Case: Ribbons an’ Bows, Inc.

In January 2006, Carmen Diaz, a recent arrival from Cuba, decided to open a small ribbon shop
in Coconut Grove section of Miami, Florida. During the month, she put together a simple
business plan, which she took to several relatives whom she believed would be interested in
helping her finance the new venture. Two of her cousins agreed to loan the business $10,000 for
one year at a 6 per cent interest rate. For her part Carmen agreed to invest $1,000 in the equity of
the business.
On March 1, 2006, with the help of an uncle who practiced law, Carmen formally incorporated her
business, which she named “Ribbons an’ Bows.” Normally, the uncle would have charged a fee of $600
for handling the legal aspects of a simple incorporations, but since Carmen was family, he waived the fee.

As soon as the new business was incorporated, Carmen opened a bank account and deposited the cousins’
$10,000 loan and her $1,000 equity contribution. The same day, she signed an agreement to rent store
space for $600 per month, paid on the last day of the month. The agreement was for an 18-month period
beginning April 1. The agreement called for a prepayment of the last two months’ rent, which Carmen
paid out of company bank account at the signing.

Over the next few weeks, Carmen was actively engaged in getting ready to open the store for business on
April 1. Fortunately for Carmen, the previous tenant had left counters and display furniture that Carmen
could use at no cost to her. In addition, the landlord agreed to repaint the store at no cost, using colors of
Carmen’s choice. For her part, Carmen ordered, received and paid for the store’s opening inventory of
ribbons and ribbons accessories; acquired for free a simple cash register with credit-card processing
capabilities from the local credit-card charge processing company after paying a refundable deposit;
signed service agreements with the local phone and utility companies; ordered, received, and paid for
some store supplies; and placed and paid for advertising announcing the store opening in the April 2
edition of the local paper. In addition, she bought and paid for a used desktop computer with basic
business software already installed to keep track of her business transactions and correspondence.

On March 31, before opening for business the next day, Carmen reviewed the activity in the company’s
cash bank account. Following the deposit of the loans and equity contribution, the following payments
were made.

1. Last two months’ rent $1,200

2. Opening merchandise inventory $3,300
3. Cash register deposit $ 250
4. Store supplies $ 100
5. April 2 edition advertising $ 150
6. Used computer purchase $2,000

After reviewing her cash transaction records, Carmen prepared a list of Ribbons an’ Bows assets and
sources of capital (See Exhibit 1).

Carmen eventually decided to expand her business by selling custom-designed ribbon table arrangements
for wedding and other special events. This decision led to the purchase of a used commercial sewing
machine for $1,800 cash on May 1.

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Later, at a family Fourth of July celebration, one of Carmen’s cousins reminded her that she had
promised to send the cousins a financial report covering the four month period from March1 to
June 30.

The next day, Carmen reviewed the following Ribbons an’ Bows information she had gathered
over the last four months.

1. Customers had paid $7,400 cash for ribbons and accessories, but she was still owed $320 for
ribbon arrangements for a large wedding delivered to the customer on June 30,
2. A part-time employee had been paid $1,510 but was still owed $90 for work performed
during the last week of June.
3. Rent for the three-month period had been paid in cash at the end of each month, as stipulated
in the rental agreement.
4. Inventory replenishments costing $2,900 had been delivered and paid for by June 30, Carmen
estimated the June 30 merchandise inventory on hand had cost $ 4,100.
5. The small opening office supplies inventory was nearly all gone. She estimate supplies
costing $20 had not been used.
Carmen believed that the initial three months of business had been profitable, but she was puzzled
by the fact that the cash in the company’s June 30 bank account was $3,390. Which was less than
the April 1 balance of $4,000.
Carmen also was concerned about how she should reflect the following in her financial report.
1. No interest had been paid on the cousins’ loan.
2. The expenditure made for the desktop computer and its related software and the commercial
sewing machine. She believed these expenditure would be beneficial to the business long
after June 30. At the time she purchased the commercial sewing machine, Carmen estimated
that it would be used for about five years from its May 1 purchase date, when it would then
have to be replaced. Similarly, on March 31, she had estimated the desktop computer and its
software would have to be replaced in two years’ time. Carmen believed the sewing machine
and the computer along with its software would have no resale value at the end of their useful
life.
3. The free legal work performed by her uncle and the free cash register provided by the local
credit-card charge processor.
4. Carmen had not paid herself a salary or dividends during the four months of operations. If
cash was available, she anticipated that some time in July she would pay herself some
compensation for the four months spent working in the business. Before starting her business,
Carmen had worked for $1,300 a month as a cashier in a local grocery store.
Questions:
1. How would you report on the three-month operations of Ribbons an’ Bows Inc., through
June-30? Was the company profitable? (Ignore income taxes). Why did its cash in the bank
decline during the three-month operating period?
2. How would you report the financial conditions of the business on June 30, 2006?
3. Do you believe Carmen’s first three months of operations could be characterized as
‘successful’? Explain your answer.
EXHIBIT 1

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Assets $ Liabilities $
Cash 4,000 Cousins’ Loan 10,000
Inventory 3,300 Carmen’s equity 1,000
Supplies 100
Prepaid rent 1,200
Prepaid advertising 150
Computer / Software 2000
Cash register deposit 250
TOTAL 11,000 TOTAL 11,000

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Teaching Notes:
Approach
In the first few classes, the usual objective is to create interest in the subject, to set the scene, and
to give an overview of the course. The cases are intended to get the student to start thinking like
accountants and users of accounting information, without knowledge of any of the techniques.
Ribbons an’ Bows gives students an opportunity to construct a simple set of financial statements.

Approach
This is an introductory case and it should be taught as an introductory case. There will be
plenty of time in the course for the students to learn the correct form of financial statements and
details of accounting standards. In short, the instructor should be prepared to allow a variety of
formats for the financial statements and tolerate some “not quite correct” accounting.

The instructor may want to have students discuss Carmen’s March 31 statement, but the
bulk of the class should focus on the three case questions. Any discussion of the March 31
statement should deal with the nature of the various accounts (i.e. prepaid rent is rent paid in
advance of using the property and it is an asset because it has future economic benefits for the
company, etc), rather than the format of the statement. It is better to leave the beginning of the
course’s instruction in financial statement formats to the assigned case question discussions.

Comments on Information Gathered and Carmen’s Concerns

1. The three month sales total is the sum of the cash sales ($7,400) and credit sales ($320).
2. Cost of sales is derived from the following equation
Beginning merchandise inventory $3,300
Plus Purchases 2,900
Equals Total available merchandise $6,200
Less Ending merchandise inventory 4,100
Equals Cost of sales $2,100
3. Rent expense is $1,800 of $600 per month times three months. Paid in cash.
4. Part-time employee expenses ($1600) is the sum of cash paid ($1510) plus amount owed
($90).
5. Supplies expense ($80) is beginning supplies inventory ($100) less supplies inventory on
hand on March 31 ($20).
6. The prepaid advertising ($150) was run by the local paper on April 2. The benefit of the
asset expired so the asset became an expense.
7. The commercial sewing machine purchase led to an $1800 asset being recorded (a future
benefit). The asset’s benefit was partly consumed during May and June resulting in a $60
depreciation charge ($1800/ 5 years/ 12 months x 2 months – straight line depreciation.)
8. Some of the future benefits of the computer and related software asset were consumed
during the three month period. A $250 depreciation charge must be recognized ($2000/
2/ 12/ x 3 – straight line depreciation.)
9. Cash balance at the end of period lower than beginning balance. See Question 1
discussion.

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10. Four month’s interest must be recorded on the cousins’ $10,000 loan. ($10,000 x .06 x 4/ 12).
Carmen has “rented” the cousins’ money for four months. (She forgot to include the March
rent in her March 31 balance sheet.)
11. No depreciation is recorded on the cash register loaned by the local credit-card charge
processor and the furniture left by the former tenant. These “assets” were not recognized on the
financial statement because they were neither donated nor acquired in business transactions.
12. The uncle’s legal work is neither an asset nor an expense of the business. It did not result in a
business transaction.
13. Carmen’s potential salary payment in July is neither an expense nor a liability as of March 31.
The company does not have an obligation on March 31 to pay her any compensation.

Question 1

Exhibit 1 presents the company’s initial three month income statement. It does not contain a
provision for taxes, since Carmen at this early date did not know if income taxes would be due
on the annual results.

The principal reasons why the cash balance declined during the three month profitable operating
period are:

1. The commercial sewing machine purchase reduced cash by $1,800 while the
related depreciation charge only reduced income by $90.
2. Ending inventory was higher than beginning inventory and the increase was paid
for with cash. That is, more inventory was bought for cash ($2,900) than the cost
of goods sold ($2,100).

Exhibit 2 present a cash flow analysis for the three month operating period.

Question 2

Exhibit 3 presents the company’s June 30 balance sheet.

Question 3

Carmen’s business is off to a good start, but it will have to do better over the rest of the year if
Carmen plans to pay herself any meaningful compensations and repay the cousins’ loan at the
end of the year.

When discussing Question 3 some students believe that Carmen should include a consideration
of an imputed compensation expense in deciding how well she has done. Students accept the
non recognition of her compensation in the income statement, but believe she should recognize
that personally she has incurred an opportunity cost for lost wages (at least four months x
$1300).

In addition, students believe Carmen’s non-recognition of any cost associated with using the
abandoned counters and display equipment overstates how well she is doing from an economic

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point of view. These students would include some depreciation cost based on the asset’s fair
value in their evaluation of how “successful” the business has been to date.

Some students advocate including the free legal advice’s value ($600) in their assessment
of the company’s success to date.

The instructor may challenge the class to consider why these items (free legal advice,
imputed salary and depreciation) are not included in the company’s income statement.

Exhibit 1

Ribbons an’ Bows

Income Statement for the Period
April 1 to June 30, 2006

Sales $7,720
Cost of Sales (2,100)
Gross Margin $5,620
Employee wages (1,600)
Rent (1,800)
Office Supplies (80)
Depreciation – Computer (250)
Depreciation – Sewing Machine (60)
Interest (200)
Advertising (150)
Profit before Taxes $1,480

Exhibit 2

Ribbons an’ Bows

Analysis of Cash Flows for the Period
April 1 to June 30, 2006

Beginning Cash $4,000

Sales 7,400
Wages (1,510)
Rent (1,800)
Merchandise Inventory (2,900)
Sewing Machine (1,800)
Ending Cash $3,390

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Exhibit 3

Ribbons an’ Bows

Balance Sheet as of June 30, 2006

Assets Liabilities
Cash $3,390 Wages owed $90
Accounts receivable 320 Interest owed 200
Merchandise Inventory 4,100 Cousins’ loan 10,000
Supplies 20 $10,290
Prepaid rent 1,200 Owner’s Equity
Computer (net) 1,750 Carmen’s equity $1,000
Sewing machine (net) 1,740 Earnings 1,480
Cash register deposit 250 $2,480
Total $12,770 Total $12,770