Chapter 7, Problem 6E

Effect of warranties on income and cash flow

To support herself while attending school, Daun Deloch sold stereo systems to other students. During the first year of operations, Deloch purchased the stereo systems for $140,000 and sold them for $250,000 cash. She provided her customers with a one-year warranty against defects in parts and labor. Based on industry standards, she estimated that warranty claims would amount to 2 percent of sales. During the year she paid $2,820 cash to replace a defective tuner.

Required

a. Prepare an income statement and a statement of cash flows for Deloch’s first year of operation.

b. Explain the difference between net income and the amount of cash flow from operating activities.