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Lutz Realty Company
Author(s):
Reece, James S.
Functional Area(s):
   Financial Accounting
Setting(s):
   For Profit
Difficulty Level: Beginner
Pages: 2
Teaching Note: Not Available. 
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First Page and the Assignment Questions:

Lutz Realty Company was incorporated on July 1, for the purpose of buying eight houses in a bankrupt housing development and then selling them. Two persons were involved in the company. Helen Lutz was to be responsible for the day-to-day affairs of the company and for selling the houses. Paul Wagner invested $180,000 in cash in return for all the common stock in the company.

The understanding between the two was that Ms. Lutz would receive a sales commission of 25 percent of the gross margin on the houses and a bonus at the end of the year. Mr. Wagner would be entitled to a $4,200 cash dividend for the first six months, plus one half the income (before income taxes) of the company, after deducting the $4,200. Ms. Lutz would receive shares of stock equal in value to the remainder of the pretax income (after the $4,200 and the additional payments to Mr. Wagner).

This arrangement would be continued in succeeding years, except that each stockholder would be entitled to a cash dividend of 5 percent of his or her equity, and the remainder of the income would be divided equally. In this way, Ms. Lutz would build up a stock ownership without having to invest cash.

The housing development consisted of 25 houses, of which 17 had been sold before the project went bankrupt. The bank that had taken over the property sold the eight houses to Lutz Realty Company for $915,000 on July 1. Lutz Realty paid $120,000 cash and took out a five-year 12 percent loan for $795,000 with the bank; this loan was secured by the inventory of unsold homes that Lutz Realty might have at any point in the next five years. Semi-annual payments of $79,500 plus interest were to be made on December 31 and June 30.

By the end of December (6 months later), five of the houses had been sold for a total of $661,000; they had cost $571,750. Also, during the year the company had incurred costs of $5,895 for incorporation fees and miscellaneous expenses, about which there were no questions. Questions arose, however, with regard to certain other events that affected the calculation of income. These events are listed below.

  1. Because few vacant houses remained, because the neighborhood had acquired a good reputation, and because economic conditions in the area had improved, Ms. Lutz judged that the value of the unsold houses had increased by at least 5 percent since July 1. She increased the asking prices accordingly. She recommended that 90 percent of this increase be added to the inventory cost of the houses (the other 10 percent, or 0.5 percent of the original cost, would be recorded as profit when the houses were sold). Mr. Wagner agreed that the value of the houses had increased 5 percent. . . .

Assignment

  1. What should Ms. Lutz’s commission be for the period July 1 to December 31?
  2. Prepare an income statement for the six months ended December 31, and a balance sheet as of that date. Be certain that your income statement differentiates between gross margin and income. (Ignore income taxes.) For the balance sheet, assume that the company has no office space or equipment; Ms. Lutz runs the business “from her home, phone, and automobile.” She has been paid her commission on the five sold houses.