Individual Assignment - Sky's Skateboards

University Canada West

Acct 621: Accounting for Managers

Yasamin, Alami

February 27, 2022

To: Sky’s Skateboards

From: Fernanda Tamascia

Data: February 27, 2022

Subject: Business analysis

This accounting review will analyze the case brought by Sky, a young entrepreneur who

works in the skateboarding design business and wants to have a better view of the direction of

her business activity.

The business has advantages and disadvantages that will be explored throughout this

document. All the recommendations will be based on Sky's scenarios, figures, and information

that was made available.

Initially, we can highlight that Sky has an excellent talent for designing its products, a

good network that counts with relatives, friends and new customers. In addition, its products do

not represent a single purchase; that is, customers can purchase a skateboard or more and so on.

However, entrepreneurship has many challenges, especially considering the Covid-19

scenario, high rental values of physical spaces, uncertainty about the number of customers,

discovering the best approach to the possibility of purchasing machinery and equipment

necessary for business operation, among others.

Further details will be provided below to serve as a basis for Sky to resolve its doubts and

adopt the best possible strategies.

Sky started a small skateboard customizing business last year (2021) in Vancouver,

British Columbia; at first, it had a good demand with skateboard customizing for relatives and

friends. After a year, it noticed a drop in their demands. Sky is looking for advice on what would

be the best paths to follow with her business. Sky exposed a series of variables that will be

addressed appropriately in this analysis; however, based on information provided by Sky, this

consultation seeks to address the following points:

1. What are the pros and cons of continuing to work with used skateboards?

2. What were your revenues and costs last year?

3. Should Sky buy or lease the machinery needed for its business expansion? What are the

appropriate accounting and tax treatments for the machinery?

4. Should sky start the online business?

5. Should Sky rent a small retail space?

6. Should Sky invest in the advertisement every other month or every month?

7. Considerations about sole proprietors maintaining accurate records for business and tax

purposes.

8. Should Sky consider the proposed partnership with Libby?

9. Should Sky go to college or continue with her skateboard company?

10. Advice on business ethics.

1. What are the pros and cons of continuing to work with used skateboards?

Analyzing the information computed in the tables below, the best scenario for Sky would

be to focus its efforts on the production of premium skateboards because she earns 26 dollars per

hour worked. For used skateboards, Sky makes 25 dollars for every hour of work. The best

strategy then would be the customization of premium skateboards. If Sky does not have enough

demand for this customization, it should complement working with the design of the used

skateboard. Additionally, the most unfavourable scenario is the regular design of new

skateboards, where she only makes 20 dollars per hour worked.

Calculations:

Contribution margin regular: 100-50-10=40

Contribution margin Premium: 125-50-10=40

Contribution per hour=CM/ hours

Total CM month=Sell units * CM.

are some pros and cons of selling the customized used skateboard:

CONS

• The demand for custom-used skateboards has slowed down. However, there is an unmet

local demand for custom-designed skateboards; Sky should focus more on the premium

custom-designed because it has higher growth potential.

• The demand is seasonal doubling the demand in the 3 months of summer. Since there is

unmet demand for new custom skateboards there is the potential to increase the sales in

the other 9 months of the year if Sky focuses on new custom designs.
 • Used custom skateboards have a lower contribution per hour of work than the Premium

new skateboard designs.

PROS

• Used skateboard custom designs have a higher contribution per hour of work than the

regular new skateboard regular custom design.

• Since used skateboard custom designs have a higher contribution per hour of work than

the regular new skateboard regular custom design, it is sky interesting to keep this service

to offer it when the demand for Premium skateboards reaches its peak and there is excess

capacity.

2. What were your revenues and costs last year?

Considering that last year Sky customized only used skateboards, according to the

numbers detailed in the table below, Revenues were $6,750.00 and costs were $1,125.00,

resulting in an annual gross profit of 5,625.00

3. Should Sky buy or lease the machinery needed for its business expansion? What are the

appropriate accounting and tax treatments for the machinery?

Considering that Sky did not present all the information necessary for this evaluation,

some assumptions were adopted to demonstrate the scenarios (all assumptions are duly described

below and shown in the calculations).

If the machine is purchased and Sky borrows money from the bank, on day 1 a long-term

debt will be recorded in the balance sheet and an asset for 10,000. Interest expenses will be

accrued annually for a total amount of $575.00 (10,000*5.75) considering that the amount of the

credit will be paid in full at the end of the 5th year and there will be no amortization of principal.

Lease payment will be expensed to the P&L, there is not asset recorded in the balance

sheet. Since lease payments are deductible for tax purposes there will be a tax credit of $264.00

every year.
 • Assuming that there are no payments of principal until the end of the useful life of the

asset. The amount of the line of credit will be paid in full at the end of year 5.

• Since there is not enough information available in the problem in regards to the type of

machinery Sky is planning to buy we will assume that the machinery is a CRA class 8

asset with a capital cost allowance of 20%. (10,000*0.2*0.11) =220 (T2inc.ca, 2021).

• Interest expense is equal every year 10,000*5.75%=575.00.

Given this, the recommendation is to lease the equipment as the present value of the cash

flows for the five years will be lower 9,059.13 in comparison with 9,379.59 of purchasing the

machine.

In addition, leasing can bring benefits to Sky, such as, for example, 1. preserving the

liquidity available for investment money; 2. reducing the initial cash disbursement; and 3. in

addition, Sky will still be able to choose at the end of the five years if desired, renew the
contract, buy the machinery at different prices or return the good, a fact that gives her the

flexibility to choose the best scenario in the future and will also help her not to have obsolete

equipment on her property after the years of use specified in the contract.

Additionally, in both (purchase or leasing), there will be a tax credit; however, this credit is

higher in the leasing scenario, which reinforces the recommendation of this accounting opinion.

4. Should sky start the online business?

Digital entrepreneurship is a market trend. Here are some advantages: Virtual stores have

great potential for reaching the public and audience; 24-hour availability for sales, that is, even if

it is not business hours, online stores have the potential to continue recording sales in any period;

online stores demand low initial capital investment since you will not have to rent a physical

space and Sky can manage it without the help of employees initially. Finally, Sky can monitor

access to its website and make marketing and advertising based on the profile of its buyers and

visitors.

Calculations

Unit sales regular: 150*2=300 projected sales will double if goes online.

Unit sales premium: 50*2=100

Contribution margin regular:40-10=30

Contribution margin premium: 65-10=55

Despite the fact, the contribution margins will decrease for skateboards sold online,

because of the increase in sales volume Sky will increase its total profitability to $14,500 a
 year in comparison with the $7,450. We assume that there are no units sold of the used

custom skateboard for this analysis. For the reasons above, the recommendation is that Sky

adopts an online business strategy.

5. Should Sky rent a small retail space?

Continuing with the analysis, Sky brought up the possibility of renting a small space for a

physical store. Since the expected sales increase is double of current sales, current sales are

225 units a year, which will increase sales up to 450 units. Since is considering current sales

only used customized skateboard contribution margins was used for this calculation.

The total gross profit before rent expense will be 11,250.00 in comparison with 5,625.00

without renting a store. However, the $24,000 annual rent expense will result in a negative

net profit of $12,750.

Another factor to be considered when opening a physical store is the pandemic scenario

caused by Covid-19 and the restrictions imposed in some places. Still, it is not possible to

know if new waves and lockdowns may occur in the future, and therefore the safest option

would be to invest in the creation of the online store and, in the future, carry out a new

expansion analysis.

For all the mentioned above, it is not recommended to rent a store for $2,000 a month.

6. Should Sky invest in the advertisement every other month or every month?
 If we analyze the net income of both scenarios as detailed below, we find that in the

option with 6 months advertisement, the net income is $7,450.00, and with a year advertisement,

it is $6,575.00. Therefore, I would recommend to do only the newsletters every other month

which will increase the gross profit by $875 a year.

Calculations:

6 months advertisement

Unit sales Regular 6 months advertisement: 200*0.75=150

Unit sales Premium 6 months advertisement:200*0.25=50

Contribution margin per constraint Regular= 100-50-10=40

Contribution margin per constraint premium=125-50-10=65

Gross profit regular= 150*40=6,000

Gross profit regular=50*65=3,250

Advertisement 6 months = 6*300 = 1,800

Advertisement 12 months = 12*300=3,600

12 months advertisement

Unit sales Regular 12 months advertisement: 200*0.75*1.1=165

Unit sales Premium 12 months advertisement:200*0.25*1.1=55

Contribution margin per constraint Regular= 100-50-10=40

Contribution margin per constraint premium=125-50-10=65

Gross profit regular= 150*40=6,600

Gross profit regular=50*65=3,575

Advertisement 12 months = 12*300=3,600

purposes.

The owner of a sole proprietorship, such as Sky, is solely responsible for decisions, risks,

profits and does not have a legal status separate from his business; that is, the risks extend even

to personal property (Canada Revenue Agency, 2022).

Keeping all accounting records updated and correct is essential for better business

quality. Through the accounting records, all company financial events are registered. It is

possible to evaluate obligations, profits and income, expenses, inventory, accounts receivable,

and accounts payable. It is also an essential tool to plan the next steps of your business.
Records help the entrepreneur with the business administration and allow government bodies to

evaluate the company for tax or legal purposes (Canada Revenue Agency, 2022).

Considering the above, the recommendation is for Sky to keep all records duly updated

either with the help of control through software available on the market or through accounting

firms.

8. Should Sky considers the proposed partnership with Libby?

Without Libby 5 years projection

For the purpose of this analysis and since these were the choices in our previous analysis,

we will assume that the machine will be leased, and the online store will be lunch with 6-month

advertising newsletters.

Under this scenario the present value of the 5 years cash flows is $44,804.

Partnership with Libby

If partnering with Libby then advertising will be all year, sales will be 10% higher,

distribution will be zero and financing of the machine will be zero.

ownership that Libby will own.

Under this scenario the present value of the 5 years cash flows is $86.308 however only

70% will be distributed to Sky. The total present value of the 5 years profit projection that will

be earned by Sky is 60,415.

Since Sky will make $15,612 more, my recommendation is that Sky should partner with

Libby.

9. Should Sky go to college or continue with her skateboard company?

To analyze if Sky should go to college or continue with her business, we will project the

present value of the annual cash flows to perpetuity in both scenarios.

The following assumption was made for these calculations:

• Interest rate= 5.75% to calculate the present values and perpetuities.

• The interest on the $40,000 borrowed is zero

they lunch the shop online

• There is no sales growth overtime, these projections assume that sales will remain steady.

• Perpetuities are calculated by dividing the salaries and profits by the interest rate.

Here are the calculations:

The analysis below shows that the total present value of all salary payment to perpetuity

if Sky decides to study are $996,810, in the other hand if sky decided to continue with the

business the total present value of the annual profits to perpetuity are 353,913.

Based on these results, we will recommend that Sky should study and pursue a career

because she will make an additional $654,897 (996,810-353,913).

9. Advice on business ethics.

Companies must act ethically and in the most professional way possible to better serve

their customers, employees and society.

Conclusion

Looking at the long-term Sky should pursue her studies because she will make a

significant amount of money more than working on her business. In addition, she can gain
market experience and create a more significant financial reserve. If she decides later, she can re-

analyze the opportunity to open her own business when she is more mature and financially

prepared.

However, even with the considerations made throughout this opinion, Sky decides to go

ahead with the idea of opening his own business, the ideal in terms of business advice would be

Sky add online sales, focus on the production of premium skateboards and partner with Libby

because it will make the most economic sense.

References

Canada Revenue Agency. (2022). Sole proprietorship - Canada.ca.

Https://www.Canada.ca/En.Html. https://www.canada.ca/en/revenue-

agency/services/tax/businesses/small-businesses-self-employed-income/setting-your-

business/sole-proprietorship.html

T2inc.ca. (2021, December 10). Catégories d’amortissement et leurs taux | Fiscalité d’entreprise.

https://t2inc.ca/en/blog/cca-classes-and-rates
University Canada West | login. (2022). Week 3 Capital Assets and Financial Analysis.

https://www.myucwest.ca/login/?id=8600

University Canada West | login. (2022). Week 4 Financial Analysis.

https://www.myucwest.ca/login/?id=8600

What’s the matter with business ethics? (2014, August 1). Harvard Business Review.

https://hbr.org/1993/05/whats-the-matter-with-business-ethics