Solved by verified expert :CP16Part IMindy Feldkamp
and her two colleagues, Oscar Lopez and Lori Melton, are personal trainers at
an upscale health spa/resort in Tampa, Florida. They want to start a health
club that specializes in health plans for people in the 50+ age range. The
growing population in this age range and strong consumer interest in the health
benefits of physical activity have convinced them they can profitably operate
their own club. In addition to many other decisions, they need to determine
what type of business organization they want. Oscar believes there are more
advantages to the corporate form than a partnership, but he hasn’t yet
convinced Mindy and Lori. They have come to you, a small-business consulting
specialist, seeking information and advice regarding the choice of starting a
partnership versus a corporation.
Instructions
(a)Prepare a memo (dated May 26, 2011) that
describes the advantages and disadvantages of both partnerships and
corporations. Advise Mindy, Oscar, and Lori regarding which organizational form
you believe would better serve their purposes. Make sure to include reasons
supporting your advice.
Part IIAfter deciding to
incorporate, each of the three investors receives 20,000 shares of $2 par
common stock on June 12, 2011, in exchange for their co-owned building
($200,000 fair value) and $100,000 total cash they contributed to the business.
The next decision that Mindy, Oscar, and Lori need to make is how to obtain
financing for renovation and equipment. They understand the difference between
equity securities and debt securities, but do not understand the tax, net
income, and earnings per share consequences of equity versus debt financing on
the future of their business.
Instructions
(b)Prepare notes for a discussion with the three
entrepreneurs in which you will compare the consequences of using equity versus
debt financing. As part of your notes, show the differences in interest and tax
expense assuming $1,400,000 is financed with common stock, and then
alternatively with debt. Assume that when common stock is used, 140,000 shares
will be issued. When debt is used, assume the interest rate on debt is 9%, the
tax rate is 32%, and income before interest and taxes is $300,000. (You may
want to use an electronic spreadsheet.)
Part IIIDuring the discussion
about financing, Lori mentions that one of her clients, Roberto Marino, has
approached her about buying a significant interest in the new club. Having an
interested investor sways the three to issue equity securities to provide the
financing they need. On July 21, 2011, Mr. Marino buys 90,000 shares at a price
of $10 per share.
The club, LifePath Fitness, opens on January 12, 2012, and
after a slow start, begins to produce the revenue desired by the owners. The
owners decide to pay themselves a stock dividend, since cash has been less than
abundant since they opened their doors. The 10% stock dividend is declared by
the owners on July 27, 2012. The market price of the stock is $3 on the
declaration date. The date of record is July 31, 2012 (there have been no
changes in stock ownership since the initial issuance), and the issue date is
August 15, 2012. By the middle of the fourth quarter of 2012, the cash flow of
LifePath Fitness has improved to the point that the owners feel ready to pay
themselves a cash dividend. They declare a $0.05 cash dividend on December 4,
2012. The record date is December 14, 2012, and the payment date is December
24, 2012.
Instructions
(c)(1) Record all of the transactions related
to the common stock of LifePath Fitness during the years 2011 and 2012. (2)
Indicate how many shares are issued and outstanding after the stock dividend is
issued.
Part IVSince the club opened, a
major concern has been the pool facilities. Although the exist- ing pool is
adequate, Mindy, Oscar, and Lori all desire to make LifePath a cutting-edge
facility. Until the end of 2012, financing concerns prevented this improvement.
However, because there has been steady growth in clientele, revenue, and income
since the fourth quarter of 2012, the owners have explored possible financing
options. They are hesitant to issue stock and change the ownership mix because
they have been able to work together as a team with great effectiveness. They
have formulated a plan to issue secured term bonds to raise the needed $600,000
for the pool facilities. By the end of April 2013, everything was in place for
the bond issue to go ahead. On June 1, 2013, the bonds were issued for
$548,000. The bonds pay semiannual interest of 3% (6% annual) on December 1 and
June 1 of each year. The bonds mature in 10 years, and amortization is computed
using the straight-line method.
Instructions
(d)Record (1) the issuance of the secured
bonds, (2) the interest payment made on December 1, 2013, (3) the adjusting
entry required at December 31, 2013, and (4) the interest payment made on June
1, 2014.
Part VMr. Marino’s purchase of
the stock of LifePath Fitness was done through his business. The stock
investment has always been accounted for using the cost method on his firm’s
books. However, early in 2014 he decided to take his company public. He is
preparing an IPO (initial public offering), and he needs to have the firm’s
financial statements audited. One of the issues to be resolved is to restate
the stock investment in LifePath Fitness using the equity method, since Mr.
Marino’s ownership percentage is greater than 20%.
Instructions
(e) (1)Give the entries that
would have been made on Marino’s books if the equity method of accounting for
investments had been used since the initial investment. Assume the following
data for LifePath.
2011
2012
2013
Net Income
$30,000
$70,000
$105,000
Total cash dividends
$2,100
$20,000
$50,000
(2)Compute the balance in the Stock Investment
account (as it relates to LifePath Fitness) at the end of 2013.
