Income statement preparation On December 31, 2006, Cathy Chen, a selfemployed

certified public accountant (CP!, completed her first full year in business" Durin# the
year, she billed $360,000 for her accountin# ser%ices" &he had t'o employees( a
boo))eeper and a clerical assistant" In addition to her monthly salary of $*,000, +s" Chen
paid annual salaries of $,*,000 and $36,000 to the boo))eeper and the clerical assistant,
respecti%ely" -mployment ta.es and benefit costs for +s" Chen and her employees totaled
$3,,600 for the year" -.penses for office supplies, includin# posta#e, totaled $10,,00 for
the year" In addition, +s" Chen spent $1/,000 durin# the year on ta.0deductible tra%el and
entertainment associated 'ith client %isits and ne' business de%elopment" 1ease
payments for the office space rented (a ta.0deductible e.pense! 'ere $2,/00 per month"
Depreciation e.pense on the office furniture and fi.tures 'as $12,600 for the year"
Durin# the year, +s" Chen paid interest of $12,000 on the $120,000 borro'ed to start the
business" &he paid an a%era#e ta. rate of 30 percent durin# 2006" a" Prepare an income
statement for Cathy Chen, CP, for the year ended December 31, 2006" b" -%aluate her
2006 financial performance"
(a)
Cathy Chen, CPA
Income Statement
For the Year Ended December 31, 2006
Sales revenue $360,000
Less: Operating expenses
Salaries 180,000
Employment taxes and benefits 34,600
Supplies 10,400
Travel & entertainment 17,000
Lease payment 32,400
Depreciation expense 15,600
Total operating expense 290,000
Operating profits $70,000
Less: Interest expense 15,000
Net profits before taxes $55,000
Less: Taxes (30%) 16,500
Net profits after taxes $38,500
(b! In her first year of business, Cathy Chen co%ered all her operatin# e.penses
and earned a net profit of $3*,200 on re%enues of $360,000
3is) and probability +icro0Pub, Inc", is considerin# the purchase of one of t'o microfilm
cameras, 3 and &" 4oth should pro%ide benefits o%er a 100year period, and each re5uires
an initial in%estment of $,,000" +ana#ement has constructed the table (at the top of the
facin# pa#e! of estimates of rates of return and probabilities for pessimistic, most li)ely,
and optimistic results" a" Determine the ran#e for the rate of return for each of the t'o
cameras" b" Determine the e.pected %alue of return for each camera" c" Purchase of 'hich
camera is ris)ier6 7hy6 In -.cel Please
(a)
Camera Range
R 30% 20% = 10%
S 35% 15% = 20%
(b)
Possible
Outcomes
Probability
P
ri
Expected Return
k
i
Weighted
Value (%)(k
i
P
ri
)
Camera R Pessimistic 0.25 20 5.00
Most likely 0.50 25 12.50
Optimistic 0.25 30 7.50
1.00 Expected Return 25.00
Camera S Pessimistic 0.20 15 3.00
Most likely 0.55 25 13.75
Optimistic 0.25 35 8.75
1.00 Expected Return 25.50
(c) Camera S is considered more risky than Camera R because it has a much broader
range of outcomes. The risk-return trade-off is present because Camera S is more
risky and also provides a higher return than Camera R.