Chemalite Case

Journal Entries:

Jan 2, 2003 Cash $375,000

Patent $125,000
Common Stock $500,000

Jan 15, 2003 Legal Fees , etc $7,500

Cash $7,500

June 15, 2003 Machinery $62,500

Cash $62,500

June 24, 2003 Materials Inventory $75,000

Cash $75,000

J-D (1) Prototypes Expense $23,750

Cash $23,750

J-D (2) Cash $685,000

Accounts Receivable $69,500
Sales $754,500

J-D (3) Materials Inventory $175,000

Cash $175,000

J-D (4) Advertising Expense $22,500

Cash $22,500

J-D (5) Manufacturing Labor and Overhead $350,000

Salaries and Corp Expenses $80,000
Cash $430,000

J-D (6) Machinery $150,000

Cash $150,000

J-D (7) Cash $50,000

Loans Payable $50,000
Loans Payable $50,000
Interest Expense $750
Cash $50,750

Dec 31, 2003 Depreciation Expense $10,625

Accumulated Depreciation $10,625
Dec 31, 2003 Patent Amortization Expense $25,000
Patent $25,000

Dec 31, 2003 Cost of Goods Sold $195,000

Materials Inventory $195,000

Written Answers:

1. No, we have not lost the money. The cash has been re-invested into the company by purchasing
machinery and chemicals that will be used to produce the Chemalites. Instead of “losing the
$145,000” think of it as Chemalite gaining $145,000 of goods.

2. Calculation of Net Income

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0 7 0 5 0
0 0 0
0 5 0
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0 0 0

Expense Components = Cost of Goods Sold + Prototype Expense + Legal Fees + Advertising +
Salaries + Interest + Depreciation + Amortization + Labor and Overhead
Total Expense = $715,125

Net Income = Sales – Expenses

Net Income = $754,000 - $715,125
Net Income = $39,375
 Instead of looking just at the cash balance, we examined the net income of Chemalite over the
past year. We found that Chemalite had generated a net income of $39,375 after accounting for
all its expenses (cost of goods sold, advertising, legal fees, labor, salaries, depreciation and
amortization, and the prototype expense). This indicates that the company is actually doing
well, since it is generating a net operating profit (before accounting for taxes). Therefore, even
though the cash balance in our bank account has fallen, we have still turned a profit for the
fiscal year, based off our sales and expenses.

3. No, because the only prototype component recorded in the financial statements is the
prototype expense. Therefore if the expense stays the same, even if the “value” increases, this
does not change the financial statement.

4. Prototypes can be considered assets or expenses. Prototypes contain the knowledge the firm
has and therefore is valuable the same way a patent is. This explains why it could be part of the
assets on the balance sheet. Others see prototypes as merely a business expense necessary for
setting up the firm and creating the goods that will actually be sold. In that respect, they can be
thought as similar to advertising expenses - necessary for bringing the product to consumers,
but not an actual asset to the firm.