Question

The text states, "Over sufficiently long time periods, net income equals cash inflows minus cash outflows, other than cash flows with owners." Demonstrate the accuracy of this statement in the following scenario: Two friends contributed $50,000 each to form a new business. The owners used the amounts contributed to purchase a machine for $100,000 cash. They estimated that the useful life of the machine was five years and the salvage value was $20,000. They rented out the machine to a customer for an annual rental of $25,000 a year for five years. Annual cash operating costs for insurance, taxes, and other items totaled $6,000 annually. At the end of the fifth year, the owners sold the equipment for $22,000, instead of the $20,000 salvage value initially estimated. (Hint: Compute the total net income and the total cash flows other than cash flows with owners for the five-year period as a whole.)

Answer 1

Answer:

                                 Cash       Equipment   Common stock Net income

Cash contributed

by Owners        $ 100,000               $  100,000  

Purchase of

machine for cash $ (100,000)    $ 100,000  

Recoginition of

rent revenue         $125,000                                   $125,000

Recoginition of

operating

expense                $(30,000)                                   $(30,000)

Recoginition of

Depreciation                             $ (80,000)                                 $(80,000)

Sale of Machine   $ 22,000     $ (20,000)                          $ 2,000

Totals               $ 117,000          $0                $100,000         $ 17,000

Explanation: