Mr. and Mrs. Ilyong Kim purchased the Larkin Motel in 1998 with their life savings, supplemented by a loan from a close personal friend. The motel consisted of 20 units (i.e., rentable rooms) and was located near a vacation area that was popular during the summer and winter seasons. The Kims had long wanted to run a business of their own.
Mr. and Mrs. Kim felt that they had been successful. Each year saw a growth in revenue from room rentals. Furthermore, their bank balance had increased. They noted that many of their customers returned each year. This was attributed to their location and their efforts to provide consistently clean rooms and up-to-date furnishings.
The Kims had no formal business training but felt their experience since acquiring the motel had alerted them to the management problems involved. Both Mr. and Mrs. Kim devoted their full time to operating the motel. In addition, they hired part-time help for daily room-cleaning work. They had no dining facilities but had installed vending machines to supplement room rentals. The vending machines posed no inventory or maintenance problems as the vending machine company provided servicing and maintenance.
A frequent guest at Larkin Motel was Marcus Carter, controller of a large company. Mr. Carter visited a company branch plant near the motel several times a year. As he stayed at the motel during these trips, he became acquainted with the Kims. In May 2003, Mrs. Kim showed Mr. Carter the current issue of a motel trade journal that contained operating data for motels with 40 or fewer units for the calendar year 2002. Mrs. Kim commented:
These figures show a profit of 21 percent. Our profit last year was $95,718 on sales of $174,615, or 55 percent. We think 2002 was our best year to date, but we can’t make our figures jibe with those in the magazine, and we wonder if we really are 34 percent ahead of the industry average. Can you help us?
Mr. Carter was interested and willing to help, and told Mrs. Kim to get the available figures for 2002 so he could look them over that evening. The main records the Kims kept to reflect the motel’s financial transactions were listings of receipts from the cash register and a check-book showing cash paid out. In addition, they had certain rough notations of other expenses incurred.
That evening Mrs. Kim showed Mr. Carter the cash summary for the year 2002, as given in Exhibit 1. Mr. Carter immediately noted that the difference between receipts and expenditures was $34,218, and asked Mrs. Kim to explain why she had stated the profit was $95,718.
Mrs. Kim replied,
Oh, that’s easy. Our drawings aren’t expenses; after all, we are the owners. My husband and I have consistently taken only about $60,000 a year out because we want the rest of the profits to accumulate in the business. As I said, our bank balance has steadily risen. Furthermore, I have a local accountant make out the annual income tax statements so I don’t have to worry about them. That income tax stuff is so complicated that I avoid it.
Mr. Carter worked with the trade journal’s figures (Exhibit 2) and the cash summary (Exhibit 1) that evening and quickly found he needed more information. He told Mrs. Kim that he was . . .
- Prepare an operating statement such as Mr. Carter prepared.
- As Mr. Carter, what comments would you make to the Kims regarding the motel’s progress to date?