The business that I am going to start is a small coffee microroastery and shop. The company will perform two basic functions. The first is a product function, the roasting of coffee beans. Green beans will be received by the company, roasted, and then both used in the shop and made available for a variety of retail channels. The second function will be a service function, based on the production and serving of beverages and light snacks. The staffing plan will be simple. The owner/manager/roaster will perform most of the management tasks associated with the shop. There will be an assistant manager who doubles with barista duties, as well as 4-6 part-time staff members, filling 3 FTEs in the barista/service function. This plan is based on experiences at other, similar operations, in addition to meeting a few other needs. One is the need to keep costs down, and the other is the need to have two people in the shop whenever it is open.
b. The business is going to be an LLC. The business will be privately owned by the proprietor. An LLC has flow-through taxation benefits so that company income flows through to my personal income at the state level, but at the corporate rate at the federal level (Perez, 2012). Because LLC is a state designation, it will be treated as “disregarded entity” at the federal level (IRS, 2012). The LLC structure also has the benefit of exposing the owner to limited liability. This is important both when hiring other workers and when in the food service industry, where a customer illness could result in a substantial lawsuit. It is best to insulate the owner’s personal assets from such actions.
c. The accounts will be created as needed. It is expected that the accounts will include the following asset categories: Cash, Accounts Receivable, Inventories, , and “Other.” Fixed asset categories will be “Plant, Property and Equipment,” and will include both real estate and equipment in the category, the latter being for example the roaster, computers, espresso machine, and other such assets. PPE will be listed on the of depreciation. Shareholder’s equity in the form of both common stock and retained earnings will also be listed on the balance sheet.
Income statement accounts will include under revenues a split between the wholesale business and the retail business. Internally, the online business will be a separate category of wholesale. Cost of goods sold will be a major expense category. Operating expenses will include those associated with property, salaries and wages (net of benefits), utilities, insurance, interest and depreciation. Tax expense is not recorded because it flows through.
3. Based on the form of the business, I do not need to utilize either GAAP or IFRS. Being an American company, there is no requirement to use International Financial Reporting Standards. Being a privately-held company, Generally Accepted Accounting Principles are also not required. I can account on a cash basis if I choose to (Inc., 2000). However, the company will use GAAP in the production of financial statements. There are two reasons for this. The first is that I prefer it over the cash accounting system. The second is that the long-term goal is to build this company into something significantly bigger than its humble beginnings. Eventually, GAAP financial statements will need to be produced, for example if I want to seek funding from outside sources. It is easier to scale up GAAP as the company grows than to overhaul the entire accounting system two or three years down the road.
It is also worth mentioning that a managerial accounting system is also going to be put into place. Both the manager and assistant manager will be splitting time between the wholesale and retail sides of the business, and both businesses will share floor space. Thus, techniques like activity-based costing will help to make more informed decisions about the use of company resources. Any managerial accounting system that is used will run in parallel to the GAAP financial accounting system.
3. There are a number of assumptions built into the income statement. Wholesale revenue is $500/day, retail revenue $2,000/day. is 70% of price, retail markup is 1x, so COGS is 50% of price. Rent is $2,500/mo; salaries are $20,000 per FTE except assistant manager $30,000 and general manager (owner) $40,000, all net of benefits. Depreciation is mainly for the roaster, espresso machine, computers and kitchen equipment. It will be $40,000 initial cost, and this type of equipment is on the 10-year MACRS, which has a first-year percentage of 10%. Insurance is $300/mo and utilities $700/mo. There is no interest income under this scenario because the owner is financing the business without debt (or with only personal debt that does not show on the business balance sheet. With a $40,000 salary, it is expected that the owner will not make any dividend withdrawals, and instead will plow back profits into growing the business.
Pro Forma Income Statement
Total Operating Expenses
The pro forma balance sheet is as follows, based on 100% equity for initial financing and $40,000 in initial equipment. Cash float will be around $10,000, while inventory is expected to be around 12% of total sales for the year, implying an inventory turn of 8.3x, or more than a month. Accounts receivable are expected to be in the range of 30 days outstanding at any given time for wholesale, and 3 days’ sales for retail credit card, which is expected to be 20% of all retail transactions. Prepaid expenses are expected to be one month of insurance and rent. Accounts payable is expected to be 30 days of COGS. Accrued utilities is expected to be one month of utilities. It is not expected that there will be any accrued salaries at the end of a reporting period, since employees are paid at the end of the month. the startup financing, which was the cost of the equipment ($40,000), the cash float ($10,000), one month of inventory ($50,100), one month of rent and insurance ($2,800) and money set aside for a month of utilities ($700).
The pro forma balance sheet is therefore as follows:
Pro Forma Balance Sheet
Total Current Assets
Total Current Liabilities
Total Liabilities & Equity
4. There are a few different internal control methodologies that can be applied to this business. The first type of control will safeguard the assets through effective financial reporting. The first is that there must be more than one person with access to the accounts, in order to ensure that all the person in control is not tinkering with the numbers. Both the GM and the AGM will therefore have access to the figures. The AGM will serve as the internal auditor of the books. This will provide a positive control environment. To further improve the control environment, there should be an ethics statement that serves as a guiding principle for all activities at the company, including accounting (KPMG, 1999).
All financial accounting will be done in accordance with GAAP. Having such a system is also part of internal control. While the company can perform its accounting any way it wants, freelancing the accounting function without any standards all but guarantees errors, and provides no control at all. Utilizing an established system like GAAP provides clear standards. All methods of accounting, such as how inventory will be recorded, will be outlined at the outset, and will likely not be changed unless there is a compelling reason.
Another category of control lies with the physical protection of assets. There are multiple approaches to this. The first is insurance, which will be taken out on the key equipment and inventory. This cost has been built into the pro forma income statement. In addition, the premises will be secured, and there will be a safe for any cash deposits that need to remain on the premises overnight. Mostly, it is expected that only the cash float (around $200) will remain on the premises, and this will be locked in the safe. Locks, alarms and other security features are the responsibility of the landlord, and it will be ensured that such security features are included in the space, and therefore in the rent. Additionally, there will be training procedures as well as procedures built into the hiring process to ensure that the staff are honest. Having two people on the premises whenever the shop is open is another way to boost the physical security of assets, and there will also be a closed circuit system over the till and over the door.
5. The explanation of the controls discussed most of the implementation as well. It is not expected that there will be any resistance to these controls, as all are relatively standard.
6. Sarbanes-Oxley applies to publicly-traded company. Coffee Co. is an LLC, therefore Sarbanes-Oxley does not apply to Coffee Co. The regulatory environment is a minimal risk for the most part. The most significant regulatory issues are with the health inspectors because this is a food service facility. We will work with the health inspectors prior to opening and will follow their recommendations carefully. A code of ethics will help to ensure that no criminal activity takes place, and the internal controls will help to ensure that tax codes are followed. However, as an LLC the company holds little liability if the owner decides to misrepresent something on his personal taxes. There are also requirements under the Equal Pay Act, Title VII of the Civil Rights Act of 1964, the National Labor Relations Act and other such legislation governing the treatment of works in the workplace. All of these regulations will be adhered to, and their tenets built into the company’s recruitment and human resources strategy.
Inc. (2000). Cash vs. accrual accounting. Inc. Magazine. Retrieved November 13, 2012 from http://www.inc.com/articles/2000/04/19194.html
IRS.gov (2012). Limited liability company (LLC). Internal Revenue Service. Retrieved November 13, 2012 from http://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Limited-Liability-Company-%28LLC%29
KPMG. (1999). Internal control: A practical guide. KPMG. Retrieved November 13, 2012 from www.ecgi.org/codes/documents/kpmg_internal_control_practical_guide.pdf
Perez, W. (2012). Types of business organization. About.com. Retrieved November 13, 2012 from http://taxes.about.com/od/taxplanning/a/incorporating_2.htm