Question

TOO HOT TO HOLD
Gwendolyn Bonnefille, a single mother, is barely scraping by. Although she earns a fair salary working in the accounts receivable department of a local business, she has to pay for child care for her two children, Samantha who is 5 and Merlin who is 3. While surfing the Web, under a listing titled “businesses that can be moved,” she found for sale a business that makes a great hot sauce called Caterwauling Coyote, with the slogan, “You’ll howl at the moon!” The sauce is made in the kitchen of the owner, bottled, labeled, and then delivered to gift and specialty shops in south Texas. The equipment to make the sauce is commercial quality and appears to be in good condition.
The business financial statements and the owner’s 1040 C business tax returns do not agree. The financial statements show that in the most recent year the business earned $60,000 on sales of $200,000. The 1040 C shows a profit of only $10,000, and a zero tax liability because of deducting losses suffered in prior years. The sellers are asking $240,000 for the business. They are willing to finance $190,000 at 10 percent for 15 years.
When Gwendolyn sat down with the owner, Sylvester Gatos, he attempted to explain the discrepancy between the accounting and the tax returns.
“You see,” Sly said, “there are two things. First, some of the expenses on the schedule C aren’t really business expenses, if you know what I mean. Second, when we did the income statement, we took out depreciation, interest, property tax, and the money that we used from the business because a buyer will not have those expenses.”
CASE DISCUSSION QUESTIONS
1. What do you think about Sly’s explanation of the differences between his income statement and his 1040 Schedule C?
2. Suppose that the income statement is reasonably accurate. What do you think about the purchase price?
3. What information should Gwendolyn obtain before making a decision to purchase the business?

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Answer 1:
The difference arises due to the differing objectives when these statements are prepared. When income statement is prepared to be shown to prospective buyer, the aim is to maximize the profits so that a good value can be obtained for the business. On the other hand, when form 1040C is made, the aim is to minimize profits so that the tax liability can be minimized. In my opinion, some of the expenses were not real in nature and had been shown on the statement to inflate costs or claim deductions for income tax determination (Anderson & Gardner, 2012)....

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