-League, and the other for the next generation Sphere game system. She worked half of each day on managing the two projects, and the other half managing the business and looking for new clients. During the first part of October she had hired three prior UM-D classmates to handle the current projects, as well as an office secretary/receptionist. She also worked on referrals to obtain additional clients to create a steady work stream for her new employees. Megan was not a quantitative person, and just felt far too busy to work on the financial side of the business. When clients paid M-DAC, the money went into the bank account. Her four employees were paid weekly, and she paid rent and other bills when they were received. In the ninth week of operations, Megan and her brother were on their weekly hangout chat and he asked her how things were going. Megan really could not answer many of Kelly’s questions. It was time to find out how well M-DAC was doing for its first two months of operations.
Megan found the following information she had accumulated during the two months of operations:
- Clients had paid $49,500 for completed work, and Diablo-League still owed a total of $10,500 for work that had been completed and delivered to them in late October. There were no projects underway, as the office closed for Halloween on October 31st.
- On October 15th she invested $7,000 in Green's Folly Inc. The stock price on October 15th was $70 per share. The October 31st stock price was $62 per share.
- Additional office supplies had been purchased for cash for $1,500, and office supplies that had cost $1,300 were still on hand.
- To increase the number of clients, Megan paid a digital marketing firm $2,000 for six months of direct digital ads.
- Rent of $2,800 was paid at the end of October and September ($5,600 in total). Utility bills (electric, water, cell phones, internet, etc) of $1,975, a repair of equipment of $1,800, and $36,000 in salaries where paid to the company’s four employees (which included a $6,000 withdrawal paid to Megan).
- An office renovation cost $6,000 and a one year software lease for $1,300 was purchased on October 30. Half of the total amount for both items was paid for on October 30th, and the remaining half is due one month later.
As Megan thought about the first two month’s operations, she was perplexed by the amount of cash in the bank, even though she was sure the business was operating profitably.
She also wondered how to account for the following:
- She had agreed to pay her brother 4% interest on her loan, but no interest had been paid yet.
- The computers and software were working out well, but Megan knew that they had a technological life of no more than three years from the time that she had purchased them. Furniture had a 5 year useful life, while equipment and other assets had a 4 year useful life. She was uncertain about how to handle the software lease.
In brief, Megan felt that the first two months had been successful, but she was puzzled about how to draft meaningful reports to mail to her brother.
Instructions and Questions for the M-DAC Case
You are a friend of Megan and a recent graduate of the University of Michigan-Dearborn’s MBA program. You are looking for work as a business consultant. Knowing your excellent credentials, Megan has asked you to help her get her report on the status of her business and make any recommendations that you can to help her make her business a success. Please remember that this is a small business, and any recommendations must be realistic for a small business. This is not a corporation. She cannot pay you, but she would be willing to give you a 5% ownership in the company for your work. Having taken financial accounting, you believe you have the adequate business skills, and you accept her offer. You want the report to be very professional so you decide to perform the following:
- Record journal entries to summarize the transactions from August 18 to October 31.
- Set up T accounts to post the entries with proper references, since the company does not yet have a general ledger.
- Prepare an unadjusted trial balance at October 31 from the T accounts. The trial balance should have extra columns to post adjusting entries and references to come up with an adjusted trial balance.
- Prepare adjusting entries and post them to the trial balance and T accounts.
- Prepare an income statement and a classified balance sheet.
- Analyze the information you developed in the financial statements. What risks does M-DAC face? Can the selection of alternative accounting policies mitigate these risks? If no, how can the identified risks for the small business to be covered? Defend your position.
- Had the company made a profit through October 31, 2021 as Megan Teal believed? If so, how would you explain why the cash in the bank had declined? Simply saying they spent money is not a sufficient answer….but “why” is there a difference?
- How would you report the status and financial future of the business on October 31, 2021?
Other assumptions:
- The books are to be prepared using the accrual method of accounting.
- The average tax rate is 19%.
- Depreciation is computed using the straight line method.
- The business started on 9-1-21 when it was formed
- Ratio analysis may be necessary for number 8. You should discuss ratios that could be important. Remember a ratio is not an answer, it supports your analysis. Analysis uses multiple ratios in combination to understand a business.
Managerial Accounting An Introduction to Concepts Methods and Uses
ISBN: 978-0324639766
10th Edition
Authors: Michael W. Maher, Clyde P. Stickney, Roman L. Weil